Standards I(A) And I(B)

specific situations.

• I Professionalism
• I(A) Knowledge of the Law. Members and Candidates 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 government, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of conflict, Members and Candidates must comply with the more strict law, rule, or regulation.
• Members and Candidates must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.

Guidance, Code and Standards vs. Local Law Members must know the laws and regulations relating to their professional activities in all countries in which they conduct business. Members must comply with applicable laws and regulations relating to their professional activity. Do not violate Code or Standards even if the activity is otherwise legal.

Always adhere to the most strict rules and requirements (law or CFA Institute Standards) that apply.

Guidance, Participation or Association With Violations by Others

Members should dissociate, or separate themselves, from any ongoing client or employee activity that is illegal or unethical, even if it involves leaving an employer (an extreme case). While a member may confront the involved individual first, he must approach his supervisor or compliance department. Inaction with continued association may be construed as knowing participation.

Recommended Procedures for Compliance, Members

• Members should have procedures to keep up with changes in applicable laws, rules, and regulations.
• Compliance procedures should be reviewed on an ongoing basis to ensure that they address current law, CFA Institute Standards, and regulations.
• Members should maintain current reference materials for employees to access in order to keep up to date on laws, rules, and regulations. Members should seek advice of counsel or their compliance department when in doubt. Members should document any violations when they disassociate themselves from prohibited activity and encourage their employers to bring an end to such activity.
• There is no requirement under the Standards to report violations to governmental authorities, but this may be advisable in some circumstances and required by law in others. Members are strongly encouraged to report other members’ violations of the Code and Standards.

Recommended Procedures for Compliance, Firms Members should encourage their firms to:

• Develop and/or adopt a code of ethics. Make available to employees information that highlights applicable laws and regulations.
• Establish written procedures for reporting suspected violation of laws, regulations, or company policies.

Members who supervise the creation and maintenance of investment services and products should be aware of and comply with the regulations and laws regarding such services and products both in their country of origin and the countries where they will be sold.

Application of Standard I(A) Knowledge of the Law3

Example 1:

An analyst working in the underwriting department of a brokerage firm discovers erroneous financial statements that inflated earnings. These statements are with the regulator in preparation for an IPO. The firm’s legal counsel suggests that the regulator would have no idea that the analyst was aware of the falsehood, and hence the analyst can ignore it.

Comment:

While advice from counsel is recommended, members should not rely on advice that they know (or should know) is illegal. The member should obtain independent legal advice to determine if the regulator should be informed.

Example 2:

A member’s firm advertises firm performance using a composite that excludes accounts that have left the firm. This leads to inflated performance figures.

Comment:

Misrepresenting performance is a violation of the Code and Standards. The member should immediately dissociate from the activity. Additionally, the member should inform their supervisor and compliance officer.

If the firm does nothing, the member should seek other employment.

Example 3:

An employee of an investment bank is working on an underwriting and finds out the issuer has altered their financial statements to hide operating losses in one division.

These misstated data are included in a preliminary prospectus that has already been released.

Comment:

The employee should report the problem to his supervisors. If the firm doesn’t get the misstatement fixed, the employee should dissociate from the underwriting and, further, seek legal advice about whether he should undertake additional reporting or other actions.

Example 4:

Laura Jameson, a U.S. citizen, works for an investment advisor based in the United States and works in a country where investment managers are prohibited from participating in IPOs for their own accounts.

Comment:

Jameson must comply with the strictest requirements among U.S. law (where her firm is based), the CFA Institute Code and Standards, and the laws of the country where she is doing business. In this case that means she must not participate in any IPOs for her personal account.

Example 5:

A junior portfolio manager suspects that a broker responsible for new business from a foreign country is being allocated a portion of the firm’s payments for third party research and suspects that no research is being provided. He believes that the research payments may be inappropriate and unethical.

Comment:

He should follow his firm’s procedures for reporting possible unethical behavior and try to get better disclosure of the nature of these payments and any research that is being provided.

• I(B) Independence and Objectivity. Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates 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.

Guidance Do not let the investment process be influenced by any external sources. Modest gifts are permitted. Allocation of shares in oversubscribed IPOs to personal accounts is NOT permitted.

Distinguish between gifts from clients and gifts from entities seeking influence to the detriment of the client. Gifts must be disclosed to the member’s employer in any case, either prior to acceptance if possible, or subsequently.

Guidance, Investment Banking Relationships Do not be pressured by sell side firms to issue favorable research on current or prospective investment banking clients. It is appropriate to have analysts work with investment bankers in “road shows” only when the conflicts are adequately and effectively managed and disclosed. Be sure there are effective “firewalls” between research/investment management and investment banking activities.

Guidance, Public Companies

Analysts should not be pressured to issue favorable research by the companies they follow. Do not confine research to discussions with company management, but rather use a variety of sources, including suppliers, customers, and competitors.

Guidance, Buy Side Clients Buy side clients may try to pressure sell side analysts. Portfolio managers may have large positions in a particular security, and a rating downgrade may have an effect on the portfolio performance. As a portfolio manager, there is a responsibility to respect and foster intellectual honesty of sell side research.

Guidance, Fund Manager and Custodial Relationships Members responsible for selecting outside managers should not accept gifts, entertainment, or travel that might be perceived as impairing their objectivity.

