CFA CFA-Level-III Exam
CFA Level III Chartered Financial Analyst (Page 12 )

Johnny Bracco, CFA, is a portfolio manager in the trust department of Canada National (CNL) in Toronto. CNL is a financial conglomerate with many divisions. In addition to the trust department, the firm sells financial products and has a research department, a trading desk, and an investment banking division.
Part of the company's operating procedures manual contains detailed information on how the firm allocates shares in oversubscribed stock offerings. Allocation is effected on a pro rata basis based upon factors such as the size of a client's portfolio, suitability, and previous notification to participate in IPOs. Additionally, company policy discloses to clients that any trade needs to meet a minimum transaction size in an effort to control trading costs and to comply with best execution procedures.
One of Bracco's trust accounts is the Carobilo family trust, which contains a portion of nondiscretionary funds managed by Stephen Carobilo. Carobilo has a friend who runs a brokerage firm called First Trades, to which Carobilo tells Bracco to direct trades from the nondiscretionary accounts. Bracco has learned that First Trades charges a slightly higher trading fee than other brokers providing comparable services, and he discloses this to Carobilo.

Due to high prices and limited supplies of oil, Bracco has been following companies in the energy sector. He believes this area of the economy is in turmoil and should present some mispricing opportunities. One company he has been researching is Stiles Corporation, which is working on a new type of hydrogen fuel cell that uses fusion technology to create energy. To date, no one has been able to successfully sustain a fusion reaction for an extended period of time. Bracco has been in close contact with Stiles' pubic relations department, has toured their laboratories, and has thoroughly researched fusion technology and Stiles' competitors. Bracco is convinced from his research, based upon various public sources, that Stiles is on the verge of perfecting this technology and will be the first firm to bring it to the marketplace. Jerry McNulty, CFA and vice president of the investment banking division of CNL, has been working with Stiles to raise new capital via a secondary offering of Stiles common shares. One day Bracco happened to be in a stall in the bathroom when McNulty and a colleague came in and discussed the fact that Stiles had perfected the fuel-cell technology, which will greatly increase the price of Stiles1 stock.

Stiles Corporation's board of directors includes Dr. Elaine Joachim, who is a physics professor at the University of Toronto. She also works part-time for Stiles Corporation as a consultant in their fusion technology laboratory. Her husband is a materials engineer who recently started performing consulting work for Stiles.

A routine audit by the quality control department at CNL discovered trading errors in several of Bracco's accounts involving an oversubscribed IPO. Some accounts received shares they should not have and others did not receive shares they should have. Bracco and his supervisor Jaime Gun, CFA, are taking responsibility to reverse the incorrect trades. Bracco told Gun, "I'll correct the trades based on our clients' investment policy statements, previous notification of intent, and according to the company's formula for allocating shares on a pro rata basis. In so doing, we will fairly allocate shares so even small accounts that did not meet minimum size requirements will receive some shares of the IPO." Gun replied to Bracco by saying, "I'll credit short-term interest back to the accounts that should not have received the shares and subtract interest from the accounts that should have received the shares."
That evening, Bracco and his wife attended the company holiday party for CNL employees and their spouses. Jerry McNulty, whose wife was ill and could not come to the party, arrived drunk from a meeting with Stiles' upper management. During the party McNulty made inappropriate advances toward many of the female employees and joked about the inadequacies of Stiles' managers.
Was McNulty's behavior at the holiday party a violation of a moral absolute?

Shirley Riley, CFA, has just been promoted, from vice president of trading to chief investment officer (CIO) at Crane & Associates, LLC (CA), a large investment management firm. Riley has been with CA for eight years, but she has much to learn as she assumes her new duties as CIO. Riley has decided to hire Denny Simpson, CFA, as the new compliance officer for CA, Riley and Simpson have been reviewing procedures and policies throughout the firm and have discovered several potential issues.

Communications with Clients
Portfolio managers are encouraged to communicate with clients on a regular basis. At a minimum, managers are expected to contact clients on a quarterly basis to review portfolio performance. Each client must have an investment policy statement (IPS) created when their account is opened, specifying the objectives and constraints for their portfolio. IPSs are reviewed at client request at any time. Any time market conditions dictate a change in the investment style or strategy of a client portfolio, the client is notified immediately by phone or email.

Employee Incentive Program
CA offers several incentive programs to employees. One of the most popular of these programs is the CA IPO program. Whenever CA is involved in an initial public offering (IPO), portfolio managers are allowed to participate. The structure is simple—for every 100 shares purchased on behalf of a client, the manager is awarded five shares for his own account. The manager is thus rewarded for getting an IPO sold and at the same time is able to share in the results of the IPO. Any¬time shares are remaining 72 hours before the IPO goes public, other employees are allowed to participate on a first-come, first-serve basis. Employees seem to appreciate this opportunity, but CA does not have exact numbers on employee participation in the program.

