1.3 ethics

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1.3. STANDARDS OF PRACTICE HANDBOOK

The Handbook is a guide as to how the Code and the Standards are properly applied. Therefore,for each specific standard, the Handbook discusses:

a)

its purpose and scope, b) how it should be applied, andc) the procedures required in order to be in compliance with it.

Therefore, we will now examine each standard within these parameters.

I(A) - Know and Comply with Laws, Regulations, EthicalCodes and Professional Standards.

It is very important that covered persons become familiar with and comply with all applicablerules and regulations set forth by both governing bodies and the Code and Standards. In the event

that there is a conflict among these rules as to how a situation should be handled, the stricter ruleshall apply. This rule also applies when a covered person is subject to the laws of multiple jurisdictions. The logic is that be complying with the stricter rule, the less strict rule would mostlikely have been indirectly complied with.

The best way to comply with this standard is by making an effort to keep current with allapplicable rules and regulations that govern the covered person's conduct. If the covered personshould happen to be in a supervisory position, then there is also the duty to keep subordinates upto date as well. This would involve maintaining a compliance manual in accordance with currentrules.

Question: Rennie Jackson, CFA, is an analyst currently working at his firm's subsidiary in Country A.However, Rennie's residence and the head office, for that matter, are situated in Country C. Thelaws in Country C are not only more strict than AIMR's Standards, however, they explicitly pointout that all registered analysts must abide the laws of the jurisdictions that they do business in. Itswidely known that Country A's rules are much less strict than AIMR's Standards. In order not toviolate any of the Standards, Rennie should:

A) comply with Country A's rules and regulations.

B) comply with the AIMR Standards.

C) comply with Country B's rules and regulations.

D) comply with any of the widely accepted practices employed in developed countries.Answer:B

Explanation: The rule is to adhere to the strictest standards whenever there is an overlap of standards. In thiscase, Country C sets out the strictest standards. However, Country C has a clause that makes themember subject to the standards of Country A. Therefore, the choice is then between the

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standards of Country A or AIMR. And since AIMR Standards are stricter is this case, Renniemust abide by them.

Question: John Goodman, CFA, is a resident of Alpha who is currently vacationing in Beta. Beta's marketsare officially unregulated. The hotel manager, whose brother is the CFO of Gamma Corp., acompany whose stock trades over-the-counter, provides John some material non-publicinformation. John:

A) may trade on this information since the market is unregulated.

B) may not trade on this information under any circumstances.

C) may trade on this information only if such a practice is permitted in Alpha.

D) may trade on this information since John is on vacation and he has no fiduciary duties to

anyone in this situation.Answer:B

Explanation: Even though Beta has no regulations, John's conduct must always, as a minimum, adhere toAIMR's Code and Standards. In this case, John is bound by Standard (I)-FundamentalResponsibilities.

I(B) - Do Not Knowingly Participate or Assist Others in anyViolation of Applicable Regulations or Ethical Codes.

With this standard, a covered person may be in violation even if he was not aware that a rule or alaw was being violated. This is so because the previous standard mandates that a covered person

be knowledgeable about governing rules. Therefore, ignorance or a lack of knowledge will not be accepted as a defense.

Should a covered person suspect clients, fellow employees, or even senior management to beviolating rules and guidelines, the appropriate course of action would be to notify either theimmediate supervisor or the firm's legal counsel. Afterwards, the covered person must ensurethat he completely disassociates with the questionable activities. Otherwise, continued

association with these activities may be deemed as participation.As a rule, AIMR does not require the covered person to go beyond the channels within the firm inorder to bring a stop to these questionable activities. However, if the firm continuously turns a

blind eye to these activities, then the covered person may have to seek the advice of independentcounsel outside the firm. A covered person cannot claim to be innocent just because the firmaccepts illegal and unethical practices as the norm.

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Question: John Courneya, CFA, is a research analyst within a large brokerage firm. One day, he discoversthat one of his fellow analysts, Janet Smith, CFA, was spotted going through some files inside theinvestment banking division. In order to comply with the AIMR Standards of ProfessionalConduct, John should:

A) report this activity to the relevant regulatory bodies.

