CFA 2018 Quest bank 11 Reading 4 to 8 Ethical and Professional Standards

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Test ID: 7440229

Reading 4 to 8 Ethical and Professional Standards

Question #1 of 47

Question ID: 461385

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Questions #2-7 of 47

Mohawk Asset Management buyson-the-runTreasuriesatauctionforitsstandardfeeaccounts. Whenthese move off-the-run, they are placedin performance-basedaccounts viain-housecross-tradesat prevailing market prices, andreplacedinthe standardfeeaccounts withnew on-the-runissues. Whichstandardis violated, ifany?

No Standard is violated.

TheStandardconcerning Fiduciary Duty.

TheStandardconcerningPriority ofTransactions.

Explanation

Inadditionto beinga violationoftheStandardconcerning FairDealing, thisconstitutesa violationof Mohawk's Fiduciary Duty. Why? Becausetheon-the-runissuesare benchmarksandtradeatlower yieldsthantheoff-the-runissues. Inessence, the off-the-runissueshave marginally higherreturns, andthis will boostthereturnsinthe performance-basedfeeaccounts. Mohawk isallocatingtrades baseduponcompensationarrangements, andthisisnot permissibleundertheCodeand Standards.

JacquesClaudel, aCFAInstitute member, represents Vector Funds, a U.S.-basedfund manager, inCanada. Although Vector

Fundsis properly licensedtodealinallCanadianand U.S. securities, its primary objectiveistosell UnitedStatesfundsto Canadianinstitutionalinvestorsseekingdiversificationintothe U.S. dollar. Whileit would be willingtodosoifrequested by its clients, Vectorhasnot placedtradesinCanadiansecuritiessinceClaudel began workingtheretwo yearsago.

Priorto joining Vector'sCanadianoperations, Claudel wasanindependentasset managerhandlingthefundsof wealthy

individualsandsmallinstitutions. Mostoftheseaccountsremainunderhis management, underthe businessnameCoup de

Gras. Claudelisunclearasto whetherhisconsulting work isincompetition withhisnew employer, astheaccountsunderhis

managementareinvestedstrictly inCanadiansecurities, while VectorhasnottradedCanadiansecurities. However, justto be onthesafeside, heobtained written permissionfrom Vectortocontinueservinghisformerclients. Hisformerclients werenot notified.

Claudelreceivescashcompensationfor mostoftheaccountshehandlesindependently, butforonehereceivesanew carfor his personaluseevery two years, andforanotherheiscompensated withaone-week, expenses-paidholiday intheEuropean country ofhischoice.

As partofhisresponsibility, Claudel makestradesforsomeofhisCanadianclients. Herunsallofhistradesthroughtwo

brokers, AceEquity TradersandtheParlay Group. Aceofferssomeofthe bestresearchavailableonhealth-carestocks, but chargesfairly hefty commissions. Parley hassomeofthecheapestcommissionsinToronto, but providesnoresearchof value toClaudel. Vectorclaimscompliance withtheCFAInstituteSoftDollarStandards.

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Question #2 of 47

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Question #3 of 47

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Question #4 of 47

ᅞ A)

ontheexchange, and profitfrom the price movementsintheaccountatCoup de Gras. Claudelsetsup theaccount, but advisesBonnetthathe "willhavenothingtodo" withthe manipulationscheme beyond placingtradesasBonnetdirects.

Claudeliscurrently pursuinga master'sdegreeinfinancialeconomicsintheevenings. Duringtheinterview with Vectorandon hisresumeheindicatedthathe "attended Victoria University," givinghisestimateddateofgraduation. Heisnotsure whether

Vectorunderstoodthathedidnothavehis master'sdegree.

Whichofthefollowingstatementsaboutconsulting work isCORRECT?

In some circumstances the employee must receive the employer's written

permission prior to receiving additional compensation fromparties other than the firm. This requirement applies to monetary compensation only.

Insomecircumstancestheemployee mustreceivetheemployer's written permission

priortoreceivingadditionalcompensationfrom partiesotherthanthefirm. This requirementappliesto both monetary andnon-monetary compensation.

Inallcasestheemployee mustreceivetheemployer's written permission priorto receivingadditionalcompensationfrom partiesotherthanthefirm. Thisrequirement appliesto both monetary andnon-monetary compensation.

Explanation

StandardIV(A): Loyalty toEmployerrequires written permissionfrom boththeemployerandtheconsultingcustomerifthe

work involvescompetition withtheemployer. Anexampleofaninstancenotrequiring permission would beifaCFA charterholder who worksfora broker wishesto writegrantsforanonprofitfoundation. Insuchcase, heneednotget

permission, nordoesheneedtodisclosethecompensation. ThisStandardappliesfor work that provideseither monetary or nonmonetary compensation. (Study Session2, LOS 5.b)

ShouldClaudeldecidetoterminatehisrelationship with Vector, whichofthefollowingitemscanheNOTtake withhim? A list of consulting clients,with addresses and phone numbers.

A marketing presentationhedevelopedfor Vector, butuses primarily inhisside

business.

HisRolodex fullofcontactsinthe brokerageand money-management business.

