Study Notes for Professional Standards and Ethics for CFA Level 1. Unedited, but still useful.
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CFA LEVEL 1 MOCK TEST
2016, Study Session # 1, Reading # 1
“CODE OF ETHICS AND STANDARDS OF PROFESSIONAL CONDUCT” Los1.a M&C = Members & Candidates COE = Code of Ethics SOPC = Standards of Professional conduct BOG=Board of Governors PDP=Professional Development Program
CFAI PCP ⇒ covered by CFAI Bylaws & Rules of Procedures for Proceeding Related to Professional Conduct. PCP is based on principles of fairness to M&C & confidentiality of proceedings. DRC of CFAI BOG ⇒ responsible for PCP & enforcement of code & standards.
CFAI = CFA Institute PCP = Professional Conduct Program DRC = Disciplinary Review Committee PCS = Professional Conduct Statement
Circumstances Which Can Prompt Inquiry
Self disclosure by member/candidate on PCS which comprehensively questions professional conduct such as involvement in civil litigation, criminal investigation or any complaint (written) against the member/candidate etc.
Written complaints about member/staff received by professional conduct staff. Evidence of misconduct by member/candidate received by professional conduct staff through public source. A report by CFA proctor of a possible violation during examinations. CFAI designated officer conducts inquiries. Professional conduct staff (in writing) may request explanation from subject member/candidate & may: Interview the subject member/candidate. Interview the complainant / third party. Collect relevant document & records. Designated officer may decide: Disciplinary sanctions are not required. Issue a cautionary letter. To discipline the member/candidate. If disciplinary sanction is proposed, the subject member/candidate may accept the sanction. If sanction is rejected ⇒ matter may be referred to CFAI panel for hearing. Sanctions may include. Condemnation by member’s peers. Suspension of candidate’s continued participation in CFAI program.
Los1.b Act with integrity, competence, diligence, 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 of and uphold the rules governing capital markets. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.
“GUIDANCE FOR STANDARDS I-VII” M&C = Members & Candidates COE = Code of Ethics SOPC = Standards of Professional conduct BOG=Board of Governors PDP=Professional Development Program
1. Professionalism 1 A. Knowledge of Law M&C must understand & comply with all applicable laws, rules & regulations (including COE & SOPC). These rules & regulations pertain to any govt., regulatory organization, licensing agency or professional association governing their professional activities. Must comply with more strict law in case of conflict. M&C must not knowingly participate or assist & must dissociate from any violation of laws. Guidance ⇒ Code & Standards VS Local Law Members must know laws & regulations related to their professional activity in all countries where they conduct business. Adhere to more strict rule while deciding b/w local laws & Codes & Standards of CFAI. Must comply with local laws related to professional activity. Never violate Codes & Standards even if activity is otherwise legal.
Guidance ⇒ Participation in or Association with Violation by Others Members must dissociate or separate themselves from any ongoing client or employee activity which is illegal or unethical. In extreme case they may have to leave the employer. May, at first, confront the individual involved. Approach supervisor or compliance department. Inaction with continued association may be construed as knowing participation.
Recommended Procedures for Compliance-Members Members must make themselves updated with applicable laws, rules & regulations. Compliance laws must be reviewed on an ongoing basis in order to ensure that they address prevailing laws, CFAI standards & regulations. Members should maintain current reference material for employees in order to keep up-todate on laws, rules & regulations. In doubt members should seek advice of counsel or their compliance department. Members must document any violation when they disassociate from prohibited activity. Members must encourage their employers to end such activity. Under some circumstances it may be advisable or otherwise required by the law to report violations to governmental authorities. Standards (CFAI) do not require members to report violations to governmental authorities. CFAI encourages members, clients & public to submit written report against a CFA member or candidate involved in violation of the CFA Code & Standards
Recommended Procedure for Compliance-Firms Members should encourage their firms to: Develop and/or adopt a code of ethics. Highlight applicable laws and regulations to employees. Establish written procedures for reporting suspected violation of laws, regulations or company policies. Members incharge of supervision, creation and maintenance of investment services should: Be aware of and comply with regulations and laws in their country of origin. They must be aware of and comply with regulations of countries where products/services will be sold.
