Photography courtesy of Hector Emanuel © 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, 2008, 2007, 2006 by CFA Institute All rights reserved This copyright covers material written expressly for this volume by the editor/s as well as the compilation itself It does not cover the individual selections herein that first appeared elsewhere Permission to reprint these has been obtained by CFA Institute for this edition only Further reproductions by any means, electronic or mechanical, including photocopying and recording, or by any information storage or retrieval systems, must be arranged with the individual copyright holders noted CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute To view a list of CFA Institute trademarks and the Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional should be sought All trademarks, service marks, registered trademarks, and registered service marks are the property of their respective owners and are used herein for identification purposes only ISBN 9781119396642 (ebk) ETHICAL AND PROFESSIONAL STANDARDS AND QUANTITATIVE METHODS CFA® PROGRAM CURRICULUM 2018 • Level I • Volume TABLE OF CONTENTS Cover Copyright Page 2018 CFA Program Level I Volume Ethical and Professional Standards and Quantitative Methods Title Page Table of Contents How to Use the CFA Program Curriculum Curriculum Development Process Organization of the Curriculum Features of the Curriculum Required vs Optional Segments [OPTIONAL] End-of-Reading Problems/Solutions Glossary and Index LOS Self-Check Source Material Designing Your Personal Study Program Create a Schedule CFA Institute Topic Tests CFA Institute Mock Exams Preparatory Providers Feedback Ethical and Professional Standards Study Session Topic Level Learning Outcome Study Session Ethical and Professional Standards Reading Assignments Reading Ethics and Trust in the Investment Profession Learning Outcomes Introduction Ethics Ethics and Professionalism Challenges to Ethical Conduct The Importance of Ethical Conduct in the Investment Industry Ethical vs Legal Standards Ethical Decision-Making Frameworks 7.1 Applying the Framework Conclusion Summary Practice Problems Solutions Reading Code of Ethics and Standards of Professional Conduct Learning Outcomes Preface Evolution of the CFA Institute Code of Ethics and Standards of Professional Conduct Standards of Practice Handbook Summary of Changes in the Eleventh Edition Inclusion of Updated CFA Institute Mission Updated Code of Ethics Principle New Standard Regarding Responsibilities of Supervisors [IV(C)] Additional Requirement under the Standard for Communication with Clients and Prospective Clients [V(B)] Modification to Standard VII(A) General Guidance and Example Revision CFA Institute Professional Conduct Program Adoption of the Code and Standards Acknowledgments Ethics and the Investment Industry Why Ethics Matters Ethics, Society, and the Capital Markets Capital Market Sustainability and the Actions of One The Relationship between Ethics and Regulations Applying an Ethical Framework Commitment to Ethics by Firms Ethical Commitment of CFA Institute CFA Institute Code of Ethics and Standards of Professional Conduct Preamble The Code of Ethics Standards of Professional Conduct Reading Guidance for Standards I–VII Learning Outcomes Standard I: Professionalism Standard I(A) Knowledge of the Law Guidance Relationship between the Code and Standards and Applicable Law Participation in or Association with Violations by Others Investment Products and Applicable Laws Recommended Procedures for Compliance Members and Candidates Distribution Area Laws Legal Counsel Dissociation Firms Application of the Standard Example (Notification of Known Violations): Example (Dissociating from a Violation): Example (Dissociating from a Violation): Example (Following the Highest Requirements): Example (Following the Highest Requirements): Example (Laws and Regulations Based on Religious Tenets): Example (Reporting Potential Unethical Actions): Example (Failure to Maintain Knowledge of the Law): Standard I(B) Independence and Objectivity Guidance Buy-Side Clients Fund Manager and Custodial Relationships Investment Banking Relationships Performance Measurement and Attribution Public Companies Credit Rating Agency Opinions Influence during the Manager Selection/Procurement Process Issuer-Paid Research Travel Funding Recommended Procedures for Compliance Application of the Standard Example (Travel Expenses): Example (Research Independence): Example (Research Independence and Intrafirm Pressure): Example (Research Independence and Issuer Relationship Pressure): Example (Research Independence and Sales Pressure): Example (Research Independence and Prior Coverage): Example (Gifts and Entertainment from Related Party): Example (Gifts and Entertainment from Client): Example (Travel Expenses from External Manager): Example 10 (Research Independence and Compensation Arrangements): Example 11 (Recommendation Objectivity and Service Fees): Example 12 (Recommendation Objectivity): Example 13 (Influencing Manager Selection Decisions): Example 14 (Influencing Manager Selection Decisions): Example 15 (Fund Manager Relationships): Example 16 (Intrafirm Pressure): Standard I(C) Misrepresentation Guidance Impact on Investment Practice Performance Reporting Social Media Omissions Plagiarism Work Completed for Employer Recommended Procedures for Compliance Factual Presentations Qualification Summary Verify Outside Information Maintain Webpages Plagiarism Policy Application of the Standard Example (Disclosure of Issuer-Paid Research): Example (Correction of Unintentional Errors): Example (Noncorrection of Known Errors): Example (Plagiarism): Example (Misrepresentation of Information): Example (Potential Information Misrepresentation): Example (Plagiarism): Example (Plagiarism): Example (Plagiarism): Example 10 (Plagiarism): Example 11 (Misrepresentation of Information): Example 12 (Misrepresentation of Information): Example 13 (Avoiding a Misrepresentation): Example 14 (Misrepresenting Composite Construction): Example 15 (Presenting Out-of-Date Information): Example 16 (Overemphasis of Firm Results): Standard I(D) Misconduct Guidance Recommended Procedures for Compliance Application of the Standard Example (Professionalism and Competence): Example (Fraud and Deceit): Example (Fraud and Deceit): Example (Personal Actions and Integrity): Example (Professional Misconduct): Standard II: Integrity of Capital Markets Standard II(A) Material Nonpublic Information Guidance What Is “Material” Information? What Constitutes “Nonpublic” Information? Mosaic Theory Social Media Using Industry Experts Investment Research Reports Recommended Procedures for Compliance Achieve Public Dissemination Adopt Compliance Procedures Adopt Disclosure Procedures Issue Press Releases Firewall Elements Appropriate Interdepartmental Communications Physical Separation of Departments Prevention of Personnel Overlap A Reporting System Personal Trading Limitations Record Maintenance Proprietary Trading Procedures Communication to All Employees Application of the Standard Example (Acting on Nonpublic Information): Example (Controlling Nonpublic Information): Example (Selective Disclosure of Material Information): Example (Determining Materiality): Example (Applying the Mosaic Theory): Example (Applying the Mosaic Theory): Example (Analyst Recommendations as Material Nonpublic Information): Example (Acting on Nonpublic Information): Example (Mosaic Theory): Example 10 (Materiality Determination): Example 11 (Using an Expert Network): Example 12 (Using an Expert Network): Standard II(B) Market Manipulation Guidance Information-Based Manipulation Transaction-Based Manipulation Application of the Standard Example (Independent Analysis and Company Promotion): Example (Personal Trading Practices and Price): Example (Creating Artificial Price Volatility): Example (Personal Trading and Volume): Example (“Pump-Priming” Strategy): Example (Creating Artificial Price Volatility): Example (Pump and Dump Strategy): Example (Manipulating Model Inputs): Example (Information Manipulation): Standard III: Duties to Clients Standard III(A) Loyalty, Prudence, and Care Guidance Understanding the Application of Loyalty, Prudence, and Care Identifying the Actual Investment Client Developing the Client’s Portfolio Soft Commission Policies Proxy Voting Policies Recommended Procedures for Compliance Regular Account Information Client Approval Firm Policies Application of the Standard Example (Identifying the Client—Plan Participants): Example (Client Commission Practices): Example (Brokerage Arrangements): Example (Brokerage Arrangements): Example (Client Commission Practices): Example (Excessive Trading): Example (Managing Family Accounts): Example (Identifying the Client): Example (Identifying the Client): Example 10 (Client Loyalty): Example 11 (Execution-Only Responsibilities): Standard III(B) Fair Dealing Guidance Investment Recommendations Investment Action Recommended Procedures for Compliance Develop Firm Policies Disclose Trade Allocation Procedures Establish Systematic Account Review Disclose Levels of Service Application of the Standard Example (Selective Disclosure): Example (Fair Dealing between Funds): Example (Fair Dealing and IPO Distribution): Example (Fair Dealing and Transaction Allocation): Example (Selective Disclosure): Example (Additional Services for Select Clients): Example (Minimum Lot Allocations): Example (Excessive Trading): Example (Limited Social Media Disclosures): Example 10 (Fair Dealing between Clients): Standard III(C) Suitability Guidance Developing an Investment Policy Understanding the Client’s Risk Profile Updating an Investment Policy The Need for Diversification Addressing Unsolicited Trading Requests Managing to an Index or Mandate Recommended Procedures for Compliance Investment Policy Statement Regular Updates Suitability Test Policies Application of the Standard Example (Investment Suitability—Risk Profile): Example (Investment Suitability—Entire Portfolio): Example (IPS Updating): Example (Following an Investment Mandate): Example (IPS Requirements and Limitations): Example (Submanager and IPS Reviews): Example (Investment Suitability—Risk Profile): Example (Investment Suitability): Standard III(D) Performance Presentation Guidance Recommended Procedures for Compliance Apply the GIPS Standards Compliance without Applying GIPS Standards Application of the Standard Example (Performance Calculation and Length of Time): Example (Performance Calculation and Asset Weighting): Example (Performance Presentation and Prior ... Participants in CFA Institute Programs Guidance Confidential Program Information Additional CFA Program Restrictions Expressing an Opinion Application of the Standard Example (Sharing Exam Questions):... Valuation Recommendations [OPTIONAL] Additional Private Equity Valuation Recommendations [OPTIONAL] III GIPS Advertising Guidelines [OPTIONAL] Purpose of the GIPS Advertising Guidelines [OPTIONAL]... by CFA Institute To view a list of CFA Institute trademarks and the Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org This publication is designed to provide