cfa level iii sp17 ss1_mharbour... · 2017-03-14 · 1 university of southern california cfa...
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University of Southern California
CFA Society of Los Angeles
CFA Review Program
CFA LEVEL III
Ethical and Professional Standards
Study Session 1
March 18, 2017
Mark Harbour [email protected]
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Ethical and Professional Standards
You must be able to demonstrate a thorough
knowledge of the:
CFA Institute Code of Ethics
Standards of Professional Conduct
Including - o The rules and sanctions relating to disciplinary
proceedings
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Reading Assignments
1. Code of Ethics and Standards of Professional
Conduct Standards of Practice Handbook,
Eleventh Edition
2. Guidance for Standards I-VII, Standards of
Practice Handbook, Eleventh Edition
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Learning Outcomes
Code of Ethics and Standards of Professional
Conduct: You should be able to –
Describe the structure of the CFA Institute
Professional Conduct Program and the disciplinary
review process for the enforcement of the Code of
Ethics and Standards of Professional Conduct;
Explain the ethical responsibilities required by the
Code of Ethics and the Standards of Professional
Conduct, including the subsections of each standard.
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Code of Ethics
Members and candidates must:
Act with integrity, competence, diligence, and respect, and in an ethical manner
Place integrity of the investment profession and interests of clients above their own personal interests
Use reasonable care and exercise independent professional judgment
Practice and encourage others to practice in a professional and ethical manner
Promote the integrity and viability of the global capital markets for the ultimate benefit of society
Maintain and improve professional competence and help others to do so as well
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Standards of Professional Conduct
Standard I: Professionalism
Standard II: Integrity of Capital Markets
Standard III: Duties to Clients
Standard IV: Duties to Employers
Standard V: Investment Analysis, Recommendations, and Actions
Standard VI: Conflicts of Interest
Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate
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General Comments
Look for multiple provisions
Code and Standards apply globally
Look for assisting/participation and/or supervisory
responsibility whenever several people are
involved
Disclosure frequently is a separate obligation, but
doesn’t always cure other violations
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Enforcement of
Code and Standards Rules of Procedure:
Fair Process
Confidentiality of proceedings
The CFA Institute’s Board of Governors
maintains oversight and responsibility
through the Disciplinary Review Committee
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Possible Sanctions for Violators:
Cautionary letter
Institution of proceedings to discipline
If disciplinary action is appropriate, the following
sanctions may be imposed in increasing order of
severity: o Private censure
o Public censure
o Suspension of membership
o Revocation of membership
o In the case of CFA charterholders, suspension or revocation of
CFA charter
Enforcement of
Code and Standards
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If member or candidate rejects a proposed
disciplinary sanction the matter is referred to a
hearing panel of CFA Institute members
Enforcement of
Code and Standards
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Guidance for Standards I-VII:
You should be able to
Demonstrate a thorough knowledge of the Code
of Ethics and Standards of Professional Conduct
by interpreting the Code and Standards in various
situations involving issues of professional
integrity;
Recommend practices and procedures designed to
prevent violations of the Code of Ethics and
Standards of Professional Conduct
Learning Outcomes
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Standard I Professionalism
(A) Knowledge of the law
Must understand and comply with all applicable laws,
rules and regulations (including CFA Institute Code of
Ethics and Standards of Professional Conduct) licensing
agency, or professional association governing activites
In the event of a conflict, comply with the more strict law,
rule or regulation
Must not knowingly participate or assist in and must
dissociate from any violation of such laws, rules, and
regulations
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Standard I Professionalism
(A) Knowledge of the law Recommended Procedures for Compliance
Members and Candidates
Stay informed
Review procedures
Maintain current files
Firms
Develop and/or adopt a code of ethics
Provide information on applicable laws
Establish procedures for reporting violations
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Standard I Professionalism
(B) Independence and Objectivity
Must use reasonable care and judgment to achieve and
maintain independence and objectivity in their
professional activities
Must not offer, solicit, or accept any gift, benefit,
compensation, or consideration that reasonably could
be expected to compromise their own or another’s
independence and objectivity
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Standard I Professionalism
(B)Independence and Objectivity Investment recommendations must reflect opinions that
free of bias – select guidance highlights are -
Buy-Side Clients –Respect and foster intellectual honesty of sell-side research
Investment-Banking Relationships –Firewalls can minimize conflicts of interest
Public Companies –Analyst is responsible for assessing a company’s prospects and stock
price performance in a factual manner
Issuer-Paid Research –Best practice is for analysts to accept only a flat fee, without regard to
conclusions or recommendations
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Standard I Professionalism
(B) Independence and Objectivity
Recommended Procedures for Compliance
Protect the integrity of opinions
Create a restricted list (disseminate factual
information)
Restrict special cost arrangements
Limit gifts
Restrict investments (for example, IPOs)
Implement review procedures
Establish formal written policies on independence
Appoint a senior officer for oversight
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Standard I Professionalism
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(C) Misrepresentation – Must not knowingly make any misrepresentation
relating to investment analysis, recommendations,
actions, or other professional activities
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Standard I Professionalism
(C) Misrepresentation
Recommended Procedures for Compliance
Periodically review employee
correspondence/documents
Develop procedures to verify 3rd party information
Regularly monitor website postings
Maintain current files
o Copies of statutes/rules/regs/important cases
o Attribute quotations
o Attribute summaries
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Standard I Professionalism
(D) Misconduct
Must not engage in any professional conduct involving
dishonesty, fraud, or deceit or commit any act that
reflects adversely on professional reputation, integrity, or
competence
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Standard I Professionalism
(D) Misconduct
Recommended Procedures for Compliance
Develop or adopt a code of ethics
Disseminate to all employees a list of potential
violations and associated disciplinary sanctions
Check references of potential employees
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Standard II Integrity of Capital Markets
(A) Material Nonpublic Information
Members and candidates who possess material nonpublic
information that could affect investment value of an
investment must not act or cause others to act on the
information.