Explanation

Marketing presentationsandany other materialsdevelopedforanemployer belongtotheemployer, nottheemployee,

accordingtoStandardIV(A): Loyalty toEmployer. ThefactthatClaudel wasalready usingthe marketing presentationonhis ownindefianceoftheStandarddoesnot makeit OK forhim totakethe presentation whenheleaves. Therestoftheitems areClaudel's personal property. (Study Session2, LOS 5.b)

Claudel'sstatementabouthiseducation backgroundis:

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ᅚ B) ᅞ C)

Question #5 of 47

ᅞ A)

ᅚ B)

ᅞ C)

Question #6 of 47

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ᅞ B)

ᅚ C)

truthful, andinaccord withtheCodeandStandards.

nottruthful, andnotinaccord withtheCodeandStandards.

Explanation

StandardI(C) Misrepresentationstatesthat "membersshallnot makeany statements, orally orin writing, that misrepresent the member'sacademicor professionalcredentials." Inthiscase, Claudel'sstatementsaretruthful, andarenota violationof theStandard. Hecouldhave been moreclear, but whathesaidisundeniably correct. Whether Vectorunderstood whathetold them isnothis problem, aslongashe wastruthfulanddidnotattempttodeceivethem. (Study Session1, LOS2.a)

WhichofthefollowingstatementsisCORRECT?

Bonnet has violated Standard II(A): Material Nonpublic Information, and Claudel has not violated Standard III(A): Loyalty, Prudence, and Care. Bonnethas violatedStandardIV(A): Loyalty toEmployer, andClaudelhas violated StandardI(A): Knowledgeofthe Law.

Bonnethas violatedStandardIII(B): FairDealing, andClaudelhas violatedStandard I(B):Independenceand Objectivity.

Explanation

Bonnet violatedseveralStandards, includingIV(A)andII(B), by manipulatingstock pricesand profitingfrom that manipulation attheexpenseofother purchasers. StandardIV(A)requiresthatemployeesnotacttoinjurethefirm ordepriveitof profits,

andBonnet's personaltradingand market manipulationcrosses welloverthatline. However, Bonnetdidnot violateStandard II(A) MaterialNonpublicInformation becausenononpublicinformation wasinvolved. Claudel violatedStandardI(A) by

contributingtoBonnet's plansto break thelaw. UndertheCodeandStandards, Claudelcannot knowingly assistothers who are violatingtheStandardsorthelaw, evenifhedoesnot profit personally. WhileClaudel'sethicsarein question, nothinghe didforBonnetislikely toaffecthisindependence, andhedidnot violateStandardI(B)Independenceand Objectivity. (Study

Session2, LOS 5.b)

Withregardtohisconsulting work, Claudelis:

in competition with Vector because he advises individual investors, and in compliance with the Code and Standards.

notincompetition with Vector because Vectordoesn'ttradeCanadiansecurities, and incompliance withtheCodeandStandards.

incompetition with Vector becauseheadvisesindividualinvestors, andnotin compliance withtheCodeandStandards.

Explanation

Since Vector both possessesthecapability andthe willingnesstotradeinCanadiansecurities, Claudel'sactivitiesclearly put him incompetition withhisemployer. Hehasreceived permissionfrom hisemployertoconsult, buthasnotreceived

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Question #7 of 47

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Question #8 of 47

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Question #9 of 47

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Assumingthat bothAceEquity TradersandtheParlay Group offer bestexecution, Claudel:

must disclose to clients whether client-directed brokerage will prevent him from

getting the best execution.

mustdirectallthetradesforclients whodonot wishtoownhealth-carestockstothe Parlay Group.

canselectthe brokerthatrefersthe most business back tohim, aslongasany

research purchased benefitstheclient whoseaccountis beingtraded.

Explanation

TheStandardsrequirethat purchased brokeragedirectly benefitstheclient. Clients whodonotholdhealth-carestocksgetno

benefitfrom Ace'sresearch, soClaudelisobligatedtosendtheirtradestothe broker withthelowesttransactioncosts. While disclosingtherisksofclient-directed brokerageisagoodidea, itisonly recommended, notrequired, intheSoftDollar Standards. Referralscan play no partinthe broker-selection process. TheStandardsrequiretheinvestment managerto keep

alltherecordsrequiredtodemonstratecompliance withtheStandards-the broker'srecordkeeping prowessisnotrelevant. (Study Session1, LOS 3.b)

BlueRock Fundusesa proprietary assetselection modelthatit believesgivesthefirm acompetitiveadvantage. The modelis appliedtoauniverseofallsmall-cap domesticequitiesandall publicly-tradedcorporate bonds. Theassetallocations generated by this modelrangefrom +200 percentinsmall-cap equities/-100 percentin bondsto +200 percentin bonds/-100

percentinsmall-cap equities. Sincethefundcaninvestin bothequitiesand bonds, itisclassifiedasa balancedfund. Inthe

prospectusBlueRock describesthefund'sinvestment policy as "a balancedfund, with 50 percentoftheassetsinvestedin

bondsand 50 percentinequities, onaverage." Onthis basis, BlueRock is:

in violation of the CFA Institute Standard concerning Fiduciary Duty.

in violationofCFAInstituteStandardsconcerningthedisclosureofsecurity selection and portfolioconstruction processes.

notin violationofany CFAInstituteStandard.

Explanation

Clearly, therisk profileofthisfundis muchdifferentfrom atypical balancedfund. Infact, itcould beeffectively describedasa hedgefundif +200/-100allocationsaretypical. BlueRock isin violationoftheStandardconcerningdisclosureofsecurity

selectionand portfolioconstruction processes.

WhichofthefollowingstatementsregardingallocatingtradesisCORRECT? Itis:

never permissible to deviate from a proportional account value weighting

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Question #10 of 47

Question #11 of 47

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permissibleunderthestandardstoallocatetradesonthe basisofa predetermined formulathat may deviatefrom a prorata basis butisinherently fair.

never permissibletodeviatefrom a prorata basis, unlessthisisdoneonthe basisof anadvanceindicationofinterestintheissue.