B) consult with the company's own compliance officer and ensure that he completelydisassociates himself from Janet's actions.

C) consult with counsel outside the firm to ensure objectivity.

D) report this activity to the relevant regulatory bodies as well as the investigative branch of theAIMR.

Answer:B

Explanation: John is simply required to consult with the company's own compliance officer and ensure that hecompletely disassociates himself from Janet's actions.

Question: Jane Bell is a broker's assistant at a large brokerage firm. She notices that a fellow broker'sassistant is committing an act that is unethical, if not illegal. Which of the following actionsshould Jane pursue?

I.

Bring these acts to the attention of the compliance officer and express her desire to seethese acts stopped.

II. The Code and Standards would also require Jane to report these acts to the appropriateregulatory agencies.

III. If Jane is unsatisfied or suspect of the compliance officer's response to the matter, shewould then be justified in consulting with legal counsel outside the firm.

IV. Association with the guilty party without actual participation in these suspect activitiesshould be enough to clear Jane of any wrongdoing.

Answer:I and III only.

Explanation: The Code and Standards would not require Jane to report illegal activities to the regulators.However, in certain instances, if Jane feels compelled to report these activities, than she wouldnot be violating any standards by doing so.

Furthermore, even if Jane does not partake in any of these illegal activities, by simply associatingherself with the perpetrator, she may be deemed as a participant.

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Question: John Seibert, a candidate who is a broker's assistant to Ray Vanelli, CFA, was recently told thatRay and one of his clients are suspected of trading based on inside information. Subsequently, a

few governing bodies launched an investigation into the activities of the broker and his client.Which of the following should John do so that he will not be found to have violated Standard I(B)- Prohibition against Violating any Codes or Regulations?

I. Resign immediately so as to no longer be deemed to have any association with the brokerand his client.

II. Only report to the firm's compliance officer and avoid breaching confidential informationeven to AIMR's Professional Conduct Program.

III. Usually, breaches occur at the senior levels, thus John just needs to do what he is told byhis supervisors and compliance officer.

IV. John is not required to independently approach the authorities and report all activities that

he deems as violations.

Answer: IV only.

Explanation: Resigning is perhaps an extreme form of disassociation. Instead, John should consult with thefirm's compliance officer to determine his duties throughout the investigation.

(II) is incorrect because providing confidential information to AIMR's Professional ConductProgram would not be a breach of confidentiality.

(III) John should not think that he is immune just because of his junior position.

II(A) - Use of Professional Designation.

While the CFA charter is an extremely prestigious designation to obtain, covered persons mustnever claim that its mere possession guarantees a superior investment performance or superiorknowledge. Instead, a covered person may only state the factual requirements that are necessaryin order to obtain the charter. Furthermore, a covered person may not refer to herself as a CFA;instead, she would be a "CFA charterholders".

When presenting credentials, a covered person may attach either of the following to his or hername:

a) CFA, or b) Chartered Financial Analyst.

Furthermore, the designation cannot be in a larger letter type than the size that is used to print thename of the covered person. As well, in order to maintain the right to use the designation, a

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covered person must, on an annual basis, file the Professional Conduct Statement and pay therequired dues.

As for candidates, it is a violation to express an expected date of being awarded the charter.Instead, candidates may simply state that they are participants in the CFA program and the levelof the Program that they have successfully completed.

Question: Babarino Securities is putting a brochure together in order to market the firm more effectively.Which of the following statements would not violate Standard II(A)- Use of ProfessionalDesignation?

I. "Our firm has some of the most respected CFAs working in the industry."

II. "Our head of research is a CFA charterholder who was recently awarded the MostAccurate Forecaster Award."

III. "The Chartered Financial Analysts in our fixed income department have a combinedexperience of 157 years."

IV. "Our managing director has earned the right to use the CFA designation."

Answer:II and IV only.

Explanation: (I) is incorrect because "CFA" or "Chartered Financial Analyst" should never be used as a noun.For instance, the firm can say that they have CFA charterholders on staff, but they can't say thatthey have CFAs. For this same reason, (III) is incorrect.