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Standard II Integrity of Capital Markets
Must be
Material (disclosure likely would affect price or
reasonable investor would want to know the
information before making an investment
decision) o look at specificity, extent of difference from public information,
nature and reliability
Non-public (not disseminated – defined as “made
known”)
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Standard II Integrity of Capital Markets
Materiality –Examples Earnings
Mergers, acquisitions, tender offers or joint ventures
Changes in assets or asset quality
Innovative, products, processes or discoveries
New licenses, patents, regulatory approvals
Developments regarding customers or suppliers
Changes in management
Changes in auditor’s reports or opinions reliance
Bankruptcies
Significant legal disputes
Events regarding issuer securities & debt rating changes
Large trade orders (before they are executed)
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Standard II Integrity of Capital Markets
Companies can’t disclose material, non-public
information to a “chosen few”
Information made available to analysts remains
non-public until it is made available to investors in
general
A company can’t discriminate among analysts in
the disclosure of information or blackball analysts
who have given negative reports on the company
in the past
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Standard II Integrity of Capital Markets
Mosaic Theory – An analyst may use significant
conclusions derived from the analysis of public and
non-material nonpublic information as the basis for
investment recommendations and decisions even if
those conclusions would have been material inside
information had they been communicated directly to
the analyst by the company.
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Standard II Integrity of Capital Markets
(A) Material Nonpublic Information
Recommended Procedures for Compliance
Make efforts for public dissemination (e.g. encourage
issuer to disseminate by press release)
“Firewalls” are the most widely used approach to
preventing the communication of material nonpublic
information within firms
Reporting system for interdepartment communication
Written compliance policies and guidelines should be
circulated to all employees of a firm
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Standard II Integrity of Capital Markets
(B) Market Manipulation
Must not engage in practices that distort prices or
artificially inflate trading volume with the intent to
mislead market participants
May be informational in nature (for example,
spreading false rumors), or
Transactional in nature (trading among various
accounts to artificially increase the bid price of a
stock)
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Standard III Duties to Clients
(A) Loyalty, Prudence, and Care
Members and candidates have a duty of loyalty
to their clients and must act with reasonable
care and exercise prudent judgment
Place client’s interest first, before their
employer’s or their own interests
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Standard III Duties to Clients
(A) Loyalty, Prudence, and Care
Recommended Procedures for Compliance
Submit statements to clients at least quarterly
Members/candidates should review investments periodically to ensure compliance with governing documents
Establish policies and procedures regarding proxy voting, use of client brokerage including soft dollars
Members/candidates should encourage firms to deal with the following topics in manuals:
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Follow all applicable rules and laws
Establish client investment objectives
Consider all information when taking actions
Diversify investments to reduce risk of loss
Carry out regular reviews
Deal fairly with all clients
Disclose conflicts of interest
Disclose compensation arrangements
Determine authorization for voting proxies
Maintain confidentiality
Seek best execution
Place client interests first
Standard III Duties to Clients
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Standard III Duties to Clients
(B) Fair Dealing
Must deal fairly and objectively with all clients when
providing investment analysis, making investment
recommendations, taking investment action, or
engaging in other professional activities
May not discriminate against any clients when
disseminating investment recommendations or taking
investment action
“Fair” treatment does not necessarily mean “equal”
treatment
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Standard III Duties to Clients