Explanation

Ifthefirm hasdevelopedanallocation procedurethatisformula-based, inherently fair, andthedetailsaredisclosedtoclients,

itis possibletodeviatefrom a prorataallocation basis.

Whichofthefollowingtradeallocation proceduresisimproper? Allocation:

based upon a predetermined formula.

basedupon past participationinIPOs.

onastrict prorata basisoverallsuitableaccounts.

Explanation

Participationin priorIPOsdoesnotinsuresuitability forsubsequentIPOs. Moreover, this methodofallocationcouldresultina fairness problem, sincelargeraccountsare morelikely tohavehadagreaterlevelof participationin pastIPOs.

PatriciaSpraetz isthechieffinancialofficerandcomplianceofficeratSuperSelectionInvestmentAdvisors. SuperSelectionis a medium-sized money managementfirm whichhasincorporatedtheCFAInstituteCodeofEthicsandStandardsofPractice intothefirm'scompliance manual.

Karen Jacksonisa portfolio managerforSuperSelection. SheisnotaCFAcharterholder. Jacksonisfriendly withDavid

James, presidentofAMD, arapidly growing biotechcompany. Jameshas provided Jackson withrecommendationsinthe

biotechindustry, whichshe buysforherown portfolio before buyingthem forherclients. Forthree years, Jacksonhasalso servedonAMD's boardofdirectors. Shehasreceivedoptionsandfeesascompensation.

Recently, the boardofAMDdecidedtoraisecapital by votingtoissuesharestothe public. This wasattractiveto board

members (including Jackson) who wantedtoexercisetheirstock optionsandselltheirsharestogetcash. Whenthedemand forinitial publicofferings (IPO)diminished, just beforeAMD's publicoffering, Jamesasked Jacksontocommittoalarge

purchaseoftheofferingforher portfolios. Jacksonhad previously determinedthatAMD wasa questionableinvestment but agreedtoreconsiderat James' request. Herreevaluationconfirmedthestock to beoverpriced, butsheneverthelessdecided to purchaseAMDforherclients' portfolios.

Whichofthefollowingactionsare mostappropriateforSpraetz?

If, after her investigation Spraetz finds that Jackson has committed violations,

Spraetzmust report them to senior management and seek legal counsel for

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ᅚ B)

ᅞ C)

Question #12 of 47

ᅞ A) ᅞ B) ᅚ C)

Question #13 of 47

Spraetz, asthechiefcomplianceofficer, mustsetcompany policy incleartermsand

monitortheactionsoftheemployees. Incaseof violations, sheshouldinvestigate thoroughly, initiatedisciplinary action, andissueguidelinesthat must befollowedin orderto preventfuture violations. She mustnotonly detect violationsthrougha continuous monitoring process butalso provideguidancefor properconduct consistent withthefirm's policy manual.

EventhoughSpraetz doesnotsupervise Jackson, asthecomplianceofficerofthe firm sheisresponsibleforidentifying violations. Spraetz isnotresponsiblefor

preventingthem andshouldnotgo beyondtheirdocumentationforsenior

management. Thus, sheshouldrecordthe violations butneednottakeany further action.

Explanation

SinceSpraetz hastheauthority tohire, fire, reward, and punish Jackson, Spraetz hassupervisory dutiesinadditionto being thechiefcomplianceofficerofSuperiorSelection. She mustinvestigate Jacksonandreportherfindingstohersuperiorsand

possibly the board. Ifnoactionistaken, Spraetz mustconsiderresigningundertheCFAInstituteCodeandStandards.

Spraetz isalsoresponsibleforsettingthe policy, preventinganddetecting violations, and puttinginto placereasonable

proceduresto monitoremployees' actions. Herroleasthechiefcomplianceofficerrequireshertotakedisciplinary actionsin ordertodeterfurther violations.

Inordertoremainincompliance when managing privateclientaccounts, members mustdoallofthefollowingEXCEPT:

Conduct regular reviews of client circumstances. Seek authorizationforchangesininvestment policy. Usearisk-factor modeltoassesstheclient'srisk tolerance.

Explanation

Thereisnorequirementtouseaspecific modelinordertoassessanddocumentaclient'srisk tolerance. Risk toleranceis

morelikely to beaddressedimplicitly intheassetallocationguidelinesthatareestablishedandupdated baseduponclient circumstances.

RickardAdvisorsrecently hadatradingerrorinacustomeraccountthat wassubsequently discovered by Rickard. Thefirm felt embarrassed by thedisclosureofthiserror, and, inordertoinducetheclienttocontinueitsrelationship, Rickardoffersthe client preferentialaccesstoanew issuethatisexpectedto be "hot." WhichStandardis violated, ifany?

The Standard concerning Independence and Objectivity. TheStandardconcerning FairDealing.

TheStandardconcerning Fiduciary Duty.

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Question #14 of 47

Question #15 of 47

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Question #16 of 47

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ᅚ B)

ᅞ C)

Rickardisin violationoftheStandardconcerning FairDealing by offeringtheclient preferentialaccesstoa "hot" new issue.

Thereisnoobvious violationof Fiduciary Duty, sincethereisnoevidencethatRickardis placingitsownfinancialinterest

aheadoftheclient.

Adequateinvestment policy disclosuretypically meansclearly identifyingthe policy in: the annual report.

the prospectus.

anannuallettertoallfundshareholders.