Private Equity Fund
CA has a private equity fund that is internally managed. This fund is made available only to clients with more than $5 million in assets managed by CA, a policy that is fully disclosed in CA's marketing materials. Roughly one-third of the fund's assets are invested in companies that are either very small capitalization or thinly traded (or both). The pricing of these securities for monthly account statements is often difficult. CA support staff get information from different sources—sometimes using third party services, sometimes using CA valuation models. In some instances, a manager of the private equity fund will enter an order during the last trading hour of the month to purchase 100 shares of one of these small securities at a modest premium to the last trade price. If the trade gets executed, that price can then be used on the account statements. The small size of these trades does not significantly affect the fund's overall position in any particular company holding, which is typically several thousand shares.

Soft Dollar Usage
Several different managers at CA use independent research in developing investment ideas. One of the more popular research services among CA managers is "Beneath the Numbers (BTN)," which focuses on potential accounting abuses at prominent companies. This service often provides early warnings of problems with a stock, allowing CA managers the opportunity to sell their clients' positions before a negative surprise lowers the price. Stocks covered by BTN are typically widely held in CA client accounts. Managers at CA have been so happy with BTN that they have also subscribed to a new research product provided by the same authors —"Beneath the Radar (BTR)." BTR recommends small capitalization securities that are not large enough to attract much attention from large institutional investors. The results of BTR's recommendations are mixed thus far, but CA managers are willing to be patient.
As they discuss these issues, Riley informs Simpson that she is determined to bring CA into full compliance with the CFA Institute's "Asset Manager Code of Professional Conduct." The following questions should be answered with the Asset Manager Code as a guide.

Indicate whether CA's policies related to investment policy statement (IPS) reviews and notification of changes in investment style/strategy are consistent with the Asset Manager Code of Professional Conduct.

Dynamic Investment Services (DIS) is a global, full-service investment advisory firm based in the United States. Although the firm provides numerous investment services, DIS specializes in portfolio management for individual and institutional clients and only deals in publicly traded debt, equity, and derivative instruments.

Walter Fried, CFA, is a portfolio manager and the director of DIS's offices in Austria. For several years, Fried has maintained a relationship with a local tax consultant. The consultant provides a DIS marketing brochure with Fried's contact information to his clients seeking investment advisory services, and in return. Fried manages the consultant's personal portfolio and informs the consultant of potential tax issues in the referred clients' portfolios as they occur. Because he cannot personally manage all of the inquiring clients' assets, Fried generally passes the client information along to one of his employees but never discloses his relationship with the tax accountant. Fried recently forwarded information on the prospective Jones Family Trust account to Beverly Ulster, CFA, one of his newly hired portfolio managers.

Upon receiving the information, Ulster immediately set up a meeting with Terrence Phillips, the trustee of the Jones Family Trust. Ulster began the meeting by explaining DIS's investment services as detailed in the firm's approved marketing and public relations literature. Ulster also had Phillips complete a very detailed questionnaire regarding the risk and return objectives, investment constraints, and other information related to the trust beneficiaries, which Phillips is not. While reading the questionnaire, Ulster learned that Phillips heard about DIS's services through a referral from his tax consultant. Upon further investigation, Ulster discovered the agreement set up between Fried and the tax consultant, which is legal according to Austrian law but was not disclosed by either party Ulster took a break from the meeting to get more details from Fried. With full information on the referral arrangement, Ulster immediately makes full disclosure to the Phillips. Before the meeting with Phillips concluded, Ulster began formalizing the investment policy statement (IPS) for the Jones Family Trust and agreed to Phillips' request that the IPS should explicitly forbid derivative positions in the Trust portfolio.
A few hours after meeting with the Jones Family Trust representative, Ulster accepted another new referral client, Steven West, from Fried. Following DIS policy, Ulster met with West to address his investment objectives and constraints and explain the firm's services. During the meeting, Ulster informed West that DIS offers three levels of account status, each with an increasing fee based on the account's asset value. The first level has the lowest account fees but receives oversubscribed domestic IPO allocations only after the other two levels receive IPO allocations. The second-level clients have the same priority as third-level clients with respect to oversubscribed domestic IPO allocations and receive research with significantly greater detail than first-level clients. Clients who subscribe to the third level of DIS services receive the most detailed research reports and are allowed to participate in both domestic and international IPOs. All clients receive research and recommendations at approximately the same lime. West decided to engage DIS's services as a second-level client. While signing the enrollment papers, West told Ulster, "If you can give me the kind of performance I am looking for, I may move the rest of my assets to DIS." When Ulster inquired about the other accounts, West would not specify how much or what type of assets he held in other accounts. West also noted that a portion of the existing assets to be transferred to Ulster's control were private equity investments in small start-up companies, which DIS would need to manage. Ulster assured him that DIS would have no problem managing the private equity investments.