(B) Fair Dealing
Recommended Procedures for Compliance (page 1 of 2)
Develop firm policies to
limit the number of people involved
Shorten the time frame between decision and dissemination
Publish guidelines for pre-dissemination behavior
Simultaneous dissemination timing
Maintain a list of clients and their holdings
Develop/document trade allocation procedures
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(B) Fair Dealing
Recommended Procedures for Compliance (page 2 of 2)
With regard to trade allocation procedures -
Document and time stamp orders
Execute orders on a first-in, first-out basis
Develop policies to address prices for partial fill orders and group orders for block trades
Give all client accounts participating in block trades the same execution price and commission
Standard III Duties to Clients
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Standard III Duties to Clients
(C) Suitability (in advisory relationships w/ client)
Make reasonable inquiry into client/prospect financial situation, investment experience, risk and return objectives and financial constraints before actions
Must reassess and update information regularly
Consider suitability before making recommendation or taking action and consider it in the context of the client’s total portfolio
You are responsible for making only investment recommendations and taking actions that are consistent with stated objectives and constraints of the portfolio
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Standard III Duties to Clients
(C) Suitability
At the inception of a relationship, the client’s
needs, circumstances and investment objectives
should be outlined in a written “investment
policy statement” (IPS)
The IPS should be reviewed/updated annually
and prior to making a material change to any
investment recommendation or decisions on
behalf of the client
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Standard III Duties to Clients
(C) Suitability
Recommended Procedures for Compliance
Written investment policy statement:
Client identification
Investor objectives
Investor constraints
Performance measurement benchmarks
Compare the above with capital market
expectations to develop appropriate asset allocation
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(D) Performance Presentation
Make reasonable efforts to ensure that presentation of
performance is fair, accurate and complete
Inform employer (supervisor) about Global
Performance Standards (also known as “GIPS”) and
encourage use
Standard III Duties to Clients
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(D) Performance Presentation
Recommended Procedures for Compliance
Compliance in the absence of GIPS -
Consider knowledge/sophistication of audience
Present performance of a weighted composite of
similar portfolios (rather than using a single account)
Include terminated accounts as part of performance
history
Include disclosures explaining the results
Maintain data and records used for calculations
Standard III Duties to Clients
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Standard III Duties to Clients
(E) Preservation of Confidentiality
Must keep information about current, former, and
prospective clients confidential unless
The information concerns illegal activities on the part
of the client
Disclosure is required by law
The client or prospective client permits disclosure
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Standard III Duties to Clients
(E) Preservation of Confidentiality
Recommended Procedures for Compliance
Simplest, most conservative/effective way to comply is
to avoid disclosing any client information except to
authorized fellow employees working for the client
If considering making disclosure of client information
you should ask:
• What is the context (i.e., is the disclosure relevant to your work?)
• Will the disclosure enable improved client service?
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Standard IV Duties to Employers
(A) Loyalty
Must act for the benefit of employer and not
deprive employer of the advantage of their skills
and abilities, divulge confidential information or
otherwise cause harm to employer
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(A) Loyalty
Must disclose matters that could affect ability to perform duties or render unbiased advice
Must also comply with rules on disclosure of conflicts and any limits imposed to deal with conflict
Consider:
o Whether independent practice could create conflicts
o Whether plans to leave could create conflicts (can’t solicit clients, steal trade secrets, etc.)
