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Reading Guidance for Standards I–VII FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 2: Guidance for Standards I–VII Question ID: 10529 Correct Answer: A Standard II (A) Material Nonpublic Information prohibits members/candidates who possess material nonpublic information, which could affect the value of the security, from act or causing others to act/trade on the information Information is considered to be nonpublic until it has been publically made available in the marketplace This standard does not prohibit members/candidates to use items of non-material or material and public information to form an opinion regarding a potential corporate action This holds true even if the member/candidate’s analysis leads him/her to producing conclusions which comprise of material nonpublic information This is termed as the mosaic theory By using his observations of Y.T Automobiles’ production site to produce his conclusion, Webber has not violated this standard (with the information obtained from the observations constituting items of material, public information as well as non-material non-public information) This holds true despite the fact that Webber used the information to conclude that the manufacturer could be at risk of being acquired in a takeover or could file for bankruptcy (which itself can be considered material nonpublic information that investors would like to know) Furthermore the discussions with industry experts and representatives from different manufactures as well as the industry information used as part of the analysis not violate this standard In short, Webber has used mosaic theory to arrive at his conclusion and has thus not violated this standard Standard V (A) Diligence and Reasonable Basis requires members and candidates to exercise thoroughness, independence, and diligence when conducting investment analysis, making investment recommendations and taking investment action Additionally the standards require members to have a reasonable and adequate basis supported by an appropriate level of research and thorough investigation Webber’s conclusion is backed by thorough research and investigation and is thus in compliance with this standard Question ID: 10530 Correct Answer: C Standard II (B) Market Manipulation prohibits members and candidates from “engaging in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.” Transactions that artificially distort prices or volume to give the impression of activity or price movement in a financial instrument reflect violations By transferring stocks, possessing a low level of liquidity, from the distressed fund to the developed equity fund, Bridges has violated this standard This is because he has transferred stocks to the latter fund to artificially increase the demand for these stocks Although this action has been done to improve the value of stocks which may benefit potential investors, such an activity deceives potential investors into believing the stocks they are buying are highly liquid and attractively priced Standard III (C) Suitability requires members and candidates, in advisory roles, to make a reasonable inquiry into the client’s investment experience, risk and return objectives, and financial constraints and must reassess and update this information regularly The standard also requires recommending investments and taking investment actions which are consistent with the client’s financial constraints, FinQuiz.com © 2018 - All rights reserved Guidance for Standards I–VII Reading FinQuiz.com risk and return objectives, constraints, and written mandates Additionally members/candidates must judge the suitability of the investment in the context of the client’s total portfolio The process of transferring securities from the former to the latter fund does not violate this standard as these stocks are not owned by any clients nor recommended at the time of the transfer Question ID: 10531 Correct Answer: A Webber has described distressed securities as possessing a low level of liquidity In addition such stocks of distressed companies are generally highly risky and require a long-term investment horizon These securities are suitable for those investors with high risk tolerances; sufficient liquidity reserves/low liquidity requirements; and an intermediate to long-term investment horizon making them capable of tolerating the associated risks Based on standard III (C) Suitability’s requirements, recommending these stocks to client categories A, B and E violate this standard This is because: client category A has a short-term time horizon, significant liquidity requirements, and a low risk tolerance level; client category B has significant liquidity requirements; client category E has a below average risk tolerance; making such an investment highly unsuitable for all three categories Additionally by sending out the recommendation to existing clients only as opposed to suitable prospective clients and existing clients, standard III (B) Fair Dealing has been violated This standard requires members and candidates to deal fairly with clients when disseminating investment recommendations and in their professional activities Question ID: 10532 Correct Answer: C All the three client categories to receive the recommendation should not have received such an investment recommendation (see the solution to Part 3(10531)) Question ID: 10533 Correct Answer: B Standard III (D) Performance Presentation requires members and candidates to make every reasonable effort to ensure that the performance they present is fair, accurate, and complete Members and candidates should not mislead clients by misrepresenting their past performance or reasonably expected future performance By presenting the performance attained by Emerson at Denver Associates as being attained at Holler and Brookes Associates, the advertisement has violated this standard Standard V (C) Record Retention requires members and candidate to “develop and maintain appropriate records to support their investment analysis, recommendations actions and other investment related communications with clients and prospects.” This standard is not relevant in the context of the advertisement FinQuiz.com © 2018 - All rights reserved Guidance for Standards I–VII Reading FinQuiz.com Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program requires members and candidates to avoid misrepresenting or exaggerating the “meaning or implications of membership in CFA institute, holding the CFA designation or candidacy in the CFA Program.” Additionally, there is no such thing as a partial designation Forecasting that Emerson will successfully complete and pass the Level III examinations violates this standard Additionally indicating