(IV) is correct because "CFA" is used as an adjective.

Question: Tom Duran just received confirmation that he passed the CFA Level 1 exam. Which of thefollowing courses of action can Tom undertake without violating the Code or the Standards?

I. He may refer to himself as a Level 2 Candidate.

II. On his personal letterhead, he may put CFA (Level I) after his name.

III. On his resume, he may state that he hopes to finish the CFA Program at the earliest possible date.

IV. He may communicate to his clients that this accomplishment is indicative of what hecould do for them.


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Explanation: (II) and (IV) are just not allowed. Both these acts would constitute a violation of the Code and theStandards.

(III) actually is allowed. Tom is not setting a specific date; he is simply expressing his goal.

(I) is the proper way for Tom to present himself.

II(B) - Do Not Engage in any Act that Adversely Reflects UponYour Honesty, Trustworthiness, or ProfessionalCompetence.

This standard requires that a covered person be on proper behavior both on the job and during personal time. If a covered person consistently misbehaves during personal time, then it would

only be a matter of time before this conduct interferes with his profession.

As a result, the following acts would constitute a violation of this standard:

a) a felony conviction or any conviction with a jail sentence of greater than a year, b) a conviction for a misdemeanor due to such acts a lying or stealing,c) repeated convictions for various misdemeanors, ord) any act that disgraces the profession.

Supervisors should therefore conduct background checks when hiring new employees. As well,all employees should be made aware of what acts constitutes a violation of proper conduct.

Question: You are the human resources manager of a large brokerage firm. Over the last month, variousincidents have been brought to your attention involving the employees of the firm. Which of thefollowing incidents are violations of Standard II(B)- Refraining from acts that reflect poorly uponthe profession.

I. A serious car accident as a result of the employee grossly violating the local highwaytraffic act.

II. A worker shows up to work in an intoxicated state because he was entertaining clientsduring lunch.

III. A worker has been convicted a third time for a misdemeanor involving loitering in public. You know for a fact that this was a hard working employee who probably justdidn't have time to find a garbage can on his way to work.

IV. A complaint has been filed against the head of research by one of his subordinates because he, the head of research, conducted a criminal background check that thesubordinate felt was an invasion of her privacy.

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Answer:II and III only.

Explanation: (I) would be a violation if the conviction was a felony or is a something that could result in prisontime greater than one year. However, most car accidents do not fall under this category.

(IV) is not a violation because it is the duty of supervisors to conduct a background check onemployees to determine their eligibility to work in the finance profession.

Question: Joe Skinner, CFA is perhaps one of the hardest working analysts in the industry. Recentlyhowever, he was arrested for drunk driving. This follows his two recent arrests last year fordomestic violence. Through the skillful negotiation skills of his lawyer, Joe was given no jail timeand his probation period was shortened to just 6 months. Which of the following statementswould be true in this situation?

A) None of these arrests are tied to his line of work and thus his private life should be segregatedfrom his professional life.

B) Standard II(B), which relates to the misconduct of members, has clearly been violated.

C) Standard II(B) was not violated because this conviction was neither a felony nor did it result in jail time greater than a year.

D) Standard II(B) would only be violated if Skinner violates his parole conditions.

Answer:B

Explanation: Skinner has had a few arrests and while his lawyer got him off a conviction based on hisnegotiation skills, it does not change the fact that Skinner has very little respect for the law. Thisclearly reflects poorly on his integrity and competence.

II(C) - Do Not Plagiarize.

When using material that originated with some other party, covered persons must identify thesource, author, and the publisher of that work. However, when the material that's being used is

simply factual information that is published by a widely recognized reporting service, then thedisclosure requirements need not apply. The following then would constitute a direct violation ofthis standard:

a) rewriting parts of a third party report without acknowledging the source, b) attributing some statements as having been made by leading experts without specifically

mentioning who these experts are,c) attributing statements to their original source, however, neglecting to mention certain

conditions that may have been attached to those statements in the original report, or

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d) copying spreadsheets or models without first obtaining permission from the originalauthor.