Explanation

Adequatedisclosureistypically accomplished by clearly statingthe policy inthe prospectus.

A managerof pooledfunds mustdoallofthefollowingtoremainincompliance withtheStandardsEXCEPT: Print the investment policy statement in all quarterly reports.

Notify potentialinvestorsofany changesininvestment policy. Disclose basicsecurity selection processes.

Explanation

Thereisnorequirementtoincludetheinvestment policy statementinall quarterly reports.

ConcerningStandardIII(B), FairDealing, whichofthefollowingactionsisNOTa valid procedureforcompliance withthe Standard?

Communicate investment recommendations simultaneouslywithin the firm and to customers,where possible.

Communicateinvestmentrecommendationstoallcustomersincludingthoseaccounts

for whichthesecuritiesarenoteligiblefor purchase.

Limitthenumberof peoplethatareinvolvedandare privy tothefactthatan investmentrecommendationisgoingto bedisseminated.

Explanation

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Question #17 of 47

Question ID:412421

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ᅚ C)

Question #18 of 47

Question ID:461386

ᅞ A)

ᅞ B) ᅚ C)

Question #19 of 47

Question ID:412640

WhichofthefollowingstatementsregardingallocatingtradesisCORRECT? Itis permissibleundertheStandardstoallocate trades:

based upon compensation arrangements.

baseduponany methodthefirm deemssuitablesolongastheallocation procedure has beendisclosedtoallclients.

ona pro-rata basisoverallsuitableaccounts.

Explanation

Itis permissibletoallocatetradesona pro-rata basisoverallsuitableaccounts. Itisnot permissibleto baseallocationsupon compensationarrangements. Any methodisnotnecessarily suitable, anddisclosuredoesnotabsolvethe memberfrom ensuringthattheallocationisnecessarily fair.

Whichofthefollowingstatementsisleastaccurate? Itis permissibleundertheStandardstoallocatetrades: on a pro rata basis over all suitable accounts on the basis of an advance

indication of interest and indicated order size.

ona prorata basisoverallsuitableaccounts baseduponaccount value. ona prorata basisoverallaccounts.

Explanation

Allocatingtradesona prorata basis, prorata baseduponordersize (whentherearetoofew sharestofillallorders, e.g., filling2/3 ofallordersactually submitted), or prorata baseduponanadvanceindicationofinterestareall permissible. However, accounts must becheckedforsuitability.

PatriciaSpraetz isthechieffinancialofficerandcomplianceofficeratSuperSelectionInvestmentAdvisors. SuperSelectionis

a medium-sized money managementfirm whichhasincorporatedtheCFAInstituteCodeofEthicsandStandardsofPractice intothefirm'scompliance manual.

Karen Jacksonisa portfolio managerforSuperSelection. SheisnotaCFAcharterholder. Jacksonisfriendly withDavid James, presidentofAMD, arapidly growing biotechcompany. Jameshas provided Jackson withrecommendationsinthe biotechindustry, whichshe buysforherown portfolio before buyingthem forherclients. Forthree years, Jacksonhasalso servedonAMD's boardofdirectors buthasnevernotifiedSuperSelectionofthisfact. Shehasreceivedoptionsandfeesas compensation.

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ᅞ C)

Questions #20-21 of 47

Question #20 of 47

QuestionID:461370

agreedtoreconsiderat James' request. Herreevaluationconfirmedthestock to beoverpriced, butsheneverthelessdecided to purchaseAMDforherclients' portfolios.

WhichofthefollowingstatementsisNOTcorrect?

Jackson violated Standard IV(B) regarding Disclosure of Additional

Compensation by not disclosing additional compensation in the form of cash and stock options received from AMD, as its board member to her employer. Jacksondidnot violateStandardIII(A)on Fiduciary Duty toclients becauseshe was bound by herfiduciary duty toAMDanditsstockholdersasa board member. Therefore, whenshereversedherdecisionto buy AMDsharesforSuperSelection's clients, portfolioson James' request, herobligationtoAMDtook precedence. Jackson violatedStandard VI(A)regardingConflictsofinterest by notdisclosingher board membership andownership ofstock optionstoheremployer.

Explanation

Jacksonhas violatedStandardIII(A) becauseherfirstobligationistoherfirm'sclients. Standard VI(A)addresses precisely these kindsofsituationsregarding potentialconflictofinterest. Giventhisconflictofinterest, Jacksonalsocompromisedher objectivity in violationofStandardI(B). Herfiduciary duty toherclientstakes precedenceoverherfiduciary duty toAMD's stockholdersundertheCFAInstituteCodeandStandards. By notdisclosingherrelationship withAMD, shealso violated StandardIV(B). Making past personalsecurity transactionsaheadof purchaseofthesamesecuritiesforherclientshas put Jacksonin violationofStandard VI(B). Thisstandardclearly prohibitssuchactions.

PrestonPartnersCaseStudy (RefertoCFAInstituteStandardsofPracticeCasebook fordetails).

Preston partnersisa medium-sizedinvestment managementfirm whichadoptedtheCodeandStandardsas partofits policy manual. GeraldSmithson, CFA, a portfolio manager, hadrecently addedthestock of UtahBiochemicalCompany and NorgoodPLCtoallhisclients' investment portfolios. Smithsonhada personalrelationship withthe presidentof Utah Biochemical. Shortly afterwards UtahBiochemicalsandNorgoodannounceda merger whichincreasedtheshare pricesof bothcompanies.

