Portfolio Theory and Behavioral Finance

([Link].20HS.V)
Exercises: Ethics in Finance

Building Competence. Crossing Borders.

Dr.-Ing. Martin Schnauss, CFA, FRM

Laura Archer-Svoboda, Vers. 1.1.4
Topics

1. Professionalism
2. Integrity of Capital Markets
3. Duties to Clients
4. Duties to Employers
5. Investment Analysis, Recommendations, and Actions
6. Conflicts of Interest
7. (Responsibilities as a CFA Institute member or CFA Candidate)

Sources: CFA Institute, [Link]

Kaplan Schweser, [Link]/
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Professionalism

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Case
Professionalism

Bob Blanford, CFA, is an investment analyst for a large global brokerage firm. He
recently moved to Ragatan, a developing country with few securities laws and
regulations. As part of conducting a company analysis, Blanford interviews Ravi
Shanti, vice-president of finance at Starr Industries. Starr is a major industrial firm in
Ragatan and a client at Blanford's firm. Based on his analysis, Blanford suspects
that Shanti may have deliberately overstated Starr's current earnings and its
earnings for the past several quarters. If this information becomes public, Blanford
believes that Starr's stock price will drop substantially. Blanford suspects that Shanti
may have violated Ragatan's securities laws.
Which of the following statements is least likely to comply with Standard I,
Professionalism? Blanford should:

a) disassociate himself from the client, if the activity is illegal or unethical.

b) determine the legality of the activity, possibly by consulting counsel.
c) take no action.

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Case
Professionalism

Nancy Hall, a candidate in the CFA program, is an analyst for a mutual fund. As part
of her job she makes company visits to interview executives. On a recent trip she
stayed with her sister instead of at a hotel. In her expenses Hall included a hotel
charge of $100, which was less than the amount allowed by her employer. After
receiving a check for her expenses, Hall disclosed to her supervisor that she had
stayed with her sister instead of at a hotel. She also returned the $100 to her
employer. According to CFA Institute Standards of Professional Conduct, which of
the following statements best describes Hall's professional conduct?

a) Hall did not engage in professional misconduct because she did not meet all of
the requirements to use the CFA designation.
b) Hall did not engage in professional misconduct because she eventually
disclosed this information and returned the $100 to her employer.
c) Hall engaged in professional misconduct.

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Case
Professionalism

Janet Green, CFA, provides investment advice and other services to clients in
several countries. She resides in Country A whose securities laws and regulations
are less strict than the Code and Standards. She also conducts business with
clients in Country B, which has no securities laws or regulations, and in Country C,
which has securities laws and regulations that are stricter than the Code and
Standards. Which of the following statements is CORRECT? According to CFA
Institute Standards of Professional Conduct, Green must adhere to the Code and
Standards in:

a) Country A and Country B but the law in Country C.

b) Country A but the law in Country B and Country C.
c) Country A, Country B, and Country C.

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Case
Professionalism

Shortly after becoming employed by Valco & Co., an investment banking firm, Stan
McDowell, CFA, learns that most of Valco's initial public offerings (IPO) are really
effected in order to profit management via price manipulation of the shares.
McDowell observes an illegal act, sanctioned by senior management, in progress
and refuses to sign off on his responsibility. Instead, McDowell takes the
documentation to his supervisor and tells him he should sign it in his place. This
action is:

a) a suitable reaction, and he is in compliance with the Code and Standards.

b) an overreaction. Senior management's sanctioning of the act absolves
McDowell from his ordinary responsibility as a CFA Institute member.
c) a violation of the Code and Standards since he is required not to knowingly
participate or assist in such an act.

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Integrity of Capital Markets

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Case
Integrity of Capital Markets

A CFO who is a CFA Institute member is careful to make his press releases-some
of them containing material and previously undisclosed information-clear and
understandable to his readers. While writing a new release, he often has his current
intern proofread rough drafts. He also sends electronic copies to his brother, an
English teacher, to get suggestions concerning style and grammar. With respect to
Standard II(A), Material Nonpublic Information, the CFO is:

a) only in violation by e-mailing the pre-release version to his brother but not the
intern, because the intern is in essence an employee of the firm.
b) violating the standard by either showing the pre-release version to his intern or
sending it to his brother.
c) not in violation of the Standard.

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Case
Integrity of Capital Markets

Andrea Waters is an investment analyst who has accumulated and analyzed

several pieces of nonpublic information through her contacts with drug firms.
Although no one piece of the information she collected is "material," Waters
correctly concluded that the earnings of one of the drug companies would be
unexpectedly high in the coming year. According to CFA Institute Standards of
Professional Conduct, Waters:

a) can use the information to make investment recommendations and decisions.

b) cannot legally invest or make recommendations based on this information.
c) may use the information, but only after approval from a compliance officer or
supervisor.