In order to ensure this standard is not violated, a covered person should:

a) keep copies of all outside work that was used in the report, b) attribute all quotes to the specific individuals who made them, andc) even when summarizing the work of others, acknowledge the original source.

Question: Randy Cross, CFA, is the head of research of a very large investment advisory firm. Upon reviewof the all the reports produced by his analysts, which of the following circumstances would not bea violation of Standard II(C) - Prohibition against Plagiarism:

A) Use of excerpts from a fellow analyst's report without acknowledgement.

B) A table that is used with the reference given, but without the disclosure items that were presented with the original table.

C) Making reference to a quote made "by a leading expert" without actually acknowledging whothis expert was.

D) A detailed graph, which is produced by a widely recognized statistical service, is used withoutacknowledgement.

Answer:D

Explanation: All facts and statistics, other than those that are obtained from widely recognized statisticalservices, must be acknowledged to their source.

Question: You are the head of research for a regional brokerage firm. According to Standard II-C(Plagiarism), which of the following acts by your department's analysts would constitute aviolation of this Standard?

I. Use of factual information published by a widely known financial and statistical reportingfirm without actually acknowledging that source.

II. Attributing quotes to "leading experts" without actually acknowledging who these expertsare.

III. In an oral discussion with a prospective client, an analyst cites a statistical finding from arecent journal article without acknowledging the source.

IV. An analyst makes some revisions to a global research report to conform with his jurisdiction's securities laws and publishes the revised report as his own.

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Answer:II, III, and IV only.

Explanation: All outside sources used by the analyst must be acknowledged. The only exception to this rule isif the analyst is using financial or statistical facts that are published by a widely recognizedreporting service.

Question: Freddie Washington, CFA is an economics professor at Kermit University. In his researchreports, all of the following measures will ensure compliance with Standard II(C)-Prohibitionagainst Plagiarism except:

A) Make copies of any proprietary spreadsheets that were developed by others and keep them onfile, if the findings of those spreadsheets were used to support the report.

B) All methodologies that were developed by parties other than recognized financial servicesshould be attributable to their source.

C) Even when just summarizing material developed by others, Freddie should attribute thesummary to the originator of the content.

D) Free use of factual information published by widely recognized financial and statisticalreporting agencies.

Answer:A

Explanation: Freddie can't just make copies of other's work without obtaining their permission, even if he isusing those findings to support his own research.

III(A) - Inform Employers of the Code of Ethics and Standardsof Professional Conduct.

A covered person must inform his employer, in writing, that he is subject to the rules as set out bythe Code and the Standards. Furthermore, unless the employer has stated in writing that the firmincorporates the rules as set out by the Code and Standards, it is up to the covered person to:

a) forward a copy of the Code and Standards to the employer, and b) make a written request that the Code and Standards be adopted by the firm.

If the covered person has supervisory duties, then it is up to her to inform subordinates of theconduct that's expected of them.

Question: David Adair, CFA was recently hired by a local brokerage firm to head up its existing research

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department. To fulfill his obligations as per Standard III(A) - Inform the Employer of the Codeand Standards, David must do all of the followingexcept:

A) Deliver a copy of the Code and Standards to his supervisor with a letter requesting that thefirm adopt these Code and Standards as part of its normal operating procedures.

B) Notify his supervisor, in writing, of his obligation to abide by the Code of Ethics andStandards of Professional Conduct.

C) Inform his subordinates of the high standards of professional conduct expected from them.

D) Inform his new clients, in writing, of his obligation to abide by the Code of Ethics andStandards of Professional Conduct.

Answer:D

Explanation: This Standard does not require members to disclose to clients their obligations to abide by theCode of Ethics and Standards of Professional Conduct.

III(B) - Duty to Employers.

A covered person must be completely loyalty to his employer. Therefore, a covered person must:

a) not engage in any independent activity that may be deemed as competition to theemployer's business (unless the covered person has a written consent to do so from boththe employer and the prospective client), or

b) not engage in any activity that may deprive the employer of profit.

