CFA Level 1 – Ethics Exam 2023 with complete solutions

6 components of the CFA Code of Ethics? - Answer- PEJMAR Priority - Always put your client's interests first. Encourage - Practice and encourage others to act professionally and ethically to reflect credit on yourself and the profession. Judgment - use reasonable care and judgment when performing all professional activities. IE conducting investment analysis, making investment recommendations, taking investment actions. Maintain - keep your knowledge up to date and encourage other professionals to do the same. Actions - employ integrity, competence, diligence, and respect in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession. Rules - promote the integrity of capital markets by following the rules. What are the Standards of Professional Conduct? - Answer- I. Professionalism II. Integrity of Capital Markets III. Duties to Clients and Prospective Clients IV. Duties to Employers V. Investment Analysis, Recommendations, and Actions VI. Conflicts of Interest VII. Responsibilities as a CFA Institute Member or CFA Candidate What is Standard I? - Answer- Professionalism I-A: Knowledge of the Law I-B: Independence and Objectivity I-C: Misrepresentation I-D: Misconduct Standard I-A? - Answer- "Knowledge of the Law: covers laws, rules and regulations" M&C must understand and comply with all applicable laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional Conduct) of any govt, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of conflict, M&C must comply with the more strict law, rule or regulation. M&C must not knowingly participate or assist in and must disassociate from any violation of such laws, rules, or regulations. What are the types of exam questions you can expect regarding applying Standard I-A? - Answer- Standard I-A covers laws, rules and regulations, will be tested on some possible violation of the law, and how a CFA Member or Candidate should proceed. The following questions may apply: Did the Member seek the advice of counsel? Consulting an attorney is typically seen as a good defense against an alleged violation of Standard I-A. Many cases involve someone who works for a firm that has violated the law (made misleading statements on a prospectus, for example). In these cases, look to see if the CFA member or candidate sought and followed the advice of counsel. Did the member report the violation, and to whom did the member report it? For any potential violation of a law, rule or regulation, if the situation suggests that the member either went along with it, did nothing, tried to cover it up or was afraid to say anything for fear of losing his or her job that is a clear sign that the Standard has been violated. In any example, look for evidence that the CFA member tried to do the right thing. If that person's firm is potentially guilty of violating a law or regulation, he or she needs to start by reporting this situation to his or her supervisor and/or compliance officer. If the situation is not remedied, he or she should distance him or herself from the potential violation and seek the advice of counsel. For multinational operations, which country's laws apply to the situation at hand? In the real world, it can be ambiguous if an advisor is domiciled in one country and operates in another. For the purposes of the CFA Level I exam, the candidate isn't expected to be a lawyer and make a judgment - the exam will indicate which country's laws apply to the situation. If a broker or advisor operates solely or exclusively in a country, assume that those laws apply unless it's stated otherwise. The rule of thumb (which states it's the law that applies if it's stricter than the Standards; otherwise, the Standards apply) is usually going to make it easy to arrive at the right answer. How can you comply with Standard I-A? - Answer- The Standards of Practice Handbook makes a number of suggestions to avoid violating Standard I-A. •Establish Files - These would cover all applicable laws, rules, regulations, statutes and important cases that might be relevant to any potential business situation involving the firm. Files must be readily accessible and a process to manage, distribute and interpret such material should be in place. •Stay Informed - Laws, rules and regulations frequently change, and key employees in a firm must be informed continually of such changes. CFA M&C are obligated to establish, or encourage others to establish, a procedure by which everyone in a firm is kept informed and applicable changes are disseminated in a timely manner. This procedure is the domain of the firm's counsel or compliance department. There are a number of real-world cases in which everyone just assumed that a certain person or department was taking care of it. •Distribution Area Laws - In an increasingly global marketplace, MC& must make every effort to understand the laws of the country or region in which they operate, including those where their products or services are distributed across borders. •Legal or Illegal? - Certain conduct may not in fact be a violation. Members should consult counsel in ambiguous situations. •Disassociate - This is a good word and a worthwhile course of action. It is good advice: it may have been OK at some time in the past to do nothing if one witnessed illegal or unethical conduct, but in today's environment, the Standards have changed. One must now disassociate from any illegal activity and actively urge the firm (either an immediate supervisor or a compliance officer) to cease any conduct that violates the law or an applicable regulation or standard. Inaction might be judged, (even in a court of law), as participating or assisting, which violates the Standard. What is Standard I-B? - Answer- "Independence & Objectivity: maintain integrity and avoid conflicts of interest" M&C must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. M&C 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. What are the types of exam questions you can expect regarding applying Standard I-B? - Answer- Applying Standard I-B, Complying with standards of independence and objectivity seems simple and straightforward in theory, but in practice there are many scenarios that could potentially conflict with one's objectivity - or create the appearance of doing so. In many cases it is not so easy to define the proper course of action. Here are some of the situations that are more likely to appear on the exam: •A company sponsors an analyst conference and picks up all the expenses. Consider a situation where a firm invites all Wall Street analysts who are actively covering its company to go on an all-expenses-paid