that Emerson will achieve the completion status following the upcoming June examinations violates this standard as there is no such designation Question ID: 10534 Correct Answer: B The code of ethics requires members and candidates to: Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets Place the integrity of the investment profession and the interests of clients above their own personal interests Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession Promote the integrity of and uphold the rules governing capital markets Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals The requirement that members and candidates/investment professionals must exercise diligence, independence, thoroughness and independence when analyzing investments, making recommendations or taking investment actions is covered by the CFA Institute’s Standards of Professional Conduct [Standard V (A) Diligence and Reasonable Basis] Question ID: 10543 Correct Answer: B When managing accounts to a specific mandate, strategy or investment style, the CFA Institute Standards of Professional Conduct require members and candidates to, “make investment recommendations or take investment actions that are consistent with the stated objectives and constraints of the portfolio.’ Based on the investment policy of Grace Incorporated’s pension plan, Peltier will need to assure he does not make allocations to growth stocks, and chooses securities which bring industry diversification (belongs to industries distinct from Grace Incorporated) and are securities of stable companies Based on the data provided, Peltier should ignore stock B altogether as it belongs to the same industry as the surgical manufacturer Peltier cannot choose stock A as its high P/E and P/B ratio (11.2 and 13.4, respectively) indicate it is a growth stock Similarly the high projected EPS growth further confirm that it is a growth stock Thus Peltier should not consider stock B for inclusion to the plan’s investment account FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com Peltier may select stock C for inclusion into the plan’s investment account The low P/E ratio and high P/B ratios (3.8 and 13.6, respectively) indicate the stock is a balanced stock Additionally, stock C belongs to the automobile manufacturing industry which indicates it will bring industry diversification to the plan’s account By allocating stock C to the investment account, Peltier does not violate the standards Thus by selecting stock B for the plan’s investment account, Peltier has violated standard III(C) Suitability as he has not followed the plan’s mandate pertaining to industry diversification Question ID: 10544 Correct Answer: A Standard III (B) Fair Dealing requires members and candidates “to deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.” By allocating 80% of the purchased shares to suitable client accounts, Lawson has not violated this standard However by not allocating the 20% portion to interested clients and holding them back for an eight-month period, Lawson has violated this standard as she has denied the interest clients of these oversubscribed corporation shares Standard III (C) Suitability requires members and candidates to make a reasonable inquiry into the client’s circumstances, risk and return objectives and financial constraints prior to making any investment recommendation or taking investment action, determining whether the investment is suitable to the client’s financial situation and consistent with the client’s written objectives, and judging the suitability of investments in the context of the client’s total portfolio There is nothing in the case which indicates Lawson has violated the standard There is nothing to indicate that standard III (A) Loyalty, Prudence and Care has been violated Additionally standard VI (B) Priority of Transactions requires members and candidates to place investment transactions of clients and employers ahead of transactions in which a member and candidate is the beneficial owner By depositing 20% of the oversubscribed corporation’s shares in her account for a period of eight months, instead of the investment accounts of interest clients, Lawson is benefitting from any potential increase in the stock’s value Question ID: 10545 Correct Answer: C Should Lawson accept the round trip cruise offer, Lawson will be violating standard I (B) Independence and Objectivity which requires members and candidates not to “accept any gift, benefit, compensation or consideration that reasonably could be expected to compromise their independence and objectivity.” The condition (to allocate 40% of the shares to Schmidt’s account in exchange for a reward) attached the cruise trip will itself impair Lawson’s independence and objectivity since, after accepting the offer, she will favor Schmidt and allocate a portion of the corporation’s shares to his account only rather to the accounts of other individuals who have expressed an interest in the shares The allocation of the 40% shares solely to Schmidt’s account additionally suggests that Lawson has violated the standard, III (B) Fair Dealing Schmidt should have allocated the shares proportionally to those accounts expressing an interest, for which the investment is suitable, as well as distribute amongst suitable accounts on a pro-rata basis Standard IV (B) Additional Compensation Arrangements requires members and candidates not to accept any gifts, benefits, compensation or consideration that competes with, or might reasonably be FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved Unless Lawson does not obtain consent for the trip, she will violate this standard She has informed her employer, MIA, of the offer and thus does not violate this standard 10 Question ID: 10546 Correct Answer: A Standard II (A) Material Nonpublic information prohibits members and candidates from trading on material non-public information or causing others to trade on such information A problem with the source code of a software development corporation’s major product line is a piece of material information However it is not necessary that the problem may lead to the discontinuation of the corporation’s major product line and result in a drop in forecasted product revenues The two retirees are merely speculating and sharing this information with others (either with his friend or fellow portfolio manager) does not result in Brewer violating this standard 11 Question ID: 10547 Correct Answer: C Standard III (C) Suitability requires members and candidates to make investment recommendations and take investment actions which are consistent with the client’s investment account and risk and return objectives as well as constraints However members and candidates can only make suitable investment