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Case
Integrity of Capital Markets

Darlene Hess, CFA, manages a pension fund that has a sizeable position in Knoll
Corporation common stock. Hess also holds Knoll common stock in her personal
account. Hess participates in an analyst conference call in which Knoll's chief
financial officer advises that the company's current-quarter earnings will slip below
consensus forecast. Knoll has not disclosed this to the public. Hess believes news
of the poor earnings will reduce the stock's value significantly. Hess may:

a) not sell Knoll stock from either the pension fund or her personal account.
b) sell Knoll stock from the pension fund but may not sell it from her personal
account.
c) sell Knoll stock from her personal account but may not sell it from the pension
fund.

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Case
Integrity of Capital Markets

Wallace Manaugh, CFA, is analyzing the stock of a manufacturer of fishing boats.

By analyzing public information, speaking with the firm's suppliers and customers,
and counting the new boats in the company's boat yard, Manaugh concludes that
the company's new fishing boat is not meeting sales expectations. Anticipating that
this will cause the stock price to decline, Manaugh takes a short position in the
stock. Manaugh has:

a) violated the Standards by acting on nonpublic information.

b) an obligation under the Standards to make reasonable efforts to achieve public
dissemination of the nonpublic information.
c) not violated CFA Institute Standards.

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Duties to Clients

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Case
Duties to Clients

In securing the shares for all accounts under her management, Linda Kammel of
Northwest Futures purchased three blocks of shares at three different prices. She
then allocated these shares by placing shares from the first block in accounts with
surnames beginning with A-G. The second was allocated over accounts H-P, and
the third over Q-Z. This action is:

a) not permissible under the Code and Standards.

b) consistent with her responsibilities under the Code and Standards.
c) permissible only if the clients are informed of the allocation procedure.

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Case
Duties to Clients

James Bush, CFA, is meeting with an investor, George Stephan, for the first time.
During their first meeting, Bush, before making any inquiry regarding the client's
circumstances, outlines several investment strategies and also describes a specific
stock with what Bush believes offers a high potential for large gains, and
recommends that Stephan include this stock in his portfolio. With regard to
suitability, Bush's actions:

a) comply with the Standards.

b) violate the Standards because Bush must determine Stephan's risk tolerance,
objectives and needs before making any investment recommendations.
c) violate the Standards because Bush must obtain information on which securities
the client has invested in previously, in order to make appropriate investment
recommendations.

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Case
Duties to Clients

Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters,
presents special requirements. To construct an investment policy statement for
Peters, Hull inquires about Peters' investment experience, risk and return
objectives, and financial constraints. Peters states that he has a great deal of
investment experience in the capital markets and does not wish to answer
questions about his tolerance for risk or his other holdings. Under Standard III(C),
Suitability, Hull:

a) may accept Peters' account but may only manage his portfolio to a benchmark
or index.
b) must decline to enter into an advisory relationship with Peters.
c) is permitted to manage Peters' account without any knowledge of his risk
preferences.

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Case
Duties to Clients

A money manager is meeting with a prospect. She gives the client a list of stocks
and says, "These are the winners I picked this past year for my clients. Their
double-digit returns indicate the type of returns I can earn for you." The list includes
stocks the manager had picked for her clients, and each stock has listed with it an
accurately measured return that exceeds 10%. Is this a violation of Standard III(D),
Performance Presentation?

a) Yes, unless the positions listed constitute a complete presentation (i.e., there
were no stocks omitted that did not perform in the double digits).
b) Yes, because the manager cannot reveal historical returns of recent stock picks.
c) No, because the manager had the historical information in writing.

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Duties to Employers

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Case
Duties to Employers

Nicholas Brynne, CFA, develops a trading model while working for CE Jones, an
investment management firm. By working on the model at home from his personal
computer, Brynne is able to devote additional work hours. Although the trading
model is successful, Brynne loses his job in a company restructuring, and decides
to start his own practice using the trading model. Nicholas is most likely:

a) in violation of the Standards because he did not receive permission from his
employer to keep or use the files after employment ended.
b) not in violation of the Standards because the trading model was created using
his home computer.
c) in violation of the Standards because he did not have permission to build the
trading model using his home computer.

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Case
Duties to Employers

Bill Valley has been working for Advisors, Inc., for several years, and he just joined
CFA Institute. Valley's sister just received a large bonus in the form of stock options
in Zephyr, Inc. Valley's sister knows nothing about financial assets and offers Valley
a week at her holiday home each year in exchange for Valley monitoring Zephyr
and the value of her stock options. In order to comply with the Code and Standards,
Valley needs to inform Advisors of:

a) nothing since no money is involved and it is a favor for a family member.

b) the compensation in the form of the use of the holiday home only.
c) both the use of the holiday home and his sister's options.