trip to tour facilities, play golf, stay in a swanky resort and so forth, all in the hopes of promoting itself and earning more favorable coverage. For analysts bound by the Code and Standards, would this sort of outing compromise their objectivity? The answer is that it just might. This Standard requires CFA members to assess if such an outing is possible while still maintaining objectivity - would they still be able to write an unfavorable opinion, if warranted by independent analysis? Many firms have created policies that require attendance at such affairs to be paid by the firm and require the itinerary to be substantially business-related as a condition of attending. No specific checklist of right and wrong is written into this Standard, but the mere appearance of conflict is a real issue in today's environment and one must be sensitive to perception. •A financial firm promises to provide research coverage of a company's stock in return for a potential business relationship. This agreement is acceptable so long as there is absolutely no requirement to make the recommendation a favorable one. This standard requires that any conclusions be made in an independent and objective manner. •In the previous example, the relationship manager asks for a favorable recommendation for the new corporate client. This case would violate Standard I-B. If the relationship manager is concerned that an unfavorable research opinion will adversely affect the cultivation of this relationship, the research department would need to restrict the company from analyst coverage and only provide factual information without any specific recommendation. Under no circumstances can the corporate client be seen as "buying" a favorable analyst opinion. •A research analyst assigned to a new sector is told by the director of research not to change the investment opinion on a certain company. This type of supervision would violate the analyst's requirement to reach an independent conclusion. If the analyst is a CFA Member or Candidate, he or she should proceed by informing the supervisor that he or she is bound by the Code and Standards, and that such a restriction is not permitted by the Standard on Independence and Objectivity. Another approach would be to study the company, reach an independent conclusion and share this opinion with the director of research, but leave it to the supervisor to decide the appropriate course of action. •A portfolio manager receives an expensive vacation package from a brokerage as a sign of gratitude for all the business. Accepting such a perk is a violation, as it compromises the manager's objectivity in regards to choosing brokers that suit the best interests of the clients and the firm (the broker offering the best execution, for example). This manager would be in compliance with Standards if he or she disclosed the perk in writing to his or her immediate supervisor. If the firm required this manager to refuse the vacation package, he or she would be required to abide by the decision of the firm. •A portfolio manager is sent two extra tickets to a local baseball game (face value $30 each), complements of the same brokerage. Given the rule of thumb that gifts lower than US$100 are perceived as sufficiently modest and are thus acceptable from both clients and business partners, the portfolio manager would not be violating Standard I-B, even if the perk went unreported. At the same time, it's a sensible practice to disclose even gifts of this nature - the Standards of Professional Conduct describe minimum standards, but staying in the habit of full disclosure should always be the preferred course of action. •A CFA member who is also a member of the local society of financial analysts solicits corporate financial support for an investor conference and issues research reports on some of those same firms. Research opinions must be unbiased. However, when an analyst takes on an outside role, how will these secondary activities influence the research? If a firm pledges generous support to this analyst, will the analyst's future research reports become more favorable? If another firm declines support, will a report on that company be less favorable? The best course of action would be to trade the coverage of those firms with a colleague, or to ask to be excused from seeking sponsors. How can you comply with Standard I-B? - Answer- The Standards of Practice Handbook provides a number of operational suggestions that one should recommend for adoption by the compliance department. •Highlight the integrity of the research - Establish that research opinions reflect unbiased opinions, and include this wording on all written reports. Salary and bonuses should be independent of any factors that might compromise the degree of independence - i.e. don't tie a quarterly bonus to the fees collected from corporate relationships (which can be affected by a stock recommendation). •Disclose conflicts of interest - For example, a directorship in a public company would need to be acknowledged by the employer, as this fact may affect research opinions of that company and of competitors. Research reports should disclose whether the analyst owns shares in a company and whether the analyst's firm makes a market in that security or has underwritten the security. •Limit direct investments in equity or equity-related IPOs - Investment firms should establish formal policies relative to employee purchase of equity and equity-related IPOs and require prior approval. •Report holdings - Report holdings in all personal accounts, those of one's immediate family and those over which the analyst has formal discretion (e.g. trusts). •Establish a restricted list - This is to limit research on those firms that have a business relationship with that company. If an adverse opinion would hurt this business relationship, the company stock should be restricted from the research universe, and only factual information on the company should be disseminated. •Cost reimbursement procedures - Identify what is acceptable and what is unacceptable practice in order to avoid the appearance of a conflict. While there is no specific checklist in the Standards, the general rule of thumb is that air transport, ground transport and hotel accommodations should be the responsibility of the individual and his or her company, and should not be covered by (for example) the issuer of a security that an analyst has started to cover. The reason that no checklist has been developed is that there are always exceptions - for example, if the issuer of a preferred security is an energy company that is headquartered in a sparsely populated