CFAI = CFA Institute PCP = Professional Conduct Program DRC = Disciplinary Review Committee PCS = Professional Conduct Statement
2016, Study Session # 1, Reading # 2 1 B. Independence & Objectivity M&C must use reasonable care & judgment to achieve & maintain independence & objectivity in professional activities. Not accept any gift, or any type of consideration that may compromise their own or another’s independence & objectivity.
Investment process must not be influenced by any external sources. Modest gifts by clients are permitted. Allocation of shares in oversubscribed IPO to personal accounts is not permitted. Distinguish b/w gifts from clients & entities seeking influence to the detriment of the client. Gifts must be disclosed to the member’s employer either prior to acceptance or subsequently.
Guidance-Investment Banking Relationships Do not get pressurized from sell-side analyst to issue favorable research on current or prospective investment-banking client. Disclose conflicts and manage these appropriately while working with investment bankers in “road shows”. Ensure effective “firewalls” b/w research/investment management & investment banking activities.
Guidance-Public Companies Do not limit research to discussions with company management. Use sources like: Suppliers Customers Competitors Analyst must not be pressured to issue favorable research by the companies they follow.
Guidance-Buy Side Clients Responsibility of portfolio managers to respect and foster intellectual honesty of sell side research. Portfolio managers must not pressure sell side analysts. They may have large positions in particular securities; rating downgrade may adversely affect portfolio performance. Guidance-Fund Manager Relationships Members responsible for selecting outside managers should not accept gifts, entertainment or travel that might be perceived to impair member’s independence and/or objectivity. Guidance-Credit Rating Agency Members employed by credit rating agencies make sure they prevent undue influence by security issuing firms. Members using credit ratings must be aware of potential conflicts of interest & therefore may consider independent validation of the rating granted.
2016, Study Session # 1, Reading # 2 Guidance-Issuer Paid Research Analyst’s compensation for such researches should be limited. Preference is flat fee. No reward must be attached with report’s recommendation.
Guidance-Travel Best practice ⇒ analysts should pay for their own commercial travel while attending information events or tours sponsored by the firm being analyzed.
Recommended Procedures for Compliance Protect the integrity of opinions (unbiased opinion of the analyst) & design proper compensation systems. Create a restricted list (remove the controversial company from research universe). Restrict special cost arrangements (limit the use of corporate aircraft to situations in which commercial transportation is not available). M&C should pay for commercial transportations & hotel charges. Limit the acceptance of gratuities and/or gifts to token items only. Develop formal policies related to employee purchases of equity or equity related IPOs (strict limits on private placements). Effective supervisory & review procedures. Ensure that research analysts are not supervised or controlled by any department that could compromise the independence of analyst. Appoint a senior officer with oversight responsibilities for compliance with firm’s COE & all regulations concerning its business.
1 C. Misrepresentation M&C must not knowingly make any misrepresentations relating to investment analysis, recommendation, actions or other professional activities.
Guidance Misrepresentation causes mistrust. Don’t give false impressions in oral, written & electronic communication. Misrepresentation includes. Guaranteeing investment performance. Plagiarism. Plagiarism ⇒ using someone else’s work without giving him credit. Misrepresentation also includes deliberately omitting information that could affect investment decision. Models and analysis developed by others at firm are the property of firmmembers can use them. A report written by another analyst employed by the firm cannot be released as another analyst’s work.
Recommended Procedure for Compliance Firms should provide employees who deal with clients a written list of firm’s available services and its qualifications. Employee qualification should be accurately presented as well. To avoid plagiarism firm must keep record of all sources and cite them. Generally understood and factual information need not to be cited. Members should encourage firms to establish procedures for verifying marketing claims of third parties whose information the firm provides to clients.
2016, Study Session # 1, Reading # 2 1 D. Misconduct M&C must not engage in dishonesty, fraud, deceit or commit any act that reflects adversely on their professional reputations, integrity or competence.
Guidance CFAI discourages unethical behavior in all aspects of members’ and candidates’ professional lives. Do not abuse CFAI PCP by seeking enforcement of this standard to settle personal, political or other disputes not related to professional ethics. Recommended Procedures for Compliance Firms are encouraged to adopt these policies and procedures to: Develop and adopt a code of ethics and make clear that unethical behavior will not be tolerated. Give employees a list of potential violations and sanctions including dismissal. Check references of potential employees.
