CFA Ethics Level I,II,& III. Code of Ethics and Standards of Professional Conduct. Ying Guo, Passed CFA III, Boston Academy

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1 CFA Ethics Level I,II,& III Code of Ethics and Standards of Professional Conduct Ying Guo, Passed CFA III, Boston Academy 1

2 Things to bear in mind The Code of Ethics is easy to understand, get familiar with the six points. The Seven Standards of Professional Conduct seem easy to grasp, but some standards require understanding of the details to draw a line between right and wrong. The level of trickiness is noted in the following part. Without notation: use common sense judgement! Notice the details of the standards would suffice!! Some traps, be careful about where to draw a line!!! Very tricky, require analysis of the context and apply appropriate rules. Read examples from Handbook is recommended.

3 The Code of Ethics (Standards of Practice Handbook 11 th Edition) Members of CFA Institute (including CFA charter holders) and candidates for the CFA designation ( Members and Candidates ) must: Act with integrity, competence, diligence, and 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 and viability of the global capital markets for the ultimate benefit of society. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

4 Standard I: Professionalism A. Knowledge of the Law o Recommended to stay informed of the changes in applicable laws o Must comply with the most strict law o Find Misconduct with reasonable grounds: o First attempt to stop it by reporting to supervisor/compliance officer. o If unsuccessful, dissociated from the activity, even at the cost of resigning.! o Suspect misconduct: consult with legal console first.! D. Misconduct o Acts involving dishonesty, fraud, or deceit!! B. Misbehave out of workplace that does not affect work, professional integrity, judgement or reputation, should not count.

5 Standard I: Professionalism B. Independence and Objectivity o Sell-side analyst should not comprise independence and objectivity due to pressure from buy-side, same firm investment banking department, subject companies. o Issuer-Paid Research should receive flat fee, not conclusion-based compensation. Require disclosure of the nature of any compensation from any subject company. o Gift and Travel funding: o Gift from subject company/external fund manager: Best practice is to pay their own travel expense and use commercial transportation if available; Modest gift/travel plan is ok, definitely not luxury gifts;!! o Gift from client: should not impair independence and objectivity, need to disclose to employer.!! A. It is recommended that members pay their own travel expense and use commercial transportation if available. But for this case, the travel required such accommodation due to lack of commercial transportation and is provided appropriately.

Standard I: Professionalism C. Misrepresentation o Presenting third-party research as your own, without attribution to the source is a misrepresentation.

6 Standard I: Professionalism C. Misrepresentation o Presenting third-party research as your own, without attribution to the source is a misrepresentation. The only exception is factual information published by recognized financial reporting service like S&P.! o Guaranteeing a specific return on securities that do not have an explicit guarantee from a government body or financial institution.!! o Cherry Picking in Performance reporting: o Selecting a valuation service because it puts the highest value on traded security holdings, esp illiquid securities.! o Presenting performance data or attribution analysis that omits accounts or relevant variables.! o Selecting a performance benchmark that is not comparable to the investment strategy employed.! o Offering misleading information about the analyst's or firm's capabilities, expertise, or experience. A. Government bonds are subject to price risk, Blush misrepresented the expected performance of the fund.

meeting with several shareholders, CFO Mosaic Information: trade on material public and nonmaterial nonpublic information is fine.

7 Standard II: Integrity of Capital Markets A. Material Nonpublic Information Definition of MNI:!!! Reliable: Company management, overhear, well-known analyst Clear impact: company change, well-known analyst recommendation change, large order Not known to all: in a meeting with several shareholders, CFO Mosaic Information: trade on material public and nonmaterial nonpublic information is fine.!! If trade or induce others (by sharing information, or change recommendation) to use MNI to trade is a violation. If discover MNI, attempt to achieve public dissemination, then report to compliance officer or supervisor, definitely not sharing and prevent leaking to others.!!! A B

8 Standard II: Integrity of Capital Markets B. Market Manipulation intent to mislead!! Through dissemination of false or misleading information Through trade that distort prices or artificially inflate trading volume B. Thompson s recommendation may increase the price of Ibex without the intent to mislead the market, thus not violating Market Manipulation. The offering is sent to clients fairly, it is not required to call each client, thus not violate fair dealing.

9 Standard III: Duties to Clients A. Loyalty, Prudence, and Care o Identify actual client: beneficiary of the pension fund or trust! o Soft dollar: research from brokerage should directly benefit the client, seek best price and best execution when selecting brokerage.!! o Proxy Voting Policies: Proxies have economic value to a client, disclose proxy voting policies.! B. Fair Dealing o Deal fairly and objectively with all clients, treat family accounts as other common accounts! o Different levels of service are acceptable, but should be disclosed and not negatively affect other clients!!! o Send recommendation to all clients and give them adequate time to process the information before accepting orders.!! B. It is not required to make recommendation public or to all clients, as long as it does not disadvantage other clients.!!

Standard III: Duties to Clients C. Suitability o reasonable inquiry into a client's or prospective clients' IPS, update IPS at least annually or upon material change; i.e. risk tolerance, liquidity need, income/capital gain need.