area (near its coal mines) and commercial transport is not available, and the only practical way to arrange a face-to-face meeting is by using a corporate jet, then an analyst can accept such an arrangement without violating this Standard. •Limit gifts - Gifts should be limited to a maximum value of US$100. •Periodically review guidelines - This is to reinforce dos and don'ts for all employees and determine whether additional guidelines are sensible. •Compliance Officer - Firms should appoint a senior-level compliance officer who ensures the code of ethics and all regulations are upheld. What is Standard I-C? - Answer- "NO Misrepresentation" M&C must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. What are some examples of violations of Standard I-C? - Answer- Plagiarism: •Putting your name on another analyst's research report. •Including a large portion of another analyst's report in your own (either verbatim or with slight modifications) without crediting the original author. •Neglecting to specifically give credit to a person who has been quoted. For example, saying "a top analyst in the field suggests..." would be a violation. •When including financial data, you neglect to include any caveats that must be included with that data. Although this is not plagiarism, it is still a violation of the Standard. What are some categories of information that are often misrepresented? - Answer- •Average year of experience of investment personnel - someone just left and his info needs to taken out of the average calculation •Professional services - For example, small financial services firms tend to specialize in a given area, such as 401(k) planning or insurance products or tax preparation. A CFA member in charge of such a firm cannot hold himself out to be a comprehensive provider of all these financial needs. •Professional credentials - A recent college graduate and CFA candidate passes one of the FINRA licensing exams and then holds herself out as a licensed investment advisor and portfolio management expert, printing these titles on marketing brochures. •Expected return on an investment - A representative from a bank makes a presentation on a mutual fund that specializes in real estate, saying the following: "You want to allocate a portion of your diversified portfolio to real estate. This fund is up 98% over the last four years, and when you add that 98% gain to your account for the next four years, it will offset the stagnant cash and bond investments and allow you to reach your goals." •Expected risk on an investment - Derivative securities of fixed income products are sometimes described as "government guaranteed" when in fact the interest portion fluctuates and will decline in periods of high interest rates. Using the idea of a guarantee masks the true risk of the security. How can you comply with Standard I-C? - Answer- •Define firm's limits - Continually reinforce what the company can and cannot do. Provide clear guidance to sales and marketing specialists who may have an inclination to promote without restraint, if left unsupervised. The line between appropriate and inappropriate exaggerations can be subtle. •Describe firm's services - Ensure that all contact people are discussing the firm's capabilities in a manner that is accurate and suitable. •Identify authorized spokespeople - Who can speak on behalf of the organization? The essential message can be controlled by simply limiting who may provide it. •Assign the support staff - These should be reliable people who will keep written and electronic materials updated and avoid unintentional misrepresentations. •Prepare a resume - Do this for each key employee, specifying important credentials and capabilities as it relates to the company. Avoiding Plagiarism •Maintain research files - By keeping a comprehensive paper trail of the process by which all investment ideas are generated and the specific source of all research materials cited in preparing a report, the analyst protects him or herself from charges that these findings or ideas were plagiarized. •Use direct quotes - Do this if an idea is going to be borrowed, and attribute the source of all directly quoted passages, as well as all statistics, charts, tables and other material that was developed and published by another source. •Obtain permission - If the report is to be publicly disseminated, get permission to use any material that is copyrighted by a publisher. In the case of quantitative financial models, the originator of the model may have licensed its use, and a fee may be required in addition to acknowledgment. •Attribute paraphrased or summarized material - While this material does not necessarily meet the stated definition of plagiarism, it should be attributed to its rightful source. For example, a lengthy research report on General Motors may include summaries on Ford, DaimlerChrysler and Toyota that were written by other analysts, mostly to give some context to the GM analysis. Even in summarized format, these commentaries have been borrowed from others, and in a spirit of fairness, proper credit should be explicitly offered. What are some potential case studies related to Standard I-C that you should consider? - Answer- Plagiarism - Case Studies As with other Standards, a number of situations could be presented on the exam that may (or may not) violate this Standard, giving rise to a number of potential questions and qualifying explanations. These are the most important to consider. •Does an owner or managing partner have a responsibility to specifically attribute ideas or information to other members of his or her firm? The short answer: it depends. If the owner is purely acting as a representative of the firm - for example, making a presentation to a client or a prospective client - he or she can disseminate information from the firm's research department without taking the additional time to credit each individual researcher and each particular contribution someone might have made to that presentation. However, take a case where a product from a firm's quantitative research process has become recognized by the public. Let's say Bob Wilson, the owner of this firm and a CFA, is asked to appear in an industry symposium on quantitative techniques. Wilson did not actually develop the ideas or techniques himself; rather, this work was accomplished by members of the research department. However, in the context of the industry symposium, Wilson has been invited as a leading expert on quantitative research methods, and he is thus representing himself, not the firm. At the conference, he would be obligated, under Standard I-C, to give specific cr