After her meeting with West, Ulster attended a weekly strategy session held by DIS. All managers were
required to attend this particular meeting since the focus was on a new strategy designed to reduce portfolio volatility while slightly enhancing return using a combination of futures and options on various asset classes. Intrigued by the idea, Ulster implemented the strategy for all of her clients and achieved positive results for all portfolios. Ulster's average performance results after one year of using the new strategy are presented in Figure 1. For comparative purposes, performance figures without the new strategy are also presented.


At the latest strategy meeting, DIS economists were extremely pessimistic about emerging market economies and suggested that the firm's portfolio managers consider selling emerging market securities out of their portfolios and avoid these investments for the next 12 to 15 months. Fried placed a limit order to sell his personal holdings of an emerging market fund at a price 5% higher than the market price at the time. He then began selling his clients' (all of whom have discretionary accounts with DIS) holdings of the same emerging market fund using market orders. All of his clients' trade orders were completed just before the price of the fund declined sharply by 13%, causing Fried's order to remain unfilled.

According to CFA Institute Standards of Professional Conduct, should Fried have taken a different course of action with respect to the limit order on the emerging market fund?

Dynamic Investment Services (DIS) is a global, full-service investment advisory firm based in the United States. Although the firm provides numerous investment services, DIS specializes in portfolio management for individual and institutional clients and only deals in publicly traded debt, equity, and derivative instruments.

Walter Fried, CFA, is a portfolio manager and the director of DIS's offices in Austria. For several years, Fried has maintained a relationship with a local tax consultant. The consultant provides a DIS marketing brochure with Fried's contact information to his clients seeking investment advisory services, and in return. Fried manages the consultant's personal portfolio and informs the consultant of potential tax issues in the referred clients' portfolios as they occur. Because he cannot personally manage all of the inquiring clients' assets, Fried generally passes the client information along to one of his employees but never discloses his relationship with the tax accountant. Fried recently forwarded information on the prospective Jones Family Trust account to Beverly Ulster, CFA, one of his newly hired portfolio managers.

Upon receiving the information, Ulster immediately set up a meeting with Terrence Phillips, the trustee of the Jones Family Trust. Ulster began the meeting by explaining DIS's investment services as detailed in the firm's approved marketing and public relations literature. Ulster also had Phillips complete a very detailed questionnaire regarding the risk and return objectives, investment constraints, and other information related to the trust beneficiaries, which Phillips is not. While reading the questionnaire, Ulster learned that Phillips heard about DIS's services through a referral from his tax consultant. Upon further investigation, Ulster discovered the agreement set up between Fried and the tax consultant, which is legal according to Austrian law but was not disclosed by either party Ulster took a break from the meeting to get more details from Fried. With full information on the referral arrangement, Ulster immediately makes full disclosure to the Phillips. Before the meeting with Phillips concluded, Ulster began formalizing the investment policy statement (IPS) for the Jones Family Trust and agreed to Phillips' request that the IPS should explicitly forbid derivative positions in the Trust portfolio.
A few hours after meeting with the Jones Family Trust representative, Ulster accepted another new referral client, Steven West, from Fried. Following DIS policy, Ulster met with West to address his investment objectives and constraints and explain the firm's services. During the meeting, Ulster informed West that DIS offers three levels of account status, each with an increasing fee based on the account's asset value. The first level has the lowest account fees but receives oversubscribed domestic IPO allocations only after the other two levels receive IPO allocations. The second-level clients have the same priority as third-level clients with respect to oversubscribed domestic IPO allocations and receive research with significantly greater detail than first-level clients. Clients who subscribe to the third level of DIS services receive the most detailed research reports and are allowed to participate in both domestic and international IPOs. All clients receive research and recommendations at approximately the same lime. West decided to engage DIS's services as a second-level client. While signing the enrollment papers, West told Ulster, "If you can give me the kind of performance I am looking for, I may move the rest of my assets to DIS." When Ulster inquired about the other accounts, West would not specify how much or what type of assets he held in other accounts. West also noted that a portion of the existing assets to be transferred to Ulster's control were private equity investments in small start-up companies, which DIS would need to manage. Ulster assured him that DIS would have no problem managing the private equity investments.

After her meeting with West, Ulster attended a weekly strategy session held by DIS. All managers were required to attend this particular meeting since the focus was on a new strategy designed to reduce portfolio volatility while slightly enhancing return using a combination of futures and options on various asset classes. Intrigued by the idea, Ulster implemented the strategy for all of her clients and achieved positive results for all portfolios. Ulster's average performance results after one year of using the new strategy are presented in Figure 1. For comparative purposes, performance figures without the new strategy are also presented.