o Whether “whistle blowing” is clearly aimed at protecting clients or the integrity of the market and not for personal gain
o Whether scope of responsibilities are clearly defined
o Firm approved social media is considered a firm asset
Standard IV Duties to Employers
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(B) Additional Compensation Arrangements
Must not accept 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 written consent is obtained
from all parties involved
Standard IV Duties to Employers
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Standard IV Duties to Employers
(B) Additional Compensation Arrangements
Recommended Procedures for Compliance
Members and candidates should make an immediate
written report to their supervisor and compliance
officer specifying any compensation they propose to
receive for services in addition to compensation and/or
benefits received from their employer
The report should specify all terms of any agreement
related to compensation (including nature, amount and
duration)
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Standard IV Duties to Employers
(C) Responsibilities of Supervisors
Make reasonable efforts to ensure that anyone subject to
their supervision or authority complies with laws, rules,
regulations and Code/Standards
Develop/implement effective compliance tools including
A code of ethics
Compliance policies and procedures
Education and training programs
An incentive structure that rewards ethical conduct
Adoption of firm-wide best practice standard (e.g., the GIPS standards, the CFA Institute Asset Manager Code of Professional Conduct)
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Standard IV Duties to Employers
(C) Responsibilities of Supervisors
Adopt a code of ethics and compliance procedures
Adequate compliance procedures should:
Be clearly written and accessible
Be easy to understand
Designate a compliance officer
Describe the hierarchy of supervision
Implement a system of checks and balances
Outline the scope of the procedures
Provide for monitoring/testing
Outline permissible conduct
Delineate procedures for reporting violations
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Standard V Investment Analysis, Recommendations, and Actions
(A) Diligence and Reasonable Basis
Members and candidates must –
Exercise diligence, independence, and thoroughness in
analyzing investments, making recommendations and
taking investment actions
Have a reasonable and adequate basis supported by
appropriate research/investigation
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(A) Diligence and Reasonable Basis
Recommended Procedures for Compliance
Members/Candidates should encourage firms to consider:
Establish a policy requiring research reports and recommendations have a basis that can be substantiated as reasonable and adequate
Develop detailed written guidance for analysts
Develop measurable criteria for assessing quality of research
Establish minimum levels of scenario testing
Establish measurable criteria for outside providers
Adopt standardized criteria for external advisers
Standard V Investment Analysis, Recommendations, and Actions
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(B) Communication - Clients / Prospective Clients
Disclose basic format and general principles of the investment process and promptly disclose changes that might materially affect those processes
Disclose significant limitations and associated risks
Use reasonable judgment in identifying factors important to analyses, recommendations, or actions; include these factors in client communications
Distinguish between fact and opinion when presenting investment analysis and recommendations
Standard V Investment Analysis, Recommendations, and Actions
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(C) Record Retention
Develop and maintain appropriate records supporting
investment analysis, recommendations, actions and
other investment-related communications with clients
and prospective clients
In the absence of regulatory guidance, CFA Institute
recommends maintaining records for at least 7 years.
Standard V Investment Analysis, Recommendations, and Actions
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Standard VI Conflicts of Interest
(A) Disclosure of Conflicts
Make full and fair disclosure of all matters that could
reasonably be expected to impair independence and
objectivity or interfere with respective duties to their
clients, prospective clients, and their employer
Ensure that such disclosures are prominent, are delivered
in plain language, and communicate relevant information
effectively
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Standard VI Conflicts of Interest
(A) Disclosure of Conflicts
Recommended Procedures for Compliance
Should disclose special compensation arrangements with
employer that might conflict with client interests (for
example, short-term bonuses, commissions, incentive
fees, performance fees, and referral fees)
Firms are encouraged to include information on
compensation packages in promotional literature
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Standard VI Conflicts of Interest
(B) Priority of Transactions
Investment transactions for clients and employers must
have priority over investment transactions in which a
member or candidate is the beneficial owner
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Standard VI Conflicts of Interest
(B) Priority of Transactions
Recommended Procedures for Compliance
Firms should adopt certain basic procedures to address conflict areas created by personal investing. These include:
Limited participation in equity IPOs
Restrictions on private placements
Establish blackout/restricted periods
Reporting requirements o Disclosure of holdings (of employee’s beneficial interest(
o Providing duplicate confirmations of transactions
o Pre-clearance procedures (prior to execution of trades)
Disclosure of firm policies (on request)
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Standard VI Conflicts of Interest
(C) Referral Fees
Members and candidates must disclose to their employer,
clients, and prospective clients, as appropriate, any
compensation, consideration, or benefit received from, or
paid to, others for the recommendation of products or
services
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Standard VII Responsibilities as a CFA Institute Member or CFA Candidate
(A) Conduct as Participants in CFA Institute Programs (e.g. CIPM and Claritas)
Must not:
Engage in any conduct that compromises the reputation or integrity of the CFA Institute or the CFA designation or the integrity, validity or security of the CFA examinations
This includes:
o cheating on the CFA examination
o disregarding CFA program rules
o improperly using CFA designation
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(B) Reference to the CFA Institute, the CFA Designation, and the CFA Program
Must not misrepresent or exaggerate meanings or implications of membership in the CFA Institute, holding the CFA designation or candidacy in the CFA Program
Improper references: o CFA, Level II
o CFA, expected [year]
o CFA charterholders achieve better performance results
o As a CFA charterholder, I am the most qualified to manage investments
Standard VII Responsibilities as a CFA Institute Member or CFA Candidate
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Proper references: Completion of the CFA Program has enhanced my portfolio
management skills
I passed all three CFA examinations in three consecutive years
As a CFA charterholder I am committed to the highest ethical standards
I passed Level I of the CFA examination
I am a [year] Level III CFA candidate in the CFA Program
CFA Logo is available for individual use only
Standard VII Responsibilities as a CFA Institute Member or CFA Candidate