2. INTEGRITY OF CAPITAL MARKETS 2 A. Material Nonpublic Information M&C must not act or cause others to act on the information that is material nonpublic (affect the value of investments). Guidance Material information ⇒ if disclosure would impact price of security. If reasonable investor would want the information before making an investment decision. Nonpublic information ⇒ not available to the marketplace. Analyst conference call is not public disclosure. Selective disclosing causes insider-trading. Prohibition against acting on material nonpublic information extends to securities, swaps, and option contracts.
Guidance-Mosaic Theory No prohibition on reaching an investment decision through public and nonmaterial nonpublic information.
Recommended Procedures for Compliance Make reasonable efforts to achieve public dissemination of information. Encourage firms to adopt procedures to prevent misuse of material nonpublic information. Use a “firewall” within the firm with Substantial control of relevant interdepartmental communication through a clearance like compliance/legal department. Review employee trades maintain watch, rumor, and restricted lists. Monitor & prohibit proprietary trading-if a firm is in possession of material non-public information. Prohibiting all proprietary trading may send a signal to the market firm should take the contra side of only unsolicited customer trades.
2016, Study Session # 1, Reading # 2 2 B. MARKET MANIPULATIONS M&C must not engage in practices that mislead market participants (distort prices or artificially inflate trading volume). Guidance Spreading false rumors is prohibited (which can distort market). Standard applies to transactions that deceive market. By distorting the price-setting mechanism of financial investments. Securing a controlling position in a financial instrument to manipulate the price of a related derivative or the asset.
3. DUTIES TO CLIENTS
3 A. Loyalty, Prudence & Care M&C: Have a duty of loyalty to clients & must act with reasonable care & exercise prudent judgment. Must act for benefit of clients & place their clients’ interests before their employer’s or own interests.
Guidance M&C must exercise same level of prudence, judgment & care as in management & disposition of their own interests in similar circumstances. M&C should manage pool of assets in accordance with the terms of governing documents (e.g. trust documents). Determine the identity of “client’” to whom duty of loyalty is owed. (May be an individual or plan beneficiaries in case of pension plan or trust). M&C must follow any guidelines set by their clients for the management of their assets. Investment decisions are judged in context of total portfolio rather than individual investments. Conflict arises when “soft dollars” are not used for benefits of clients. Cost-benefit analysis may show that voting all proxies may be not a beneficial strategy for clients.
Recommended Procedures of Compliance
M&C with control of client assets should submit to each client at least quarterly, a statement showing funds & securities. In doubt, M&C should disclose the questionable matter in writing to client & obtain client approval. M&C should address & encourage their firms to address the following regarding duties to client; Follow all applicable rules & laws. Establish the investment objectives of the clients. Consider all the information when taking actions. Diversify investments to reduce risk of loss. Carry out regular reviews. Deal fairly with all clients with respect to investment actions. Disclose conflict of interest & compensation arrangements. Maintain confidentiality & seek best execution.
2016, Study Session # 1, Reading # 2 3 B. Fair Dealing
M&C must deal fairly & objectively with clients (when providing investment analysis, making recommendations, taking action or engaging in other professional activities).
Guidance No discrimination among clients while disseminating recommendations or taking investment decision. Fairly does not mean equally ⇒ difference in timings of emails & fax received by clients are normal course of business. Different services levels are okay as far as they do not adversely affect any client. Disclose different levels of services to all clients and prospects. Premium services should be available to all those who are willing to pay for them.
Guidance-Investment Recommendation All clients must be given fair opportunity to act upon every recommendation. Clients unaware of change in recommendation should be advised before the order is accepted.
Clients must be treated fairly in the light of their investment objectives and circumstances. Both institutional and individual clients must be treated in a fair & impartial manner. Member/candidates should not take advantage of their position to disadvantage clients (e.g., in IPOs).
Recommended Procedures for Compliance
Firms are encouraged to establish compliance procedures to treat customers & clients fairly. Communicate recommendations simultaneously within the firm & to customers. M&C should consider the following: Limit the no. of people who are aware that a recommendation is going to be disseminated. Shorten the time frame b/w decision & dissemination. Publish guidelines for pre-dissemination behavior. Simultaneous dissemination (treat all clients fairly). Maintain a list of clients & their holdings. Develop & document trade allocation procedures. Disclose trade allocation procedures (must be fair & equitable). Establish systematic account review (no preferential treatment to any client or customer). Disclose level of services (different levels of services are possible for same or different fees).
3 C. SUITABILITY
2. M&C are in advisory relationship
Make inquiry into client’s investment experience, risk & return objectives, financial constraints & reassess & update this information regularly.
Determine investment’s suitability with reference to client’s objective & constraints & mandate.
Judge investment suitability in context of client’s total portfolio.
1. When M&C are responsible for a portfolio with a specific mandate, strategy or style, they must take actions according to stated objectives & constraints of portfolio.
Develop IPS at beginning of the relationship. Consider client’s needs, circumstances & risk tolerance. Consider whether use of leverage is suitable for the client or not. Make sure to abide by the stated mandate.
Recommended Procedures for Compliance Develop written IPS of each client & take the following into consideration: Client identification. Investor objectives. Investor constraints. Performance measurement benchmark Objectives & constraints should be maintained & reviewed periodically to reflect any changes in clients’ circumstances. Suitability test policies.
3 D. Performance Presentations
M&C must communicate fair, accurate & complete investment performance information.
Guidance Members must avoid misstating performance or misleading clients about investment performance of themselves or their firms. Members should not misrepresent past performance or reasonably expected performance. Members should not state or imply the ability to achieve a rate of return similar to that achieved in the past. Brief presentations should be supplemented with information that detailed report is available on request. Recommended Procedures for Compliance
Apply GIPS standards. Consider the knowledge of audience to whom performance presentation is addressed. Performance of composite rather single account. Include performance history of terminated accounts. Disclosures that fully explain the performance results being reported. Maintain data & records used to calculate the performance being presented.
3 E. Preservation of Confidentiality M&C must keep information about current, former & prospective clients confidential unless: Information concerns illegal activity. Disclosure is required by law. Client or prospective client permits disclosure.
Guidance If a client is involved in illegal activities members may have an obligation to report to the authorities. This standard extends to former clients as well. Standards do not prevent members from cooperating with CFA PCP investigation.
Recommended Procedures for Compliance Avoid disclosing information received from client except to authorized colleagues working for the same client. Follow firm’s procedures for storing electronic data. Recommend adoption of such procedures if they are not in place.
4. Duties to Employers
A. Loyalty M&C: Must act for the benefit of their employer. Not deprive employer of the advantage of their skills &abilities, divulge confidential information or otherwise cause harm to their employer.
Guidance Do not indulge in the activities that may injure the firm deprive it of profit or advantage of employee’s abilities & skills. Though client’s interests are priority than firm’s but one should consider the effects of conduct on firm’s integrity and sustainability. A careful balance b/w managing interests of employer & family manage such obligations with work obligations.
Guidance-Employer Responsibility Should not have incentive or compensation system that encourages unethical behavior. Members are encouraged to give their employers a copy of Code & Standards.
Guidance-Independent Practice Independent practice for compensation is allowed. Provide employer notification fully describing all aspects of service. Compensation details Duration Nature of activities Employer’s consent is required.
2016, Study Session # 1, Reading # 2 Guidance-Leaving an Employer Continue to act in employer’s best interest until resignation is effective. Activities that may constitute a violation include: Misappropriation of trade secrets Misuse of confidential information Soliciting employer’s client prior to leaving Self-dealing Misappropriation of client lists. Employer records on home computers, PDA, cell phones or any other medium are property of firm. After leaving the organization, simple knowledge of names and existence of former clients is not confidential. Member/candidate can use the experience or knowledge gained with former employer at any other organization.
Guidance Whistle-blowing In exceptional cases, duty to the employer may be violated in order to protect a client or upholding the integrity of capital markets. Whistle- blowing cannot be done for personal gains.
Guidance-Nature of Employment
If members/candidates are independent contractors, they still have duty to abide by the terms of the agreement.
Recommended Procedures for compliance
Competition policy (employer restrictions on offering similar services outside the firm). Termination policy (how termination is disclosed to clients & staff). Incident-reporting procedures. Employee classification (e.g. full time, part time).
4 B. Additional Compensation Arrangements
M&C 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 they obtain written consent from all parties involved.
Guidance Compensation includes both direct & indirect form. Additional benefits are also included. Written consent from employer also includes email communication.
Recommended Procedures for Compliance Immediately report to employer in written form detailing any proposed compensation and services. Performance incentives should be verified by the offering party.
M&C must make efforts to detect & prevent violations of applicable laws, rules & regulations and Code & Standards by any one subject to their supervision or authority. Guidance Members must take steps to prevent subordinates from violating laws, rules, regulations or code & standards. Make reasonable efforts to detect violations. Members with supervisory responsibility must ensure that policies regarding investment or non-investment behavior are enforced equally.
Guidance-Compliance Procedures Members with supervisory responsibility must bring an inadequate compliance system to the firm’s attention and recommend corrective action. While investigating a violation it is appropriate to limit suspected employee’s activities. Unless adequate procedures are adopted by the firm, a member must decline in writing from accepting supervisory responsibility.
Recommended Procedures for Compliance M&C should recommend to their employers to adopt a COE. Separate the COE from compliance procedures. Adequate compliance procedures: Clearly written & accessible manual. Designate a compliance officer to implement compliance procedures. Implement system of checks & balances. Describe the hierarchy of supervision. Outline scope of procedures & permissible conduct. Once a compliance program is in place, a supervisor should: Disseminate program contents to appropriate personnel & educate them regarding compliance procedures. Professional conduct evaluation as part of employee’s performance review. Review employee’s actions & identify violation. Once a violation is discovered, supervisor should respond promptly, conduct thorough investigation & increase supervision.
2016, Study Session # 1, Reading # 2 5. Investment Analysis, Recommendations and Actions 5 A. Diligence & Reasonable Basis
2. M&C must exercise diligence, independence & thoroughness in investment analysis, recommendations & actions.
1. M&C must have a reasonable & adequate basis for investment analysis, recommendation or action (supported by research & investigation).
Guidance-Reasonable Basis Level of research for due diligence depends on product/service offered. Prior to making recommendation or investment action consider; Firm’s financial results, operating history & business cycles stage. Mutual fund’s fee & past performance. Limitation of any quantitative methods used. Appropriateness of peer group comparisons.
Guidance-Using Secondary or Third-Party Research
To periodically review quality of third party research use the following: Review assumptions used. How rigorous was the analysis. How timely the research is. Evaluate objectivity & independence of recommendations.
Guidance-Quantitative Research Able to explain the nature of quantitative methods used. Consider scenarios which are not typically used to assess downside risk. Ensure that both positive & negative results have been used.
Guidance-External Advisers Ensure advisors have adequate compliance and internal controls. They present correct return information. Do not deviate from stated strategies.
Guidance-Group Research & Decision Making If a conclusion or recommendation derived from group research has a reasonable basis, do not refuse to be identified with the report merely on the basis of disagreement with the consensus view. Recommended Procedures for Compliance
Policy requiring that research reports, credit ratings & investment recommendations have a reasonable & adequate basis. Develop written guidance for analysts, supervisory analysts & review committees. Develop measureable criteria for research report quality assessment. Written guidance for computer-based models used in developing rating, &, evaluating financial instruments. Develop measurable criteria for assessing outside providers. Standardized set of criteria for evaluating the adequacy of external advisers.
5 B. Communication with Clients and Prospective Clients
M&C must: Disclose to clients & prospective clients the basic format & general principals of investment processes & disclose any change that materially affects those processes. Identify important factors (related to investments) & communicate with clients & prospective clients. Distinguish b/w fact & opinion (in investment analysis & recommendations). Guidance
Always include basic characteristics of security identified. Distinguish b/w facts and opinions. Illustrate investment decision making process utilized. All means of communication should be included not only the research reports. Communicate any specific risk factors associated with securities. Clearly communicate potential gains & losses. Failing to illustrate model’s limitations may be considered as violation. Recommended Procedures for Compliance Able to supply additional information if requested maintain relevant information.
5 C. Record Retention
M&C must develop & maintain appropriate records that support investment analysis, recommendations, actions & other investment related communications with clients & prospective clients.
Maintain records that support conclusion or any investment action. Such records are property of the firm. In the absence of regulatory requirements, keep records for 7 years. Members who change firms must recreate analysis related documentation – not rely on memory or material created at previous firms.
Recommended Procedures for Compliance Record-keeping is generally firm’s responsibility.
2016, Study Session # 1, Reading # 2 6. Conflicts of Interest 6 A. Disclosures of Conflicts M&C must: Make full & fair disclosure of all matters that impair independence & objectivity or interfere with respective duties to clients, prospective clients & employers. Disclosures should be prominent, delivered in plain language & communicate information effectively.
Guidance-Disclosure to Clients Disclose all potentially conflicting areas to existing and prospective clients to let them judge any potential bias themselves. If servicing as a board member disclose. Disclosure of broker/dealer market making activities is included. Disclosure of holdings in companies that member recommends or clients hold. Members’ compensation structure, should be disclosed if based on the recommendation issued or security sold.
Guidance –Disclosure of Conflicts to Employers Give employers enough information to judge the impact of conflict. Take reasonable steps to avoid conflict report promptly if they occur.
Recommended Procedures for Compliance Special compensation arrangements (bonus, commission etc) should be disclosed.
6 B. Priority of Transaction Investment transaction priority flow: Clients ⇓ Employers ⇓ Employees
Guidance Prioritize client’s transactions over personal transactions & those made on behalf of the member’s firm. Personal transactions may be undertaken after clients and member’s employers have been given adequate opportunity. Personal transaction – member is a “beneficial owner”. Family member accounts should not be disadvantaged to client accounts. Information about pending trades should not be disclosed to any other person if deemed material nonpublic.
Recommended Procedures for Compliance Limited participation in equity IPOs by investment personnel. Restrictions on private placements for investment personnel. Establish blackout/restricted periods for investment personnel. Reporting requirements for investment personnel. Disclosure of holdings in which the employee has a beneficial interest. Provide duplicate confirmations of transaction. Preclearance procedures. Disclosure of policies regarding personal investing.
6 C. Referral Fees M&C must disclose to employer, clients & prospective clients, as appropriate, any compensation, consideration or benefit received from or paid to others for recommendation of products & services.
Guidance Must inform employers, clients and prospects of benefits received for referrals of customers and clients. All types of consideration must be disclosed.
Recommended Procedures for Compliance Encourage firms to adopt clear procedures regarding compensation for referrals. M&C should update the employer (at least quarterly) regarding nature and value of referral compensation received. The clients should also be notified about approved referral fee programs.
2016, Study Session # 1, Reading # 2 7. Responsibilities as a CFAI Member or CFAI Candidate 7 A. Conduct as Members and Candidates in the CFA Program
M&C must not: Engage in any conduct that compromises the reputation or integrity of CFAI or CFA designation. Violate integrity, validity or security or the CFA examinations.
Must not engage in any activity that undermines the integrity of CFA charter. Standard applies to: Cheating in CFA or any exam. Revealing anything about the contents & topics of exam. Not following exam related rules & polices of CFA program. Disclosing confidential exam related information to candidates or to public. Improperly using the designation. Misrepresenting information on PCS or CFAI in the Continuing Education Program. Members can express their opinion regarding the CFA exam or program but without disclosing actual exam specific information. Members voluntarily participating in the administration of the CFA exam must not solicit or reveal information about: Exam question Deliberation related to the exam process Scoring of question
7 B. Reference to CFA Institute, the CFA Designation, and the CFA Program
M&C must not misrepresent or exaggerate the meaning or implication of membership in CFA institute, holding the CFA designation or candidacy in CFA program. Guidance
Do not over-promise individual competence. Do not over promise future investment result. Sign PCS annually. Pay CFAI membership dues annually. Do not misrepresent or exaggerate the meaning of the designation. No partial designation exists. Acceptable to state candidate successfully completed the program in 3 years ⇒ claiming superior ability is not permitted. In written/oral communications. The Chartered Financial Analyst and CFA marks must be used as adjectives or after the charterholder’s name. Prohibited to be used as nouns.
“CFA INSTITUTE RESEARCH OBJECTIVITY STANDARDS” ROP = Research Objectivity Policy CE = Covered Employees IB = Investment Banking CF = Corporate Finance RA = Research Analyst
1. GUIDING PRINCIPLES Allegations of ethical misconduct & lack of I&O of RA weaken investor confidence in the financial markets. The guiding principles that support the CFAI-ROS directly reflect the CFAI code of Ethics.