Smithsoncontendsthathesaw the presidentof UtahBiochemicaldining withthechairmanofNorgood butdidnotoverhear theirconversation. Smithsonresearched bothcompaniesextensively anddeterminedthateachcompany wasagood investment. Healso pondered whetherthere would bea mergerasthey seemedtocomplementeachother. He putin block tradesforsharesofeachcompany which wereexecutedovera periodoftwo weeksat various prices. Preston's policies were notclearinthisareasoheallocatedtheshares by starting withhislargestclientand workingdowntosmallaccounts. Someof Smithson'sclients were very conservative personaltrustaccounts; others were pensionfunds whichhadaggressive

investmentobjectives.

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ᅞ B)

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Question #21 of 47

QuestionID:461371

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ᅞ B)

ᅞ C)

Question #22 of 47

QuestionID:461396

"Preston employees who are in supervisory roles will be held accountable for the actions of those who report to them in matters of compliance with the policies and procedures of Preston. Supervisors will not be held responsible for compliance with securities laws and regulations bywhich employees' activities are governed."

"Prestonemployees whoareinsupervisory roles willnot beaccountableforthe

actionsofthose whoreporttothem in mattersofcompliance withthe policiesand proceduresofPreston. However, supervisors will beheldresponsibleforcompliance withsecuritieslawsandregulations by whichemployees' activitiesaregoverned." "Prestonemployees whoareinsupervisory roles will beheldaccountableforthe

actionsofthose whoreporttothem in mattersofcompliance withthe policiesand proceduresofPreston. Supervisors willalso beheldresponsibleforcompliance with securitieslawsandregulations by whichemployees' actionsaregoverned."

Explanation

Tocomply withStandardIV(C), supervisors must beheldaccountablefortheiremployees' actionsgoverned by lawsand regulationsandheldresponsibleforensuringthatemployees whoreporttothem, directly orindirectly, comply withcompany policiesand procedures.

Selectthe most appropriate policy statement for Preston regarding Standard III(B) concerning Fair Dealing forallocation of block trades.

"Preston shall not discriminate against any client account, and all clients will receive the same price for order execution and will be charged the same commission, if applicable. Block trades will be allocated pro rata before or immediately after the execution of the block trade."

"Preston shall not discriminateagainstany clientaccount, and all clients will receive thesame price fororderexecution and will be charged thesame commission, if

applicable. However, larger clients, whoare more profitable, can beallocated trades on a preferential basis consistent with general business practicein many industries." "Preston shall not discriminateagainstany clientaccount, and all clients will receive thesame price, adjusted for quantity discounts, fororderexecution and will be charged commissions based on numberof sharesallocated. Block trades will be

allocated prorata beforeorimmediately aftertheexecution of the block trade."

Explanation

Standard III(B) addresses fair dealing when it comesto clients. Block trades, if executed at different prices, must beallocated in such a way thatall clientaccountsare charged thesameaverage priceand commission. One way toachievethis fair

allocation istoallocatethem prorataacrossall accounts, with no preferential treatment. Thesuitability of investments fora

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ᅞ B)

ᅚ C)

Question #2

3 of 47

QuestionID:461372

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ᅚ B)

ᅞ C)

Wanda Brunner, CFA, is preparing for her first meeting with the Johnsons—her firm's newest clients. She makes notes regarding disclosureof theinvestment process. These notes most likelyincluderemindersto:

notify her supervisors of any potential change in the security selection and portfolio construction process.

anticipatechangesinherclients' investmentobjectivesthatcouldcausethem toleave herfirm.

adequately disclosethe basicsecurity selectionand portfolioconstruction process.

Explanation

Wandashouldadequately disclosethe basicsecurity selectionand portfolioconstruction process. Wandashouldgenerally stick withthestatedinvestmentstrategy intheIPS, notify clientsand prospectiveclientsofany potentialchangeinthesecurity selectionand portfolioconstruction process, andsecuredocumentationofauthorizationfor proposedchanges.

PrestonPartnersCaseStudy (RefertoCFAInstituteStandardsofPracticeCasebook fordetails).

Preston partnersisa medium-sizedinvestment managementfirm whichadoptedtheCodeandStandardsas partofits policy manual. GeraldSmithson, CFA, a portfolio manager, hadrecently addedthestock of UtahBiochemicalCompany and NorgoodPLCtoallhisclients' investment portfolios. Smithsonhada personalrelationship withthe presidentof Utah Biochemical. Shortly afterwards UtahBiochemicalsandNorgoodannounceda merger whichincreasedtheshare pricesof bothcompanies.

Smithsoncontendsthathesaw the presidentof UtahBiochemicaldining withthechairmanofNorgood butdidnotoverhear theirconversation. Smithsonresearched bothcompaniesextensively anddeterminedthateachcompany wasagood investment. Healso pondered whetherthere would bea mergerasthey seemedtocomplementeachother. He putin block tradesforsharesofeachcompany which wereexecutedovera periodoftwo weeksat various prices. Preston's policies were notclearinthisareasoheallocatedtheshares by starting withhislargestclientand workingdowntosmallaccounts. Someof Smithson'sclients were very conservative personaltrustaccounts; others were pensionfunds whichhadaggressive

investmentobjectives.

WhichofthefollowingstatementsisCORRECT?

Smithson acted on inside information because he had observed senior executives of Norgood and Utah Biochemical having lunch together, in violation of Standard II(A).

Smithsonfailedtocomply withStandardIII(C)regardingsuitability ofinvestmentsfor clients portfolios.