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Case
Duties to Employers

Mary Hiller, CFA, is a senior analyst at a mutual fund. She is also a member of the
Board of the Directors of her daughter's Skating Club. She is often asked for advice
about the management of the club budget and about possible short-term
investments, but she is not paid for this advice. She does not undertake any
research to answer these questions, providing information based only on the
general practices of the mutual fund at that moment. The only benefit she receives
is a free monthly membership for her daughter that would usually cost $182. What
should she do before making any recommendations, in order to comply with the
CFA Institute requirements?

a) Obtain prior permission from her employer.

b) Inform her current clients about her outside consulting.
c) Consult only on her free time and do not accept any benefit greater than $100

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Case
Duties to Employers

An analyst belongs to a nationally recognized charitable organization, which

requires dues for membership. The analyst has worked out a deal where he
provides money management advice in lieu of paying dues. Which of the following
must the analyst do?

a) Resign from the position because the relationship is a conflict with the
Standards.
b) Must treat the charitable organization as his employer.
c) Nothing since he is not an employee of the charitable organization.

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Investment Analysis, Recommendations, and
Actions

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Case Investment Analysis, Recommendations,
and Actions

Nicole Wise, CFA, is an analyst at Chicago Securities. She attends a meeting with
management of one of the companies that she covers. During the meeting,
management expresses great optimism about the company's recent acquisition of a
new business. Wise is excited about these prospects and issues a research report
that states that the company is about to achieve significant success with the new
acquisition. Wise has:

a) not violated CFA Institute Standards of Professional Conduct because she had
reasonable reason to believe that the statements in her report were true.
b) violated CFA Institute Standards of Professional Conduct because she did not
check the accuracy of the statements that management made.
c) violated CFA Institute Standards of Professional Conduct because she
misrepresented the optimism by turning it to certainty.

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Case Investment Analysis, Recommendations,
and Actions

Bob Hatfield, CFA, has his own money management firm with two clients. The
accounts of the two clients are equal in value. It is Hatfield's opinion that interest
rates will fall in the near future. Based upon this, Hatfield begins increasing the bond
allocation of each portfolio. In order to comply with Standard V(B), Communication
with Clients and Prospective Clients, the analyst needs to:

a) make sure that the change is identical for both clients.

b) inform the clients of the change and tell them it is based upon an opinion and not
a fact.
c) perform both of these functions.

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Case Investment Analysis, Recommendations,
and Actions

A financial analyst and CFA Institute member sends a preliminary research report
on a company to his supervisor. The supervisor approves the report, but then the
analyst receives news that causes him to revise downward the earnings estimate of
the company. The analyst resubmits the report to the supervisor with the new
earnings estimate. The analyst soon finds out that the supervisor plans to release
the first version of the report with the first earnings estimate without a reasonable
and adequate basis. In response to this the analyst must:

a) only insist that the first report be followed up by a revision.

b) both insist that a follow up report be issued and take up the issue with regulatory
authorities.
c) insist that the supervisor change the earnings forecast or remove his (the
analyst's) name from the report.

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Conflicts of Interest

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Case
Conflicts of Interest

Wes Smith, CFA, refers many of his clients to Bill Towers, CPA, for accounting
services. In return, Towers performs routine services for Smith, such as his tax
returns, for no charge. Towers has just become a member of CFA Institute. With
this development, Towers must:

a) reveal to the prospects referred by Smith that he performs services for Smith,
along with the estimated value of those services.
b) only reveal to the prospects referred by Smith that he performs services for
Smith.
c) discontinue his services for Smith.

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Case
Conflicts of Interest

Jan Hirsh, CFA, is employed as manager of a college endowment fund. The fund's
board has recently voted to divest any stocks of tobacco companies from the
portfolio. Hirsh currently owns shares of a major tobacco company. According to the
Standards, Hirsch must:

a) do nothing.
b) disclose her ownership in the stocks to the board or sell her shares.
c) disclose her ownership in the stocks to her supervisor or compliance officer.

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Case
Conflicts of Interest

Ryan Brown, CFA, is an analyst with a large insurance company. His personal
portfolio includes a significant investment in QRS common stock that his firm does
not currently follow. The director of the research department asked Brown to
analyze QRS and write a report about its investment potential. Based on CFA
Institute Standards of Professional Conduct, Brown is required to:

a) disclose the ownership of the stock to his employer and in the report.
b) decline to write the report without specific approval of his supervisor.
c) sell his shares of QRS before completing the report.

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Responsibilities as a CFA Institute member or
CFA Candidate

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Case Responsibilities as a CFA Institute
member or CFA Candidate

Ralph Lim and Susan Bland have both passed Level I of the CFA Program. Both
are currently enrolled to sit for Level II. Lim's business card reads, "Ralph Lim, CFA
Level I." Bland's resume states, "Level II Candidate in the CFA Program." According
to CFA Institute Standards of Professional Conduct involving use of the professional
designation:

a) Lim violated the Standard, but Bland did not.

b) Both Lim and Bland violated the Standard.
c) Bland violated the Standard, but Lim did not.

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