In order to comply with this standard, a covered person should:

a) Inform the employer if she plans to carry out independent services. In particular, sheshould submit in writing to the employer, the type of service, its duration, and expectedcompensation that the independent work is expected to generate.

b) Inform the client, in writing, who the covered person's employer is, the fees that theemployer would charge for similar services, and make it clear that the work which thecovered person will perform, will be done entirely independent of the employer.

Question: Richie Cunningham, CFA, is an acquisition expert with Columbia Securities. John Goodman, anold friend of Richie, asks Richie if he can provide his services, privately, to a deal that John'scompany is currently working on. In order to comply with the AIMR Standards of ProfessionalConduct, Richie needs to do all of the following except:

A) inform his employer of the services that will provided to John.

B) getting a written confirmation from John that he has read all the necessary disclosure items.

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C) inform his employer of this private compensation arrangement.

D) first give Columbia Securities an opportunity to present its services to John.

Answer:D

Explanation: Providing services privately, without the involvement of the employer, can become a delicatesituation. That is why a lot of disclosure items are required to be forwarded, in writing, to boththe employer and the private client. As well, a written confirmation that they have read all theitems is required back from both parties. The employer may insist that they have an opportunityto meet John first, however, this is not required under the Standards.

On the other hand, if the covered person plans to leave the employer soon, she must:

a) not conspire to bring about a mass resignation, b) not misappropriate any trade secrets,c) not misappropriate any client information,d) not encourage clients to leave before the covered person's termination date,e) not withhold any business that rightfully belongs to the employer, andf) not take any materials that belong to the employer.

Question: Vinnie Bombastic is a stock analyst with Yogi Securities. Vinnie's brother, Johan, has askedVinnie to serve as a consultant for a new income trust fund that he has started. Seeing how this ishis younger brother and the smallness of the operation, Vinnie decided to provide his time forfree. However, in order to ensure compliance with Standard III(B)- Duty to Employer, Vinnie is

required to do all of the following except:A) Obtain a written permission from the employer after disclosing the length and the amount ofcompensation that's to be expected from this independent project.

B) Do nothing, as he is dedicating his time for free. Only if was receiving some form ofcompensation, would the employer need to be notified.

C) Obtain a written acknowledgement from Johan that he clearly understands that Vinnie will be performing independently from his employer.

D) Inform Johan what Yogi Securities would charge for the same service that is to be provided.

Answer:

BExplanation: Even though Vinnie is providing his services for free, the fact is this was a potential account (or

business) to Yogi Securities. Hence, to the employer, this is the equivalent of losing business to acompetitor. Therefore, not informing the employer of this arrangement would be a breach of thisStandard.

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III(C) - Disclose Conflicts of Interest to Employer.

It is up to the employer to decide if a matter may impair the covered person's ability to performhis duties objectively. As a result, the covered person must disclose to the employer:

a)

any material ownership in securities, b) participation with outside boards, orc) any consulting work that's being carried on outside the firm.

Question: Homer Smith, an analyst with Springfield Securities, covers Burn's Corp as part of his duties.Homer's wife, Marge, recently bought some shares of Burn's Corp for their kid's education fundthrough her on-line account held with some other brokerage firm. In order not to violate any lawsor Standards, Homer should:

A) Discontinue coverage of Burn's Corp. because of this inherent conflict of interest.

B) Simply disclose this conflict of interest to his employer.

C) Not worry about anything since his wife did this independently and at some other brokeragefirm.

D) Encourage Springfield Securities to place Burn's Corp. on a restricted list.

Answer:B

Explanation: It is very common for analysts, or their immediate family members, to trade in shares that theanalyst covers. By notifying the employer of this potential conflict of interest, it is then up to theemployer to assess the situation and decide what course of action would best address this conflict.

III(D) - Disclose Additional Compensation Arrangements.

A covered person must have her employer's written approval before agreeing to acceptcompensation from third parties. As a result, the employer must be notified in writing as to:

a) who the third party is, b) the form of compensation, be it monetary or quid pro quo,c) the amount of compensation, andd) the duration of this compensation arrangement.

Question: At Epstein Securities, it is very common for clients to reward the managers for outstanding

performance. These rewards are in addition to the performance bonuses that the managersautomatically receive from the employer. If you were one of these managers, which of thefollowing disclosures would not be necessary to your employer?

A) The nominal value of the compensation.

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B) The duration of the agreement.

C) If the compensation is non-monetary, the items and services being received instead.

D) The objectives and risk tolerances of the clients willing to make these extra payments.

Answer:D

Explanation: Under this scenario, the issue is disclosure of extra forms of compensation to the manager.Consequently, the objectives and risk tolerances of the clients willing to make these extra

payments were already determined when the accounts were originally set up. Thus, the does notneed to be informed again of these matters.

III(E) - Responsibility of Supervisors.

Covered persons who serve a supervisory role have an even higher standard of duties to theemployer. In particular, they must:

a) construct, communicate, and enforce all applicable rules and regulations to allsubordinates, irrespective of whether they are covered persons or not,

b) be diligent in detecting improper activities,c) start an investigation once an improper activity is discovered,d) take steps to ensure that such violations do not occur again,e) encourage the firm to implement a satisfactory compliance system, if one doesn't already

exist, andf) inform new employees of the standards of conduct that's expected of them.

To aid in these duties, a supervisor should:

a) identify situations that may lead to violations and thus implement a compliance systemthat would prevent such behavior,

b) if the firm refuses to implement an adequate compliance system, then the covered personshould refuse in writing to accept any supervisory duties,

c) tailor the compliance system to the unique situation of the firm or the department,d) inform subordinates of the Code and Standards and in fact, be given a copy of,e) make clear to subordinates what the procedures are for reporting a violation,f) make clear to subordinates what the sanctions will be for any violation,g) update procedures manuals and make the subordinates aware of any changes, andh) conduct periodic professional evaluations of the subordinates.

Only after all these duties have been carried out diligently, can a supervisor be exempt from anyviolation committed by subordinates. A supervisor is not expected to detect all possibleviolations, only that he was diligent in implementing, communicating, and enforcing an adequatecompliance system.

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Question: James Brown, the head of research for Kermit Securities, just hired the most sought after retailanalyst in the industry, Gonzo Fry, CFA. Since Gonzo had even more experience than James, itwas understood that Gonzo's reports would simply be distributed as soon as he was finished

putting them together. Subsequent to the release of one of Gonzo's recent Buy ratings, the issuer

in question lost a major lawsuit, which at the time of the buy rating was a pending matter thatGonzo had overlooked. Which of the following statements would best describe James' situation?

A) James would be responsible only if he actually Okayed the report.

B) Gonzo is a CFA, he should have known Standard IV(A.1)-Reasonable Basis andRepresentation, and thus he alone is responsible for this mistake.

C) James is not responsible since Gonzo clearly has more experience than him.

D) James violated his duty because he did not have adequate checks and balances to ensure thelegitimacy of his firm's research reports.

Answer:

DExplanation: Even if a subordinate is a star analyst, it does not relieve the supervisor from his or her duties. Inthis case there was an inadequate compliance system. Since James did nothing about it, he isresponsible for this mistake.

Question: Fred Downer, CFA, was recently hired by the compliance department of a very large brokeragefirm. Soon after beginning his employment, he discovered that the heads of the compliance

department were consistently being unduly influenced by the heads of the sales departments. Inshort, compliance procedures were not being followed. In order not to violate AIMR's Code andStandards, Fred should:

A) disassociate himself only from the activities which he deems to be in breach of compliance procedures.

B) simply have a discussion with his supervisors and point out all the breaches of the compliance procedures.

C) inform the regulatory agencies that govern such matters.

D) decline, in writing, to accept any supervisory duties until compliance procedures are properlyenforced.

Answer:D

Explanation: A system that is only partially in compliance is simply not a compliant system. Therefore, Fredcannot have any association with the compliance system unless his supervisors make the systemworkable again.

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IV(A.1) - Reasonable Basis and Representations.

In general, this standard required covered persons to:

a) be diligent in their research,

b)

avoid any material misrepresentations,c) maintain good records,d) disregard questionable sources, ande) when dealing with foreign securities, disclose any unusual risk factors involved and make

the issuer's financial statements comparable in terms of the rules required of domesticissuers.