UtahBiochemical wasanappropriateinvestmentforPreston's personaltrust accounts.

Explanation

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Question #24 of 47

QuestionID:461393

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ᅚ B) ᅞ C)

Question #2

5 of 47

QuestionID:461355

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ᅞ C)

executivesalone. Hereliedonthe "mosaic" produced by hisresearchandobservanceofthe meeting. Thecaseimpliesthat hedidnotoverheartheconversation, tradingon which wouldhave puthim in violationoftheStandardsandthelaws. Preston wasremissindischargingitsdutiesasthey didnotlay downclear policiesandguidelinesforallocationof block trades, in violationofStandardIII(B). As mentioned, UtahBiochemical was probably notanappropriateinvestmentfortrustaccounts andthestatementis, therefore, false.

Aninternalauditof Vega Fundhasdeterminedthatthefundisoutofcompliance withitsinvestment policy statementas disclosedinthe prospectus. VegashoulddoallofthefollowingEXCEPT:

seek authorization should it be determined that the investment policy requires alteration.

revisetheinternalaudit proceduretoallow suchoccurrencesinthefuture. revisetheinvestment processinorderto beconsistent withtheinvestment policy statement.

Explanation

It wouldappearthattheinternalaudit procedurehaseffectively uncoveredacompliance violation, andthatisanobjectiveof the procedure. Hence, thereisnoneedtorevisetheinternalaudit procedure.

Glenarm CaseStudy (RefertoCFAInstitute'sStandardsofPracticeCasebook fordetails.)

PeterSherman, CFA, hasrecently joined Glenarm Company afterspending 5 yearsatPearlInvestment Management. Heis responsibleforidentifying potential LatinAmericaninvestments. Previously, Shermanheld jobsasconsultantfor many Latin Americancompaniesandhad planstocontinuesuchconsulting jobs withoutdisclosinganythingto Glenarm.

Afterresigning, but beforeleavinghisemploymentatPearl, ShermanhadencouragedPearlcustomersto movetheiraccounts to Glenarm. HecontactedaccountsPearlhad beensolicitingfor business. Healsocontacted potentialclientsthatPearlhad rejectedinthe pastastoosmallorincompatible withthefirm's business. Furthermore, heconvincedseveralofPearl'sclients and prospectstohire Glenarm afterhe joinedthecompany. Healsoidentified materialsfrom Pearltotake withhim, suchas:

1. sample marketing presentationshehad prepared 2. computer program modelsforstock selection

3. research materialsoncompanieshehad beenfollowing

4. alistofcompaniesrecommended by Shermanfor potentialinvestment, but which wererejected by Pearl 5. newsarticlesfor potentialresearchideas

Undertheobligationtoactinthe bestinterestoftheemployer whilestillanemployee, Sherman'sactionsconstitutethe following violationsexcept:

solicitation of potential clients of Pearl--violation of Standard IV(A). leavingPearlto joina possiblecompetitor--violationofStandardIV(A), Loyalty to Employer.

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Question #2

6 of 47

QuestionID:461382

ᅞ A) ᅞ B) ᅚ C)

Question #27 of 47

QuestionID:461388

ᅚ A)

ᅞ B) ᅞ C)

Question #28 of 47

QuestionID:461354

Explanation

Thereisno violationifthe member joinsacompetitor withoutcompromisinghisduty tohis previousemployer.

Othersareincorrect because:SolicitingclientsofPearl, whileinitsemployment, damagedPearl's business, aclear violationof StandardIV(A); solicitationof potentialclientsisa violationforthesamereason; itisa violationofStandardIV(A)to

misappropriateemployer's property whichresultsinadamagetoemployer's business.

Whenafirm seekstoallocateadisproportionatenumberofsharesofahotIPO to performance-basedfeeaccountsthis constitutesa violationoftheStandardconcerning:

priority of transactions.

additionalcompensationarrangements. fiduciary duty.

Explanation

Theallocationofadisproportionatenumberofsharesto performance-basedfeeaccountsconstitutesa violationoffiduciary duty, inadditionto beinga violationoftheStandardconcerningfairdealing.

Prorataallocationonthe basisofanadvanceindicationofinterest meanseachaccountfor whichthesharesaresuitable: and which has expressed an advance indication of interest, shall receive m/n

fraction of their indication,where there are m shares available and indications of interest for n shares.

shallreceive m/nshares, wherethereare m sharesavailableandnsuchaccounts. and whichhasexpressedanadvanceindicationofinterest, shallreceive w*m shares, where w istheaccount's proportional valueofallsuchaccountsandthereare m sharesavailable.

Explanation

Prorataallocationonthe basisofanadvanceindicationofinterest meansthatallaccountsthathaveexpressedaninterestin theissueshallreceive m/nfractionoftheirindicationofinterest, wherethereare m sharesavailableandindicationsofinterest fornshares.

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ᅚ A)

ᅞ B) ᅞ C)

Question #29 of 47

QuestionID:461392

ᅞ A) ᅚ B)

ᅞ C)

Questions #

3 0-

35 of 47

describe to his employer in detail the activities related to this consulting arrangement.

refusethisconsultingarrangement.

obtain verbal permissionfrom hisemployertoengageinthisconsultingarrangement.

Explanation

AccordingtotheStandardsofProfessionalConduct, Jones mustdisclosetohisemployeralloutsidecompensation arrangements, describetohisemployerindetailtheactivitiesthatgiverisetooutsidecompensation, andobtain written permissionfrom hisemployerinadvance.