recommendations or take investment actions provided clients are forthcoming in providing the relevant information to their portfolio managers The chief investment officer's claims are not valid This is because the officer has not prohibited the portfolio manager from avoiding emerging market stocks Additionally, the chosen stocks meet the socially responsible criteria Thus by including such stocks, Brewer has not violated this standard Additionally, Brewer has not violated III (B) Fair Dealing 12 Question ID: 10548 Correct Answer: C Standard IV (C) Responsibility of Supervisors requires members and candidates to prevent and detect any violations of the codes and standards, laws, rules and/or regulations by anyone subject to their supervision or authority As the portfolio manager of The Senior Citizen Endowment’s portfolio, Brewer has not violated any standards (See the solution to Part 5) Thus there are no violations which Peltier need to prevent and/or detect Thus as supervisor he has not violated this standard Standard III (C) Suitability is not relevant in this context FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com 13 Question ID: 10557 Correct Answer: C Standard II (A) Material Nonpublic Information prohibits members and candidates, “who possess material nonpublic information that could affect the value of the security, from taking action on it or causing others to take action on the information.” Although the information on the G&J’s expansion plans may be material and nonpublic, the discussion between Sutton and Mullins does not violate this standard as no effort was made to act or cause someone to act on the information Standard III (E) Preservation of Confidentiality requires members and candidates to keep information about current, former, and/or prospective clients confidential unless the client permits disclosure; disclosure is required by law; or the information concerns illegal activities on part of the client As the investment banker of G&J, Sutton has the obligation to preserve the confidentiality of any information received on his client’s expansion plans, which he has exclusively received Thus by sharing these plans with Mullins, he has violated this standard Standard IV (C) Responsibility of Supervisors requires members and candidates to make reasonable efforts to prevent and detect any violations of any applicable laws, codes and standards, rules and regulations by anyone subject to their supervision or authority This responsibility includes implementing adequate compliance procedures, making reasonable efforts to ensure these procedures are monitored and enforced By implementing a structure to control the interaction between the two departments (investment banking and investment counseling/management departments) and not monitoring the effectiveness of the structure nor ensuring the flow of information between the departments is limited, Herrera as a senior compliance officer has violated this standard 14 Question ID: 10558 Correct Answer: A Standard I (B) Independence and Objectivity requires members and candidates to use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities Any recommendations should be independently arrived at If investment recommendations are made following instructions, which conflict with the member/candidate’s recommendations, the member or candidate is in violation of this standard The best action for Mullins to undertake would be to develop a research report and conclude it with a recommendation solely based on his analysis of G&J’s future prospects Since Mullins believes G&J’s expansion plans may not succeed, he will probably produce a different recommendation to the buy recommendation instructed by Herrera 15 Question ID: 10559 Correct Answer: B Standard III (A) Loyalty, Prudence and Care requires members and candidates to act for the benefit of their clients and place client interests first The standard also requires members and candidates to maintain their duty of loyalty to their clients, act with reasonable care, and exercise prudent judgment In the course of their duty to their clients members and candidates should seek best price and execution Although Mace Brokerage charges fees higher than the existing broker, the access to global and local research as well as higher execution speed (relative to the current broker) justify the fees Thus by appointing Mace Brokerage, Delgado will not be violating this standard but instead will be providing Mighty-You Inc with greater benefits (i.e execution) FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com Although Harold and Haroon Associates charges fees lower than the existing broker the execution speeds are relatively slower Additionally the firm provides access to local research only Thus the relatively slow execution speed makes this broker unsuitable for Mighty-You Inc Thus the appointment of this broker-candidate will violate the standard in question as Delgado will not be providing its client with best execution 16 Question ID: 10560 Correct Answer: B Standard III (C) Suitability requires members and candidates, in an advisory relationship, to make investment recommendations which are suitable to the individual client’s financial situation, risk and return objectives, and written investment mandates Additionally, members and candidates must judge the suitability of the investment in the context of the total client portfolio There is a lack of sufficient evidence which may suggest that the firm may have conducted a suitability analysis prior to implementing the derivative strategy on a portion of the client portfolios It is possible that such a strategy may not be suitable for or may be expressly prohibited by some clients Thus by implementing a derivative strategy, the firm has violated this standard Standard V (A) Diligence and Reasonable Basis requires members and candidates to “have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation or action.” The volatility of the national market, which in turn has substantially increased the risk of several securities in client portfolios, justifies the use of derivative to offset these risks Thus this standard has not been violated Under Standard V (B) Communication with Clients and Prospective Clients, member and candidates must disclose to clients the basic format and general principles used to analyze investments, select securities and construct portfolios and promptly disclose any material changes to the processes By delaying the notification to clients (regarding the inclusion of derivatives in their portfolios) for a period of one month, this standard has been violated 17 Question ID: 10561 Correct Answer: A Policy 1: Standard II (A) Material Nonpublic Information requires members and candidates to establish a firewall between the investment banking and investment research divisions to prevent the flow of material nonpublic information Interdepartmental communication must preferably pass through a clearance area within the firm in either the compliance or legal department Allowing unsupervised communication between the two departments (investment banking and counseling, in the firm’s case) makes Policy inconsistent with this CFA Institute Standards of Professional Conduct standard Policy 2: Standard III (A) Loyalty, Prudence and Care requires members and candidates to vote proxies in the best interests of clients and their ultimate beneficiaries as well as to vote proxies in an informed and responsible manner A fiduciary who votes blindly with management on non-routine governance issues violates this standard Due to cost and benefits, it is not necessary to vote all proxies Policy is not consistent with this standard as it does not call for voting in the best interests of clients and ultimate beneficiaries This is because the policy calls for taking into account any benefits to the firm, in addition to clients’ benefits, and ignores the benefits to beneficiaries (accruing to them as a result of the votes cast) In addition, the policy requires votes to be cast in line the firm’s management FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com which hampers the member/candidate’s ability to cast his or her vote in the best interests of its clients and ultimate beneficiaries Policy 3: Under Standard V (C) Record Retention members and candidates are required to develop and maintain appropriate records to support their investment analysis, recommendation, actions and other investment related communications with clients and prospective clients In the absence of any regulatory requirements, the CFA Institute recommends a holding period of at least seven years By complying with local record retention regulations, policy is consistent with this standard 18 Question ID: 10562 Correct Answer: A By allocating highly risky securities to the investment portfolios of his risk-averse clients (which require less risky securities), Strickland has clearly violated the standard, III (C) Suitability Additionally, Strickland’s statement does not justify the addition of these securities to the portfolios The expected decrease in market and securities’ volatility is merely a prediction which may not materialize after the quoted six-month period Thus by basing the purchase decision on a mere prediction of a market factor, Strickland has violated the standard V (A) Diligence and Reasonable Basis There is nothing which may suggest Strickland has been dishonest or engaged in fraudulent practices adversely affected his professional reputation, integrity or competence Thus Strickland has not violated standard I (D) Misconduct Strickland has not violated Standard I (C) Misrepresentation nor has he violated standard III (A) Loyalty, Prudence and Care The justification statement does not guarantee the volatility will fall from its current levels, but instead uses the term ‘projected’ which implies Strickland has not guaranteed any expected performance and thus has not violated standard III (D) Performance Presentation 19 Question ID: 10571 Correct Answer: A Standard VI (A) Disclosure of Conflicts requires members and candidates “to make full and fair disclosures of all matters that could reasonably be expected to impair their independence and objectivity or interfere with their respective duties to their clients, prospective clients, and their employer.” The disclosures need to be prominent, delivered in plain language and communicated effectively Ideally, to avoid the appearance of any conflicts, Howell should not be asked to cover a company with which he may be affiliated Howell’s family relationship with H.O Zone’s executive director must be disclosed in his research report as well as to his employer, Trinity Associates Without taking any steps to minimize this potential conflict and failing to make the relevant disclosures to clients, prospective client and to his employer, Howell has violated this standard Standard II (A) Material Nonpublic Information requires members and candidates who possess material nonpublic information, which has the potential to affect the value of a security, from acting or causing others to act on the information There is lack of evidence to suggest that Howell may have not independently arrived at a buy recommendation or used insider information to arrive at the recommendation A mere speculation by Thackeray does not necessarily mean Howell has used FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com insider information Additionally by using the recommendation, Thackeray has not violated this standard (due to the uncertainty of the information being acquired from insider resources or not) Standard V (A) Diligence and Reasonable Basis requires members and candidates to “have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation or action.” Additionally when using secondary research it is necessary to make reasonable and diligent efforts in evaluating the objectivity and independence of the recommendations; reviewing the assumptions used, the rigor of analysis performed, and the date/timeliness of the research The question of whether Howell may have arrived at his buy recommendation using insider sources remains Without thoroughly evaluating the independence and/or objectivity of the recommendations and relying on the recommendation Thackeray has violated this standard 20 Question ID: 10572 Correct Answer: A Standard I (C) Misrepresentation prohibits members and candidates from knowingly making any misrepresentations relating to investment analysis, recommendations, actions or other professional activities in oral or written communications The standard requires members and candidates to identify or acknowledge the source of ideas or material that is not their own Additionally it is necessary to cite all sources which are used to develop research reports and work products (other than those obtained from recognized statistical and financial reporting sources) Although Byrd’s model has been considerably modified from the model developed by the pharmaceutical chief industry executive, Byrd should acknowledge the fact that his model’s structure was inspired by the latter model and continues to use the same factors as those employed by the latter model By not doing so and marketing the model as his own, he has violated the standard According to this standard, Byrd must cite the annual industry forecasts obtained from discussions with industry experts but not the industry reports published by the local government agency in his research report 21 Question ID: 10573 Correct Answer: B Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program requires members and candidates to avoid misrepresenting or exaggerating the “meaning or implications of membership in CFA institute, holding the CFA designation or candidacy in the CFA Program.” Additionally, there is no such thing as a partial designation The newsletter has accurately referred to Terry and Sosa as CFA Level III candidates However by stating that Terry will attain a ‘Passed Finalist’ status, the newsletter has incorrectly referenced Terry’s candidacy in the CFA Program and this reflects a violation of this standard This is because there is no such status 22 Question ID: 10574 Correct Answer: C Standard I (D) Misconduct prohibits members and candidates from engaging in any professional conduct involving fraud, deceit, dishonesty or committing any act that reflects adversely on their professional reputation, integrity or competence By assuring McFadden that the financial FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com consultancy department will provide the required tax consultancy services when the firm outsources such services, Terry has been dishonest with her client and has violated this standard Standard II (B) Market Manipulation prohibits members and candidates from engaging in practices that distort the prices or artificially inflate trading volume with the intent to mislead market participants However the standard does not prohibit transactions done for tax purposes Thus the taxloss harvesting strategy recommended by Terry (selling securities which have fallen in value to offset the gains on securities which have risen in value) does not violate this standard Standard III (A) Loyalty, Prudence and Care requires members and candidates to act in the best interests of clients, place client interest before their own, use reasonable care, and exercise prudent judgment when managing the accounts of their clients As McFadden’s financial consultant, Terry has acted in his client’s best interests Thus she has not violated this standard Standard I (C) Misrepresentation requires members and candidates to have knowledge of all the services the firm provides and should recommend where a client can obtain the requisite service should the firm not be able to provide it By assuring her client that the firm is able to address her taxation concerns and is able to provide the necessary consultancy services, Terry has violated his standard This is because the firm outsources tax consultancy rather than providing it internally Additionally, Terry has misrepresented the tax-loss harvesting strategy by incorrectly stating that it will help to reduce the portfolio’s taxable base in both the current and future years In reality, tax-loss harvesting reduces the portfolio’s taxable basis in the current year to increase it in the future 23 Question ID: 10575 Correct Answer: C Practice 1: Standard IV (A) Loyalty requires members and candidates, in matters related to their employment, to act in their employer’s best interest and not deprive them of the advantage of their skills and abilities or cause any harm to their employers Members/candidates must continue to work in their employer’s best interest until resignation is effective A buyout of the firm’s financial consultancy department by the firm managers does not constitute a violation of this standard This is because the firm may choose how to respond to such an action Thus practice does not reflect a violation of this standard Based on standard VI (A) Disclosure of Conflict’s requirements (see the solution to Part 1), a meeting between some of the firm’s managers after office hours does not constitute a violation of this standard Thus practice does not reflect any violations of the CFA Institute Standards of Professional Conduct Practice 2: The portfolio managers have complied with standard III (A) Loyalty, Prudence and Care by using the brokerage arrangement to obtain high quality research to directly assist the managers in managing the client portfolio Standard IV (B) Additional Compensation Arrangements prohibits member and candidates from accepting any gift, benefits, compensation or consideration “that competes with or might create a conflict of interest with their employer’s interest unless they obtain a written consent from all the FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com parties involved.” The portfolio managers have not received any additional compensation which would require disclosure under this standard Thus this standard has not been violated Standard VI (C) Referral Fees requires members and candidates to disclose to their employers, current clients, and prospective clients “any compensation, consideration, or benefit received from, or paid to, others for the recommendation of products or services.” The firm’s portfolio managers have referred their clients to their respective broker and have received research in return This arrangement must be disclosed to their existing clients and/or any prospects who wish to employ any of these portfolio managers to manage his/her investment portfolio By not disclosing the arrangements to their clients, the portfolio managers have violated this standard 24 Question ID: 10576 Correct Answer: A With respect to practice 3, Byrd has violated standard I (C) Misrepresentation This is because Byrd should have known about the error in his resume as he has been quoting his experience for several years By quoting his experience incorrectly, Byrd has misrepresented his experience with the two industries and has thus violated this standard By incorrectly stated his years of experience, Byrd has not violated standard III (D) Performance Presentation, which requires members and candidates to make reasonable efforts to ensure that the performance they present is fair, complete, and accurate Since the error pertains to his industry experience as opposed to performance information, Byrd has not violated this standard Standard V (C) Record Retention is not relevant in this context and there is a lack of sufficient evidence to conclude that Byrd has not retained records used to develop research reports and make recommendations 25 Question ID: 10585 Correct Answer: B Standard I (A) Knowledge of the Law requires members and candidates to understand and comply with all applicable laws, rules and regulations of any government, regulatory organization, licensing agency, or professional association governing their professional activities In the event of any conflict, members and candidates must comply with the stricter of the two: applicable laws or code and standards Standard I (D) Misconduct requires members and candidates to avoid any professional misconduct that may reflect adversely on their professional reputation, integrity, or competence and encourages employers to conduct reference checks on potential employees for any past infractions of laws The law which is applicable to Riku Associates is the local Shimautanian law as opposed to the Japanese law applicable to its parent organization Because employees with past infractions of securities and/or trading laws of two or more counts are likely to violate such laws again, it is advisable to avoid hiring such employees Thus the requirements of the Institutes’ codes and standards govern [I (D) Misconduct] Riku Associates must preferably hire employees with a clean past record FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com 26 Question ID: 10586 Correct Answer: A Standard IV (C) Responsibility of Supervisors requires members/candidates to make every reasonable effort to prevent and detect violations of the laws, rules, regulations, and/or codes and standards by anyone subject to their supervision or authority It is permissible to delegate such responsibility but such delegation does not absolve the member/candidate of his/her responsibilities By instructing Sayuki to review Smith’s portfolio after every 18 months, Sayuki has not complied with this standard as his instructions violate the requirements of III C Suitability (see below) This is because client portfolios need to be reviewed at least annually and whenever there is a change in client and/or market conditions Any reason given to support this review schedule does not justify such a policy Standard III (C) Suitability requires members and candidates, who are in an advisory role, to make a reasonable inquiry into the client’s investment experience, risk and return objectives, investment constraints and must reassess and update this information regularly Client portfolios must be reviewed at least annually and whenever a change in client circumstances and/or market circumstances occurs By instructing Lowery to conduct reviews for a period longer than the minimum 12-month required, for whatever reason, Sayuki has violated this standard Additionally, Lowery has also violated this standard as he has conducted the reviews as instructed Standard III (A) Loyalty, Prudence and Care does not address client portfolio reviews has not been violated 27 Question ID: 10587 Correct Answer: C Standard III (A) Loyalty, Prudence and Care requires members and candidates to act in their client’s best interests, to exercise prudent judgment, and use reasonable care The client’s interests should always have priority over the firm’s and portfolio manager’s interests By recommending the sale of a stock which is harming the client’s portfolio, Lowery has complied with this standard Standard III (E) Preservation of Confidentiality requires members and candidates to keep all information concerning former, current, and prospective clients confidential unless the client permits disclosure; the disclosure is required by law; or the information pertains to illegal activities on the part of clients By sharing information regarding Smith’s portfolio holdings with his family friend, Lowery has violated this confidentiality standard 28 Question ID: 10588 Correct Answer: A Standard II (A) Material Nonpublic Information prohibits members and candidates who possess material nonpublic information, that could affect they value of a security, from acting or causing other to take action on the information The fact that such information has not yet been disclosed and pertains to the discontinuation of a product line provides sufficient evidence that this piece of information is material and nonpublic Although Conway may discuss this piece of information with his supervisor, Sayuki, his first course of action should have been to make reasonable efforts to achieve public dissemination of the information by encouraging Furniture Ltd to make the information public If Furniture Ltd had refused to release the information, his next course of action should have been to disclose the information to his supervisor or compliance department FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com However Conway has not made any such efforts and thus has violated this standard Standard III (E) Preservation of Confidentiality is not relevant here as the standard covers confidential client information received by portfolio managers as opposed to the information received by research analysts on the companies they cover 29 Question ID: 10589 Correct Answer: C Standard IV (A) Loyalty requires members and candidates, in matters related to their employment, to act for the benefit of their employer, and not deprive their employer of the advantage of their skills and abilities, or otherwise cause harm to their employer Members and candidates must not take any actions such as appropriating property for themselves, client lists, or any information or material from their employer without their permission Members/candidates must continue to act in their employer’s interest until resignation is effective In Fukui’s case, participating in an online interview does not violate this standard as she is not disrupting her duties to the firm as an employee Additionally, since Fukui has not undertaken the potential job opportunity at Howell S Erwin Associates, there is no need to disclose the opportunity to her employer Thus Fukui has not violated this standard Although Gifu has complied with this standard by informing the employer of the job opportunity before resigning, he has violated this standard with respect to the backups of past firm information stored on his home computer In order to avoid violating this standard, he should have removed the information from his computer before departing Riku Associates or should have received his employer’s consent to continue to store the information Even if he believes the information to be obsolete, Gifu has violated this standard 30 Question ID: 10590 Correct Answer: A Standard I (B) Independence and Objectivity requires members and candidates to strive to achieve and maintain independence and objectivity in all their professional activities Members/candidates must not accept gifts, benefits, compensation or consideration which could reasonably comprise their independence or someone else’s independence and objectivity Gifts must be disclosed to the member’s employer whatever the case Fukui has informed her employer of the offer and has thus not violated this standard Standard III (D) Performance Presentation requires members and candidates to make every reasonable effort that the performance they present is fair, accurate and complete By intentionally increasing the portfolio return by 0.2% (10.0% – 9.8%) when the portfolio actually achieved a return of 9.8%, Fukui has clearly violated this standard Standard IV (B) Additional Compensation Arrangements requires members and candidates not to accept any gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all the parties involved Furthermore, the standard requires members/candidates to disclose the nature of the compensation, the approximate amount of compensation and the duration of the arrangement A simple description of the location of the underwater farm is not a disclosure which meets the requirements of this standard Thus by not disclosing the required details, Fukui has violated this standard FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com 31 Question ID: 10599 Correct Answer: C Standard I (C) Misrepresentation requires members and candidates to avoid knowingly making any misrepresentations when analyzing, making investment recommendations, and/or taking investment action Among the standard’s requirements is the prohibition imposed on members and candidates from guaranteeing future investment results Youssef has not guaranteed investment results nor has he made any misrepresentations Thus he has not violated this standard Standard V (B) Communication with Clients and Prospective Clients requires members and candidates, amongst other things, to separate opinion from fact in their research reports and recommendations By using terms such as ‘will’, Youssef is implying that the political crisis in Kenya will definitely intensify as opposed to stating the probabilities of such an event happening Thus he has violated this standard 32 Question ID: 10600 Correct Answer: A Standard V (C) Record Retention requires members and candidates to maintain records indicating the nature of their research recommendations, investment analysis, actions, and other investment related communications with clients and prospects By maintaining a database which contains these records, Youssef has complied with this standard In addition to requirements presented in the solution to Part standard I (C) Misrepresentation requires members and candidates to cite all the sources used to generate work products and research reports (recognized governmental and statistical sources need not be cited) By not specifically citing the analysts’ reports, surveys, and quotations used and, instead, making a general statement, Youssef’s statement (included as part of his database) violates this standard Standard III (B) Fair Dealing requires members and candidates to deal fairly with clients when disseminating investment recommendations, taking investment actions or analyzing investments Youssef has discriminated between investors by providing free access to the database to particular investor categories while charging other investors a nominal fee 33 Question ID: 10601 Correct Answer: C Standard V (B) Communication with Clients and Prospective Clients defines communication in the form of a recommendation pertaining to an asset allocation, the market, or classes of investments However any brief communications must be supported by background reports or data that can be made available to interested parties on request By issuing the recommendation two days prior to the full-length research report, Youssef has not violated this standard This is because he intends to make the full-length report available as soon as the communication problem abates 34 Question ID: 10602 Correct Answer: C Under Standard VII (A) Conduct as Members and Candidates in the CFA Program, members and candidates must not engage in any conduct that compromises the integrity or reputation of the CFA Institute, the CFA designation or the integrity, validity or the security of the CFA examination Members and candidates are not prohibited from expressing their opinions concerning the CFA Institute or CFA Program Hanson’s statement regarding the CFA Program does not violate this standard FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com However, standard VII (B) Reference to the CFA Institute, the CFA designation, and the CFA Program, requires members and candidates not to exaggerate or misrepresent the meaning or implication of candidacy in the CFA Program, amongst other requirements By implying that individuals with a certain level of intellect (who are ‘apt’ enough) are likely to succeed in the program, Hanson has violated this standard 35 Question ID: 10603 Correct Answer: A Standard I (B) Independence and Objectivity requires members and candidates to achieve and maintain independence and objectivity and not to accept gifts, benefits, compensation, or consideration which could compromise their own or someone else’s independence and objectivity Members and candidates should pay for their own commercial transportation and residence and only use the corporate aircraft offered by a client when commercial transportation is not available By accepting the residential and transportation arrangements offered by the client and not disclosing these arrangements to his employer, Hanson is in violation of this standard In the course of allowing JTL to make these arrangements, Hanson may have compromised his independence and objectivity Despite his client’s headquarters being half an hour away, Hanson did not make any attempts to explore the transportation alternatives available Additionally despite the residential accommodation being modest, Hanson should have used the residential allowances provided by his employer to seek and pay for his own residence and transportation Standard IV (A) Loyalty requires members and candidates, in matters related to their employment, to act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information or otherwise harm the employer During his stay in Malaysia, Hanson has not violated this standard 36 Question ID: 10604 Correct Answer: A Hanson has not violated Standard I (B) Independence and Objectivity as he will be receiving a flat fee for preparing the research report This makes the research report independent of Hanson’s potential recommendation on the steel manufacturer By not disclosing the research opportunity offered by the steel manufacturer to Greenwich Limited and seeking permission prior to beginning the assignment, Hanson has violated the standard IV (A) Loyalty which requires members and candidates to disclose all aspects of independent practice and receive employer permission prior to the start of the proposed independence practice Standard VI (A) Disclosure of Conflicts requires members and candidates to make “full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with their respective duties to their clients, prospective clients, and their employer.” By not disclosing the fact that he is an employed research analyst serving Greenwich Limited and misleading the steel manufacturer’s executive to believe that he is an independent research analyst, Hanson has violated this standard FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com 37 Question ID: 10613 Correct Answer: C Standard III (C) Suitability requires members and candidates, in advisory roles, to make a reasonable inquiry into the client’s investment experience, risk and return objectives, financial constraints and reassess and update this information regularly Additionally members and candidates are required to judge the suitability of the investment in context of the client’s total portfolio By instructing portfolio managers to conduct a suitability analysis prior to allocating the emerging market stocks, Russet has complied with this standard Standard III (A) Loyalty, Prudence and Care requires members and candidates to act in their client’s best interest and exercise prudent judgment and use reasonable care There is no evidence that Russet has violated this standard Standard IV (C) Responsibility of Supervisors requires members and candidates to make reasonable efforts to prevent and detect any violations of the laws, rules, codes and standards by anyone subject to their supervision or authority There is no information in the case which may provide evidence that Russet has violated this standard 38 Question ID: 10614 Correct Answer: C Standard III (C) Suitability requires members and candidates to undertake a client portfolio review on an annual basis (minimal) and whenever client circumstances and/or economic circumstances change Rapidly changing economies will require more frequent portfolio reviews as opposed to stable economies Thus the portfolio review frequency is in compliance with this standard’s guidelines The factors which Russet instructs her portfolio managers to analyze all are factors which have been prescribed by the suitability standard Thus her instructions are in compliance with the standards 39 Question ID: 10615 Correct Answer: A Standard II (B) Market Manipulations prohibits members and candidates from engaging in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants However, this standard does not prohibit legitimate trading that exploits a difference in market power, information, or other market inefficiencies Green did not intentionally manipulate the prices of the crude oil commodity futures traded The heavy futures volume being traded has forced the futures contract prices downward resulting in a (larger than expected) positive roll return when rolling into new futures contracts Thus Green has not violated this standard Standard V (B) Communication with Clients and Prospective Clients requires members and candidates to use reasonable judgment in identifying the factors important to investment analysis, recommendations, or actions and include those factors in communications with clients and prospects Additionally members and candidates must disclose the basic principles and general format of the investment process used to analyze investments, select securities, and construct portfolios and disclose any changes materially affecting this process There are no changes to the investment process which require communication with clients and/or prospects Thus Green has not violated this standard FinQuiz.com © 2018 - All rights reserved Reading Guidance for Standards I–VII FinQuiz.com 40 Question ID: 10616 Correct Answer: B Standard III (E) Preservation of Confidentiality requires members and candidates to keep information concerning present, former and prospective clients confidential unless the client permits disclosure; information concerns illegal activities on part of the client; or disclosure is required by law By sharing information on Sanchez’s current financial circumstances with the banking consultant, Russet has not respected the confidentiality of her client’s information and has thus violated this standard Additionally, by not revising Sanchez’s IPS to reflect her changed risk tolerance and liquidity requirements (which has decreased and increased, respectively following her bankruptcy), Russet has violated the standard, III (C) Suitability, which calls for revising client information whenever client circumstances change Speculative investments in commodity futures are no longer suitable for Sanchez and thus by not liquidating the holdings Russet has violated the suitability standard 41 Question ID: 10617 Correct Answer: B Standard III (B) Fair Dealing requires members and candidates to deal fairly with clients and prospects when disseminating investment recommendations, taking investment actions, and in their general professional activities In case of oversubscribed issues, members and candidates must allocate them to suitable and interested client accounts on a pro-rata basis Cooper is in violation of the fair dealing standard on two counts Firstly, relative to other accounts, he has allocated a larger proportion of the trade to his aunt's account Secondly, by delaying the allocation of the trade to a regular-fee paying client, he has treated his aunt's account unfairly Standard VI (B) Priority of Transactions requires members and candidates to undertake personal transactions after clients and employers have had a reasonable opportunity to act upon the recommendation Family accounts which are client accounts should not be disadvantaged and must be treated like any other client account By allocating the pharmaceutical manufacturer’s stocks to his aunt’s account a day later following the allocation of the issue to his clients’ accounts, Cooper has unfairly treated his aunt’s account and has violated this standard 42 Question ID: 10618 Correct Answer: C The portfolio manager has not made any misrepresentations and has not violated the standard, I (C) Misrepresentation Standard VI (B) Priority of Transactions additionally requires members and candidates to disclose the firm’s personal holding policies upon request By not fulfilling the client’s inquiry concerning the firm’s personal trading policies and blackout period established, the portfolio manager has violated this standard FinQuiz.com © 2018 - All rights reserved .. .Reading Guidance for Standards I–VII FinQuiz.com FinQuiz Level III 20 18 – Item- sets Solution Reading 2: Guidance for Standards I–VII Question ID: 10 529 Correct Answer: A Standard II (A)... Standard III (A) Loyalty, Prudence and Care requires members and candidates to act for the benefit of their clients and place client interests first The standard also requires members and candidates... stocks, Russet has complied with this standard Standard III (A) Loyalty, Prudence and Care requires members and candidates to act in their client’s best interest and exercise prudent judgment and use
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