ROS = Research Objectivity Standards I&O = Independence & Objectivity P&P = Policies & Procedures IM = Investment Manager RR = Research Report
2. COMPARISON WITH THE NEW YORK STOCK EXCHANGE AND NATIONAL ASSOCIATION OF SECURITIES DEALERS RULES NYSE & National Association of Securities Dealers issued new rules for their members relating to analyst I&O (CFAI was supportive of these rules). CFAI-ROS are designed so that there will be no conflict for firms b/w the NYSE/NASD rules & CFAI-ROS.
3. OVERVIEW OF THE CFA INSTITUTE RESEARCH OBJECTIVITY STANDARDS
CFAI-ROS ⇒ specific, measurable standards for managing & disclosing conflicts of interest that may impede a RA’s ability to conduct independent research & make objective recommendations. CFAI-ROS are designed to complement, not replace the CFAI codes & standards. Adoption of CFAI-ROS can’t ensure the accuracy of RR & recommendations (future events are inherently uncertain). Clearly differentiate b/w fact & opinion, & fully convey the opinion of the author(s). Firms work to achieve the following objectives when implementing the CFAI-ROS. Place the interests of investing clients before their employees’ or the firm’s interest. To facilitate full, fair, meaningful, & specific disclosures of potential & actual conflicts. Creation & maintenance of effective P&P that would minimize & manage conflicts of interest. To promote self-regulation. To provide a work environment that supports, encourages & rewards ethical behavior.
Compliance & legal department ⇒ department within a firm responsible for: Implementing & enforcing a firm’s P & P. Ensuring that firm & its employees are in compliance with applicable laws. Corporate issuer ⇒ corporation obtaining funding from public capital markets. Covered employee ⇒ firm employee who: Conducts research, writes RR or assists in research process. Takes investment action on behalf of clients or the firm. May benefit, personally or professionally, from influencing research reports or recommendations. Immediate family ⇒ individual(s) whose principal residence is the same as the principal residence of subject person. Investment advisory relationship ⇒ entails entire, shared, or partial investment discretion over client funds. Investment banking ⇒ CF activities (underwriter, financial advisor, making a market in a security or placement agent). Investment manager ⇒ individual employed by an investment management firm (to research securities, take investment action), whether or not such person has the title of “investment manager”. Personal investments & trading ⇒ purchases & sales of a particular security in which an individual has a financial interest. Public appearance ⇒ participation in a seminar, open forum, radio, television in which a RA or IM makes a recommendation or offers an opinion. Quiet period ⇒ period during which CEs are prohibited from issuing RR or recommendations on, & publicly speaking, about a specific subject company.
Research analyst ⇒ person who is primarily responsible for, contributes to, or is connected with the preparations of a RR or the basis for a recommendation. Research report ⇒ written or electronic communication that firms sell or distribute to clients or to general public (represent information about a corporate issuer). Restricted period ⇒ period during which a firm prohibits its CE from trading specified securities. Subject company ⇒ company whose securities are the subject of R.R or recommendation. Supervisory analyst ⇒ person responsible for reviewing R.R (to assess & maintain quality & integrity).
4. INVESTMENT BANKS, BROKER-DEALERS AND OTHER FIRMS THAT SELL RESEARCH
1.0 Research Objectivity Policy
Firms must have: Formal written policy on the I & O of research (made available to clients, prospective clients & disseminated to all firm employees). Supervisory procedures (firm & its CE comply with the provisions of the policy). A senior officer, who attests annually to clients & prospective clients to the firm’s implementation of, and adherence to, the Policy to, the policy.
Effective ROP would clearly identify & describe the job title, function & department of CE. CE should regularly trained on their responsibilities under the policy (attest annually in writing to their understanding of & adherence to it). Full disclosure of conflict of interest that CE may face should made. Factors on which compensation of RA is based. Conditions under which a R.R can be purchased. Firms should post the policy on their website for easy access by clients & prospective clients.
2.0 Public Appearances
RA & other CE are required to fully disclose personal & firm conflicts of interest to the host or interviewer & whenever possible, to the audience in public appearances.
Provide audience with sufficient information to make informed decisions & assess suitability of investment in light of their specific circumstances & constraints. CE should be prepared to make full disclosure of all conflicts of interest. Provide full RR to audience at a reasonable price. Disclose whether RR is available to non-client audience. Firm should make copies of full RR available for purchase or review.