At the latest strategy meeting, DIS economists were extremely pessimistic about emerging market economies and suggested that the firm's portfolio managers consider selling emerging market securities out of their portfolios and avoid these investments for the next 12 to 15 months. Fried placed a limit order to sell his personal holdings of an emerging market fund at a price 5% higher than the market price at the time. He then began selling his clients' (all of whom have discretionary accounts with DIS) holdings of the same emerging market fund using market orders. All of his clients' trade orders were completed just before the price of the fund declined sharply by 13%, causing Fried's order to remain unfilled.

By utilizing the futures and options strategy as suggested by DIS's economists, did Ulster violate any CFA Institute Standards of Professional Conduct?

Dynamic Investment Services (DIS) is a global, full-service investment advisory firm based in the United States. Although the firm provides numerous investment services, DIS specializes in portfolio management for individual and institutional clients and only deals in publicly traded debt, equity, and derivative instruments.

Walter Fried, CFA, is a portfolio manager and the director of DIS's offices in Austria. For several years, Fried has maintained a relationship with a local tax consultant. The consultant provides a DIS marketing brochure with Fried's contact information to his clients seeking investment advisory services, and in return. Fried manages the consultant's personal portfolio and informs the consultant of potential tax issues in the referred clients' portfolios as they occur. Because he cannot personally manage all of the inquiring clients' assets, Fried generally passes the client information along to one of his employees but never discloses his relationship with the tax accountant. Fried recently forwarded information on the prospective Jones Family Trust account to Beverly Ulster, CFA, one of his newly hired portfolio managers.

Upon receiving the information, Ulster immediately set up a meeting with Terrence Phillips, the trustee of the Jones Family Trust. Ulster began the meeting by explaining DIS's investment services as detailed in the firm's approved marketing and public relations literature. Ulster also had Phillips complete a very detailed questionnaire regarding the risk and return objectives, investment constraints, and other information related to the trust beneficiaries, which Phillips is not. While reading the questionnaire, Ulster learned that Phillips heard about DIS's services through a referral from his tax consultant. Upon further investigation, Ulster discovered the agreement set up between Fried and the tax consultant, which is legal according to Austrian law but was not disclosed by either party Ulster took a break from the meeting to get more details from Fried. With full information on the referral arrangement, Ulster immediately makes full disclosure to the Phillips. Before the meeting with Phillips concluded, Ulster began formalizing the investment policy statement (IPS) for the Jones Family Trust and agreed to Phillips' request that the IPS should explicitly forbid derivative positions in the Trust portfolio.
A few hours after meeting with the Jones Family Trust representative, Ulster accepted another new referral client, Steven West, from Fried. Following DIS policy, Ulster met with West to address his investment objectives and constraints and explain the firm's services. During the meeting, Ulster informed West that DIS offers three levels of account status, each with an increasing fee based on the account's asset value. The first level has the lowest account fees but receives oversubscribed domestic IPO allocations only after the other two levels receive IPO allocations. The second-level clients have the same priority as third-level clients with respect to oversubscribed domestic IPO allocations and receive research with significantly greater detail than first-level clients. Clients who subscribe to the third level of DIS services receive the most detailed research reports and are allowed to participate in both domestic and international IPOs. All clients receive research and recommendations at approximately the same lime. West decided to engage DIS's services as a second-level client. While signing the enrollment papers, West told Ulster, "If you can give me the kind of performance I am looking for, I may move the rest of my assets to DIS." When Ulster inquired about the other accounts, West would not specify how much or what type of assets he held in other accounts. West also noted that a portion of the existing assets to be transferred to Ulster's control were private equity investments in small start-up companies, which DIS would need to manage. Ulster assured him that DIS would have no problem managing the private equity investments.

After her meeting with West, Ulster attended a weekly strategy session held by DIS. All managers were
required to attend this particular meeting since the focus was on a new strategy designed to reduce portfolio volatility while slightly enhancing return using a combination of futures and options on various asset classes. Intrigued by the idea, Ulster implemented the strategy for all of her clients and achieved positive results for all portfolios. Ulster's average performance results after one year of using the new strategy are presented in Figure 1. For comparative purposes, performance figures without the new strategy are also presented.


At the latest strategy meeting, DIS economists were extremely pessimistic about emerging market economies and suggested that the firm's portfolio managers consider selling emerging market securities out of their portfolios and avoid these investments for the next 12 to 15 months. Fried placed a limit order to sell his personal holdings of an emerging market fund at a price 5% higher than the market price at the time. He then began selling his clients' (all of whom have discretionary accounts with DIS) holdings of the same emerging market fund using market orders. All of his clients' trade orders were completed just before the price of the fund declined sharply by 13%, causing Fried's order to remain unfilled.

According to CFA Institute Standards of Professional Conduct, which of the following statements regarding Ulster's meeting with West is most accurate? Ulster may: