Reading Asset Manager Code of Professional Conduct 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 Asset Manager Code of Professional Conduct FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 4: Asset Manager Code of Professional Conduct Question ID: 11814 Correct Answer: A The Asset Manager Code requires managers to conduct stress tests on complex derivate products in order to understand the structure and potential vulnerabilities of such strategies Although a venture capital investment is not a derivative strategy, it is often associated with a high failure rate, irrespective of the 60% Italian venture capital firms’ success rates (and 80% of those firms exiting through an IPO) Thus it is necessary to conduct a stress test on the investment in order for the manager to determine the probability of the venture capital failing to generate the promised returns as well as the vulnerability of the investment to failure of the venture capital firm The stress tests should be conducted prior to the allocation of LeQ-Twon’s stock to the fund’s portfolio Thus by failing to conduct stress tests, Galeazzi has violated the Code As the portfolio manager of Izraac Inc.’s pension fund, Galeazzi has the responsibility to take investment actions that are consistent with the pension fund’s investment mandates However he has clearly violated the investment mandate of the pension fund The fund prohibits investments in high risk ventures An investment in LeQ-Twon’s stock generates exactly the type of risk prohibited by the investment mandate Thus Galeazzi has failed to consider the suitability of the investment when making the venture capital investment As portfolio manager, Galeazzi is not required to report the state of the Italian venture capital market to clients Thus he has not violated the Code in this regard Question ID: 11815 Correct Answer: B The Asset Manager Code requires portfolio managers to provide adequate disclosure of a change in their investment style or strategy so that investors can consider whether any proposed changes in the investment style or strategy meet their investment needs well in advance of the change Pate has informed the endowment fund sponsor of the change in investment strategy (focus on emerging market small-cap growth corporate stocks) and thus has complied with the Code in this regard In context of a material change in investment strategy, clients should be permitted to redeem their investment if desired without incurring any undue penalties A shift in focus to emerging market stocks clearly constitutes a material shift in investment strategy as the endowment fund has retained Pate solely due to his skills in U.S small-cap growth stocks However by imposing a one-year period, Pate has not provided the endowment fund the liberty to exit from the investment at its discretion Additionally it is unclear whether Pate will impose a penalty should the fund liquidate its investment prior to the end of the one-year observation period Thus, irrespective of the absence of withdrawal penalties at the end of the observation period, the ‘waiting’ period indirectly implies a restriction on the client’s investment withdrawal freedom and constitutes a violation of the Code Pate has adequately disclosed the investment strategy’s risk factors and use of leverage to the fund He has thus not violated the Code in this regard FinQuiz.com © 2018 - All rights reserved Reading Asset Manager Code of Professional Conduct FinQuiz.com Question ID: 11816 Correct Answer: A The Code requires asset management firms appoint a chief compliance officer for ’administering the policies and procedures and for investigating complaints regarding the conduct of the Manager or its personnel.’ Depending on the size and complexity of the organization, the manager may appoint an existing employee to serve as the compliance officer, hire a separate individual for that role, or require an entire compliance department Thus Fennini may hire a firm employee to fill the role of the compliance officer It is necessary for the compliance officer to be independent from the investment and operations personnel and report directly to the CEO or board of directors With respect to the recommended reporting structure, measure complies with the Code However, reassigning the senior portfolio manager to fulfill the role of the compliance officer is a recommendation which will not comply with the Code This is because the senior portfolio manager may continue to hold personal or professional relations with the investment and/or operations personnel, despite the reassignment, and thus may not effectively carry out his monitoring activities Thus the measure fails to comply with the Code by failing to consider the independence of the reassigned manager The chief compliance officer and senior management are together responsible for conveying to firm employees the importance of compliance policies and procedures and ensuring compliance Additionally the compliance officer is responsible for conducting employee training regarding the procedures as well as self-evaluations and working with management on investigating potential breaches of the procedures The potential duties to be carried out by the compliance officer have been accurately addressed by measure Question ID: 11817 Correct Answer: C The Code requires asset management firms to ‘establish a business-continuity plan to address disaster recovery or periodic disruptions of the financial markets.’ Managers must ensure that the contents of the plan should, as a minimum, include the following: adequate backup, preferably offsite, for all account information; alternative plans for monitoring, analyzing and trading investments if primary systems become unavailable; plans for communicating with mission-critical vendors and suppliers; plans for employee communication and coverage of critical business functions in the event of a facility or communication disruption; plans for contacting and communicating with clients during a period of extended disruption; training of staff on areas of responsibility and ensuring they possess the knowledge of the plan; and testing the plan on a firm-wide basis at periodical intervals Measure has addressed procedures for testing the plan on a firm-wide basis by testing for the plan’s integrity and robustness but has failed to address alternative procedures for monitoring, analyzing and trading investments if primary systems become unavailable Thus measure does not accurately outline the contents of a disaster recovery plan in this regard In addition, the plan has not addressed FinQuiz.com © 2018 - All rights reserved Reading Asset Manager Code of Professional Conduct FinQuiz.com plans for continuing communication with firm employees and ensuring coverage of critical business functions in the event of a facility or communication disruption Question ID: 11818 Correct Answer: B With respect to the fees and costs charged to clients by the Manager the Code requires, at a minimum for managers to provide clients with gross- and net-of-fees returns and disclose any unusual expenses A general statement that certain fees and costs will be assessed does not adequately convey the total amount of expenses that investors will incur as a result of investing Managers should also disclose the methods for determining all fixed and contingent fees and costs that will be borne by investors and explain the transactions that will trigger the imposition of these expenses Additionally managers should disclose to each client the actual fees and other costs charged to them as well as an itemization of such charges, when requested by clients This disclosure should include the incentive fee, management fee and amount of commissions charged Managers must disclose to prospective clients the average or expected expenses or fees clients are likely to incur With respect to Macari, David discloses the specific fees charged to Macari upon the client’s request and discloses gross-of-fees to all existing clients (including Macari) on a periodic basis By not disclosing the net-of-fees charged or methods for determining the fees and the transactions which trigger the imposition of the expenses, David’s fee disclosure practices to Macari has violated the Code’s disclosure guidelines By disclosing estimate fee figures to be charged to prospects, David’s fee disclosing practices comply with the Code’s disclosure guidelines Question ID: 11820 Correct Answer: B Policy 1: The Asset Manager Code requires ‘disclosures of the valuation methods used to make investment decisions and value client holdings’ Client portfolio holdings, optimally, should be valued using fair market values If such values are not available the firm should, in good faith, determine the fair value of the holdings for which no readily available, independent, third-party market quotations are available The valuation basis should be disclosed to clients, be asset-specific, conducted annually or as client circumstances or market conditions change, and should be applied consistently Portfolio holdings valuations based on an internal valuation model does not violate the standard as long as the valuations are conducted in good faith Policy does not violate the Code as the basis for the valuation, its frequency, and valuation-related disclosures comply with the guidelines Policy 2: In order to comply with the Code, managers should disclose their firm’s proxy voting policies to clients The policies and procedures should specify guidelines for conducting regular reviews for new or controversial issues, mechanisms for reviewing unusual proposals, guidance in deciding whether additional actions are warranted when votes are against management, and systems to monitor the delegation of share voting responsibilities to others Additionally, managers must disclose to clients how to obtain information on the manner in which their shares were voted FinQuiz.com © 2018 - All rights reserved Reading Asset Manager Code of Professional Conduct FinQuiz.com Policy complies with the Code’s guidelines with respect to the issues underlying proxy voting to be disclosed to clients However the information on how shares are voted must be disclosed to all clients as opposed to only those clients making such a request Thus the policy has not complied with the Code in this regard FinQuiz.com © 2018 - All rights reserved .. .Reading Asset Manager Code of Professional Conduct FinQuiz.com FinQuiz Level III 2018 – Item- sets Solution Reading 4: Asset Manager Code of Professional Conduct Question ID: 118 14 Correct... ID: 118 14 Correct Answer: A The Asset Manager Code requires managers to conduct stress tests on complex derivate products in order to understand the structure and potential vulnerabilities of... FinQuiz.com © 2018 - All rights reserved Reading Asset Manager Code of Professional Conduct FinQuiz.com Question ID: 11816 Correct Answer: A The Code requires asset management firms appoint a chief