3.0 Reasonable and Adequate Basis
RR recommendations must have a reasonable & adequate basis. Supervisory analyst or review committee must be appointed to review & approve all RR & recommendations.
Detailed written guidance for RA, supervisory analysts & review committee. In case of purchase, sale or ∆ in recommendation, provide supporting information to investing clients.
Firms that engage in IB activities must: Establish P&P that segregate RA from IB department & ensure that IB employees have no influence on research or recommendations. RA do not report to & are not supervised or controlled by IB or another department that could compromise analyst’s independence. Prevent IB or CF departments from reviewing, modifying, approving or rejecting RR & recommendations on their own authority.
Compliance or legal department should act as intermediary for all communications b/w RA & IB or CF. IB & CF personnel can review RR only to verify factual information or to identify potential conflicts of interest. Quiet periods of sufficient length should be implemented for IPOs (30 days) & secondary offerings (10 days). Prohibit RA from participating in marketing activities (if firms permit, disclose their participation in all interviews & public appearances).
5.0 Research Analyst Compensation
Establish & implement salary, bonus & other compensation for RA that: Align with quality research & recommendation’s accuracy. Do not link compensation to IB or other CF activities.
Compensation arrangements should depend on measureable criteria & applied consistently to all RA. Disclose the extent to which RA compensation is dependent upon firm’s IB revenues.
6.0 Relationships with Subject Companies
RA must be prohibited from: Sharing with, or communicating to, a subject company, prior to publication, any section of RR that might communicate the RA’s proposed recommendation, rating, or price target. Directly & indirectly promising a subject companies a favorable report or a specific price target or from threatening to change reports, recommendations or price targets.
Firms should establish & implement P&P that govern relationship with Subject company. Procedures that ensure that only those sections of the report containing facts that could be reasonably be checked or verified by subject company are shared should implemented. Compliance or legal department receives a draft RR before sections shared with subject company (RA provide written justification for any changes that occur after subject company verification).
7.0 Personal Investment and Trading
P &P that: Manage CE personal investments & trading activities. Ensure that CE don’t share information with any person who could have the ability of front running or otherwise disadvantage investing clients. CE & members of their immediate families don’t have the ability to trade in advance of or otherwise disadvantage investing clients relative to themselves or the firms. Prohibit CE & members of their immediate families from contrary trade except in circumstances of extreme financial hardships. Prohibit CE & members of their immediate families from purchasing or receiving securities prior to an IPO for subject companies & other companies in the industry or industries assigned.
Interests of investing clients are always placed before the interests of the employee, their immediate family members & the firm. Adequate P&P that prevent front running of investing client trades. Firms should have clear definitions of what constitutes extreme financial hardships. CE should provide (at least annually) a list of all personal investments. It is recommended that CE be required to hold securities for a minimum of 60 days (except extreme financial hardship).
8.0 Timeliness of Research Reports And Recommendations
Recommendations Reports & recommendations be issued at least quarterly. Issue a final RR including a recommendation when coverage of a subject company is being discontinued.
Firms must issue RR on subject companies on a timely & regular basis.
9.0 Compliance and Enforcement
Firms must: Have effective enforcement of P&P to ensure research objectivity. Implement appropriate disciplinary sanctions for CE. Monitor & audit the effectiveness of compliance procedures. Maintain records (results of internal audits).
Disseminate a list of activities that would be considered violations & resulting disciplinary sections to all CE, clients & prospective clients. Firms should provide this list on its website.
Firms must provide full & fair disclosure of all conflicts of interest to which firm or its CE are subject.
Disclosures should be full, fair, prominent & in plain language. Disclose if a subject company is currently an IB or CF client of the firm. Firms should determine appropriate communications method to inform investing clients. Firms should provide information about prices of the securities of subject company. Disclose the valuation methods used to determine price targets.
11.0 Rating System
Rating system must be useful for investors & for investment decisionmaking. Provides investors with information for assessing the suitability of security to their unique circumstances & constraints.
Firms should implement the rating system that incorporates the following: Rating categories (absolute or relative). Time horizon categories. Risk categories. Prohibit CE from communicating a rating that is different from current published rating. Provide clients & prospective clients with a complete description of the rating system on request.