Guidance, Performance Measurement and Attribution Performance analysts may experience pressure from investment managers who have produced poor results or acted outside their mandate. Members and candidates who analyze performance must not let such influences affect their analysis.

Guidance, Manager Selection Members and candidates must exercise independence and objectivity when they select investment managers. They should not accept gifts or other compensation that could be seen as influencing their hiring decisions, nor should they offer compensation when seeking to be hired as investment managers. The responsibility to maintain independence and objectivity applies to all a member or candidate’s hiring and firing decisions, not just those that involve investment management.

Guidance, Credit Rating Agencies

Members employed by credit rating firms should make sure that procedures prevent undue influence by the firm issuing the securities. Members who use credit ratings should be aware of this potential conflict of interest and consider whether independent analysis is warranted.

Guidance, Issuer Paid Research

Remember that this type of research is fraught with potential conflicts. Analysts’ compensation for preparing such research should be limited, and the preference is for a flat fee, without regard to conclusions or the report’s recommendations.

Guidance, Travel Best practice is for analysts to pay for their own commercial travel when attending information events or tours sponsored by the firm being analyzed.

Recommended Procedures for Compliance

• Protect the integrity of opinions, make sure they are unbiased.
• Create a restricted list and distribute only factual information about companies on the list.
• Restrict special cost arrangements, pay for one’s own commercial transportation and hotel; limit use of corporate aircraft to cases in which commercial transportation is not available.
• Limit gifts, token items only. Customary, business related entertainment is okay as long as its purpose is not to influence a member’s professional independence or objectivity. Firms should impose clear value limits on gifts.
• Restrict employee investments in equity IPOs and private placements. Require pre- approval of IPO purchases.
• Review procedures, have effective supervisory and review procedures. Firms should have formal written policies on independence and objectivity of research. Firms should appoint a compliance officer and provide clear procedures for employee reporting of unethical behavior and violations of applicable regulations.

Application of Standard I(B) Independence and Objectivity Example 1:

An analyst joins a group of his peers in a tour of a company’s facilities. Due to remoteness of the facilities, the company arranges for chartered group flights and for accommodations in the only hotel near the company site. The company pays for all the expenses.

Comment:

Members should comply with Standard I(B) by avoiding even the appearance of a conflict of interest, even if they are not necessarily violating Standard I(B). In general, when allowing companies to pay for travel and/or accommodations, members must use their judgment to ensure that the member’s independence and objectivity is not compromised. The itinerary required chartered flights, which the member was not expected to pay for.

These arrangements are not unusual and did not violate Standard I(B) so long as the member’s independence and objectivity were not compromised.

Example 2:

Maneka Fritz is an equity analyst covering the retail industry. She has concluded that the stock of Outlets “R” Us is overpriced at its current level, but wants to maintain the good relationship that her firm has with the company.

Comment:

Fritz’s analysis of the company must be objective and based solely on consideration of company fundamentals.

Example 3:

An analyst in the corporate finance department promises a client that her firm will provide full research coverage of the issuing company after the offering.

Comment:

This is not a violation, but she cannot promise favorable research coverage. Research must be objective and independent.

Example 4:

An employee’s boss tells him to assume coverage of a stock and maintain a buy rating.

Comment:

Research opinions and recommendations must be objective and arrived at independently. Following the boss’s instructions would be a violation if the analyst determined a buy rating is inappropriate.

Example 5:

A money manager receives a gift of significant value from a client as a reward for good performance over the prior period and informs her employer of the gift.

Comment:

No violation here because the gift is from a client and is not based on performance going forward, but the gift must be disclosed to her employer. If the gift were contingent on future performance, the money manager would have to obtain permission from her employer. The reason for both the disclosure and permission requirements is that the employer must ensure that the money manager does not give advantage to the client giving or offering additional compensation, to the detriment of other clients.

Example 6:

An analyst enters into a contract to write a research report on a company, paid for by that company, for a flat fee plus a bonus based on attracting new investors to the security.

Comment:

This is a violation because the compensation structure makes total compensation depend on the conclusions of the report (a favorable report will attract investors and increase compensation). Accepting the job for a flat fee that does not depend on the report’s conclusions or its impact on share price is permitted, with proper disclosure of the fact that the report is funded by the subject company.

Example 7:

A trust manager at a bank selects mutual funds for client accounts based on the profits from “service fees” paid to the bank by the mutual fund sponsor.

Comment:

This is a violation because the trust manager has allowed the fees to affect his objectivity.

Example 8:

An analyst performing sensitivity analysis for a security does not use only scenarios consistent with recent trends and historical norms.

Comment:

This is a good thing and is not a violation.

Example 9:

A member whose firm is seeking to become an investment manager for a labor union contributes a large sum to the union leader’s re election campaign. After the union hires the member’s firm, the member continues to spend significant amounts on entertainment for the union leader and his family.

Comment:

Offering gifts or other compensation to influence a decision to hire an investment manager is a violation of Standard I(B).

Example 10:

A member who is a performance analyst notices that one of her firm’s top investment managers has changed his composite construction, removing a poorly performing large account and placing it in a different composite. Knowing that the investment manager is important to the firm and a close friend of the firm’s CEO, the member does not disclose this change in her performance report.

Comment:

The member violated Standard I(B) by failing to exercise independence and objectivity in her analysis. Altering composites to conceal poor performance also violates Standard III(D) Performance Presentation and may violate Standard I(C) Misrepresentation.