10 Standard III: Duties to Clients C. Suitability o reasonable inquiry into a client's or prospective clients' IPS, update IPS at least annually or upon material change; i.e. risk tolerance, liquidity need, income/capital gain need.! o Recommend in the context of the client's total portfolio and diversification need.!! A. Evaluate risk should be in the portfolio context. It is not prohibit that clients withhold information about their financial circumstances and needs.

Standard III: Duties to Clients od. Performance Presentation o Past do not imply future, Simulated is not Actual! o Include terminated portfolio! o Use weighted average return of the portfolio!

11 Standard III: Duties to Clients od. Performance Presentation o Past do not imply future, Simulated is not Actual! o Include terminated portfolio! o Use weighted average return of the portfolio! o Make detailed information available, after distributing brief presentation! B. Rex has misled his potential clients by not disclosing that the first two years performance were with a previous employer. Including simulated results is acceptable as long as disclosed.

12 Standard III: Duties to Clients E. Preservation of Confidentiality o Must keep confidential information for current, former and prospective clients unless related to illegal activities, disclosure is required by law, or the client or prospective client permits o Should seek advice from compliance or legal counsel if they suspect illegal activity by clients, prior to take action. Beware of related laws that may forbid sharing confidential information even under such situations.!! A. Sharing information with another firm employee who is also working for the client s benefit is not a violation.

13 Standard IV: Duties to Employers A. Loyalty Not participate in independent activity that could conflict with the interests of their employer.!! Should not render services until they receive consent from their employer to all of the terms of the arrangement.!! Should not misappropriate client list or solicit employer s clients prior leaving.! Cannot reuse research report written for the former employer, must recreate from public available information.! Place their clients' interests before their employer's or their own interests. Acting against their employer to comply with the duties to the market and clients (Whistleblowing) is permitted as along as it is not for personal gain.!!! A. Whistleblowing is permitted as along as it is not for personal gain. B. Additional Compensation Arrangements o must not accept gifts, benefits, compensation, or consideration that competes with or might create a conflict of interest with their employer s interest unless they obtain written consent from all parties involved.!!

14 Standard IV: Duties to Employers C. Responsibilities of Supervisors o Must Establish policies and procedures to achieve compliance, prevent subordinates from violating laws, regulations, rules and the Code of Standards.! o Should also make reasonable efforts to detect inappropriate actions.! o Reporting the misconduct up the chain of command and warning the employee to cease the activity are also not enough. Pending the outcome of the investigation, a supervisor should take steps to ensure that the violation will not be repeated.! B. A member should decline supervisory responsibility in writing if proper compliance procedures are not in place.

15 Standard V: Investment Analysis, Recommendations, and Actions A. Diligence and Reasonable Basis o If members and candidates rely on secondary or third-party research, they must make reasonable and diligent efforts to determine whether such research is sound.!! o Can sign on a group research if believe that consensus has a reasonable and adequate basis, even if not agree.!! A. Members can rely on secondary or thirdparty research as long as they must make reasonable and diligent efforts to determine its soundness.

16 Standard V: Investment Analysis, Recommendations, and Actions B. Communication with Clients and Prospective Clients o principles of the investment processes used to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes. o Promptly disclose material change that may materially affect those processes o Communicate on significant limitations and risks, i.e. illiquidity! o Distinguish between fact and opinion! C. Record Retention Members and Candidates must develop and maintain appropriate records to support their investment analyses, recommendations, actions, and other investment-related communications with clients and prospective clients. Follow retention period law, recommend 7 years. Records are property of the firm, cannot take to new firms if cease employment.

17 Standard VI: Conflicts of Interest A. Disclosure of Conflicts o Make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer, i.e. stockholding, sit on board, consultative role, family or personal relationship.! o Company should build firewall between research and IBD department reporting structure, to limit conflict of interest.! o Recommend to put security on a restricted list if the firm is unwilling to permit dissemination of adverse opinions about a corporate client, so that the firm disseminates only factual information about the company.!!! B. The firm should continue to make markets but only execute unsolicited transactions for clients because stopping market-making is a strong signal that a significant transaction is underway, which may violate confidential information preservation principle.

employer, clients, and all prospective clients.!! A. Pre-clearance is recommended, not required.

18 Standard VI: Conflicts of Interest B. Priority of Transactions o Client > Employer > Personal C. Referral Fees o Disclose referral fee and the nature of the compensation before entering any formal service agreement to their employer, clients, and all prospective clients.!! A. Pre-clearance is recommended, not required. But in the occasion of oversubscription, client are prioritized so that employee cannot hold securities for themselves.. B. Rogers should also disclosure the nature of the compensation as percent of the management fee.

19 Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate A. Conduct as Participants in CFA Institute Programs Be disciplined in exams Cannot talk about the official exam questions! B. Reference to CFA Institute, the CFA Designation, and the CFA Program Must pass Level II and register for the Level III exam to be Level III Candidate! Cannot overpromise competency by referring to CFA experience B. Members can accept or reject a disciplinary sanction. If rejects, the matter is referred to a hearing before a disciplinary review panel.

20 Thanks!

University of Southern California CFA Society of Los Angeles CFA Review Program

University of Southern California CFA Society of Los Angeles CFA Review Program CFA LEVEL III Ethical and Professional Standards Study Session 2 March 18, 2017 Mark Harbour Level1help@cfalaCFAReview.org