WandaBrunner, CFA, isreviewingadraftfund prospectusforhernew "Leveraged LongCoffee" (LLC), aclosed-endfund. LLCusesaofcombinationfundamentalandtechnicaltrading modelstoevaluateindividualsecurities. Shenotesthe LLC prospectushasseveraldisclosures whichcauseherto worry that prospectiveclients willavoidherfund.

Disclosure1: "LLCchargesaflat 3.00% ofassetsunder management."

Disclosure2: "LLC may investup to40% ofthefund'sassetsinsecurities whicharenotrelatedtocoffeeorother consumer products."

Disclosure 3: "LLCreliesonly onfundamental valuationofindividualsecurities."

Whichofthefollowingstandards will most likely be violated by distributionofthe prospectus?

Standard III(C) Duties to Clients: Suitability because the fees are exorbitant. StandardIII(C)DutiestoClients:Suitability becauseit misleadsthereaderastothe process by whichsecuritiesareselected.

StandardIII(C)DutiestoClients:Suitability becausethefundcanholdanexcessive portionofthe portfolioinnon-coreassets.

Explanation

LLC mustadequately disclosethe basicsecurity selectionand portfolioconstruction process, andthe portfolio manager recommendationsandinvestmentactions must beconsistent withthestatedobjectivesandconstraintsofthefund. By failing toacknowledgethefund'sdependenceontechnicaltrading, thefundfailsto meetthisstandard.

Sean O'Brien, CFA, worksforParadigm Portfoliosasa portfolio manager. He managesahigh-yield (junk bond)fundas well as14large privateaccounts. O'Brien'scompensationforthehigh-yieldfundis performance based, whilethe private-account compensationis basedupona percentageofassets. Thecompany'scompensation packagesareaclosely guardedsecret, and keptin-house.

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Question #

3 0 of 47

QuestionID:472460

ᅞ A)

ᅞ B) ᅚ C)

Question #

3 1 of 47

QuestionID:461375

ᅞ A) ᅞ B)

ᅚ C)

O'Brienroutinely takes personal positionsinsecuritiesheldinthehigh-yieldfund, a practiceallowed by Paradigm. Onhis way to work, helearnsovertheradiothatahurricaneisheadingtowardthelocationof VillaRealResortsin Mexico. Landfallis expected by Dec. 23, whichcould potentially ruinthelucrativeChristmas vacationseason. Ifthehurricanehitsasexpected, it willhaveadevastatingaffectoncashflows, and O'Brien believes VillaReal mightdefaultonits bonds. Both O'Brienandthe high-yieldfundhold VillaReal bonds. Afterarrivingattheoffice, O'Briensellsoffthefund's VillaRealholdings, then

immediately liquidateshisown position.

Periodically O'Brien buysconvertible bondsinthehigh-yieldfund. Whentheseareconvertedintocommonequity hetypically doesnot votethe proxies, saying, "thefundisnotanequity fund, andtheequitiesareusually sold withinthe year."

Beforeacceptinganew account, O'Brienconductsathoroughinvestigationintohisclient'sfinancialsituation, investment experience, andinvestmentobjectives. Theinformationisupdatedannually throughasurvey mailedtotheclientandreturned toParadigm, and O'Brienfollowsup withatelephonecalltotheclient. Judy Smith's portfolio wasdeemedsuitableforthe inclusionofhigh-yield bonds basedupontheinitialinvestigation, andreaffirmedatthelastthreeannualupdates. Itisthree monthssinceSmith'slastannualupdate, andthehigh-yield markethas been weak. Smithfilesalawsuitalleging malfeasance onthe partof O'Brien.

O'Brienregularly attendsanalyst meetings. Duringthecourseof many ofthese meetings, heisobservedconsumingseveral highballs. Onafternoonsfollowingthe meetingsheiseasily angeredandattimes belligerent. However, hisinvestment prowessdoesnotseem todiminish.

Inthecourseofeffecting money-markettransactionsfortheaccounts, O'Brienroutinely placesnumeroustrades, allocating the paper with marginally higher yieldstothehigh-yieldfundandtheremaindertothe privateaccounts.

WithregardtotheSmithaccount, O'Brien'sactionsarebestdescribedas beingin:

violation of Standard V(B) - Communication with Clients and Prospective Clients.

violationofStandardIII(A)- Loyalty, Prudence, andCare.

compliance withallapplicableCFAInstituteStandards.

Explanation

O'Brien'sactionsareinfullcompliance withtheStandards. Hedidappropriateresearchtodeterminethesuitability of

high-yieldinvestmentsinSmith'saccount, andfollowedup regularly, asisrequired. O'BriencannotreadSmith's mind, norishe expectedtodoso. ItisincumbentuponSmithtonotify O'Brienofachangeinherrisk toleranceandobjectivesifthesechange betweenannualupdates. (Study Session2, LOS 6.b)

O'Brien'sdrinkingatanalyst meetingsandsubsequentconductis:

in violation of Standard I(B): Independence and Objectivity.

in violationofStandardIV(A): Loyalty toEmployer, becausehisdrinkingdeprivesthe

company of quality work.

in violationofStandardI(D): Misconduct becauseitreflectsadversely onhis professionalcompetence.

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Question #

3 2 of 47

QuestionID:461376

ᅚ A)

ᅞ B)

ᅞ C)

Question #

33 of 47

QuestionID:461377

ᅚ A)

ᅞ B)

ᅞ C)

Question #

3 4 of 47

QuestionID:461378

ᅚ A) ᅞ B)

O'Brien'sconductisnotillegal, butitdoes violatethe professional-misconductStandard, whichstates, "Membersshallnot ...

commitany actthatreflectsadversely ontheirhonesty, trustworthiness, or professionalcompetence." Thefactthat O'Brien's

investment work hasnotsufferedisirrelevant, becausethelunchtimedrinking "reflectsadversely" on O'BrienandParadigm

Portfolios. Theconductdoesnot violateStandardI(B)orStandardIV(A), thoughitcould violatethelatterifthe quality of

O'Brien's work beginstotailoff. (Study Session1, LOS2.a)

Whichofthefollowingstatementsabout O'Brien'suseofconvertible bondsisCORRECT?

Unless O'Brien makes arrangements for someone else to vote the proxies, he is in violation of Standard III(A): Loyalty, Prudence, and Care.

O'Brien'slack ofexpertiseinequity analysis, despiteusageoftheCFA mark,

representsa violationofStandard VII(A):Conductas MembersandCandidatesinthe

CFAProgram.

Theuseofconvertible bondsin O'Brien'shigh-yieldfund violatesStandard V(A): DiligenceandReasonableBasis.

Explanation

O'Brienhasafiduciary duty toensurethatthe proxiesare votedaccordingtothe bestinterestsofhisclients. Heneednotdo

the votinghimself, buthe mustsetup asystem by whichsomebody takesresponsibility. Thereisnothingaboutconvertible bondsthat makesthem necessarily unfitforahigh-yieldfund. If O'BrienearnedtheCFAdesignationand kepthisduesup to date, hecanusethedesignationevenifhespecializes. StandardI(C), Misrepresentation, relatesto marketingservices, not voting proxies. (Study Session2, LOS7.b)

Withregardtothe VillaRealinvestment, O'Brien'sactions:

violate neither the reasonable-basis Standard nor the priority-of-transactions Standard.

donot violatethefiduciary-dutiesStandard butdo violatethe priority-of-transactions

Standard.

violatethereasonable-basisStandardandthefiduciary-dutiesStandard.

Explanation

O'Brienisallowedtoinvestinsecuritieshecoversaccordingtocompany policy. Sincehetradedforthefirm'saccountsfirst

andhis personalaccountsecond, O'Briendidnot violateafiduciary duty orthe priority-of-transactionsStandard. Since O'Brien actedoninformationheobtainedthrougha weatherforecast, hedidnotuseany materialnonpublicinformation. Hissell decision was basedonhis knowledgeofthecompany anditscircumstances, and, assuch, isnota violationofthereasonable basisstandard. (Study Session1, LOS1.b)

O'Brien's money-marketallocationsrepresent:

a violation of Standard III(B): Fair Dealing.

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ᅞ C)

Question #

35 of 47

QuestionID:461379

Question #

36 of 47

QuestionID:461353

ᅚ A)

ᅞ B)

ᅞ C)

a breachofhisfiduciary duty to mutual-fundaccountowners.

Explanation

O'Brien breachedhisfiduciary duty to private-accountholders, butnottoownersofthefund. Hedid violatethefair-dealing Standard by attemptingto boosthiscompensation, butnotStandard V(B), whichrelatestooutsidecompensation, notthat

from hisfirm. (Study Session2, LOS8.a)

The practiceof "payingup" fortheresearchis:

not OK for the fund and not OK for the private accounts.

OK forthefundand OK forthe privateaccounts. OK forthefund butnot OK forthe privateaccounts.

Explanation

CFAInstituteSoftDollarStandardsallow forthe purchaseofresearch withclient brokerageaslongasthe brokerdelivers best execution. Sincetheresearch benefitsallof O'Brien'sclients, hecanuse brokerageto purchaseitinthe beliefthatthe benefit

oftheresearchoutweighstheeffectofhighertransactioncosts. (Study Session1, LOS 3.a)

Glenarm CaseStudy (RefertoCFAInstituteStandardsofPracticeCasebook fordetails.)

PeterSherman, CFA, hasrecently joined Glenarm Company afterspending 5 yearsatPearlInvestment Management. Heis

responsibleforidentifying potential LatinAmericaninvestments. Previously, Shermanheld jobsasconsultantfor many Latin Americancompaniesandhad planstocontinuesuchconsulting jobs withoutdisclosinganythingto Glenarm.

Afterresigning, but beforeleavinghisemploymentatPearl, ShermanhadencouragedPearlcustomersto movetheiraccounts to Glenarm. HecontactedaccountsPearlhad beensolicitingfor business. Healsocontacted potentialclientsthatPearlhad rejectedinthe pastastoosmallorincompatible withthefirm's business. Furthermore, heconvincedseveralofPearl'sclients

and prospectstohire Glenarm afterhe joinedthecompany. Healsoidentified materialsfrom Pearltotake withhim, suchas: 1. sample marketing presentationshehad prepared

2. computer program modelsforstock selection

3. research materialsoncompanieshehad beenfollowing

4. alistofcompaniesrecommended by Shermanfor potentialinvestment, but which wererejected by Pearl

5. newsarticlesfor potentialresearchideas

UponSherman's joining Glenarm, whichofthefollowingactsdidNOT violatethestandards?

He allowed Glenarm to advertise the fact that they had hired a portfolio

manager who was a CFA charterholder.

Hedidnotgive Glenarm a writtenstatementdisclosinghisindependentconsulting

practiceanddetailsofactivitiesthatresultedincompensationsincethey hadalready beenapproved by Pearl-his previousemployer.