Specifically, if the covered person is a "broker" or a "portfolio manager", the following additionalduties would be required before recommending a security for a client's portfolio:

a) the recommendation is made on the firm's own research or the research of an outsidereliable source,

b) basic characteristics of the security have been examined, andc) the security suits the client's objectives and constraints.

Note that the client's objectives and constraints must be updated the earlier of either every year orevery time there is a major shift in the client's situation. Furthermore, a security must be chosenwithin a portfolio context, as opposed to analyzing it on a stand-alone basis.

If the covered person is a "securities analyst", then the following additional duties would berequired under this standard:

a) be diligent in the research process, b) comply with the standard covering "Research Reports", andc) maintain all records used to construct the research report.

Finally, if the covered person is an "investment banker", then this standard requires:

a) a diligent examination of the how the proceeds will be used, b) identification of any conflicts of interest or legal issues, andc) a maintenance of all important documentation.

Question: During the investment process, which of the following duties are members expected to carry outin order to comply with Standard IV: Relationship with and responsibility to clients and

prospects.

I. Ensure that all recommendations are adequately supported by keeping a record of allmaterials that were used in order to make the recommendation.

II. Publish unadjusted ratios of foreign securities but with a disclaimer indicating thatdifferences may exist between foreign reporting and home country reporting.

III. Avoid material misrepresentation in research reports and investment recommendations.

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IV. A member may make investment recommendations by relying on sources other than hisown firm's research department, so long as this outside source is known to have done athorough and diligent work on the specific issue.

Answer:

I, III, and IV only.Explanation: A member must make an effort to make ratios reported by foreign entities compatible to the ratiosthat would be reported by companies listed in the local markets.

Question: John Smith just got his first job as an analyst. As he gets ready to submit his first research reportto his supervisor, which of the following should he keep in mind so that he doesn't end upviolating Standard IV (A.1) - Reasonable Basis and Representation?

I. Include all information related to the investment, even that which he may deem asimmaterial.

II. Be diligent in the research, even if some data may seem obvious.

III. If foreign companies are involved, an effort must be made to make the ratios of theforeign companies comparable to that of domestic corporations.

IV. The risk and constraints of the investors likely to purchase the recommendedinvestments.


Explanation: (I) is incorrect because even though full disclosure is a must, the reason why he is being paid asan analyst is to distinguish between important information and that which is immaterial.

(IV) is incorrect because as an analyst, John is simply required to produce an objective reportabout the investment. It is then up to the investment managers to decide if the investment issuitable for their clients.

Question: York Co. happens to be one of the companies that analyst Ray Vanelli, CFA advises his clientsabout. During a golf tournament, John Franklin, CFA, an analyst friend of Ray who also coversYork Co. for a different brokerage firm, told Ray to just watch and see how York Co's new

product is going to dominate its market. Soon after that exchange, Ray changed his rating forYork Co. from market-perform to market-outperform. Ray:

A) violated the Standards because he effectively plagiarized someone else's research.

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B) violated Standard IV(A.1)- Reasonable basis and representation.

C) did not violate any standards because his friend is a practicing analyst who also happens to bea CFA charterholder.

D) violated the Standards because he did not disclose to his employer the possible conflict of

interest arising out of using his friends opinion.

Answer:B

Explanation: A member cannot just issue a recommendation without having a reasonable basis for doing so.Hearing a comment on a golf course, even those made by other analysts, does not constitutereasonable basis.

IV(A.2) - Research Reports

When constructing a research report, a covered person is required to:

a) include all relevant information, b) ensure that all information is reliable,c) acknowledge any outside sources used,d) distinguish between fact and opinion,e) state the basic characteristics of the underlying issue,f) indicate any limitations that the research report might have.

These requirements apply for all research reports, irrespective of the medium in which they aredistributed (i.e. in person, through the media, over the internet, or by phone).

Question: When it comes to research reports, which of the following duties are members expected to carryout in order to comply with Standard IV: Relationship with and responsibility to clients and

prospects?

I. Members must indicate the limitation of the analysis and distinguish between fact andopinion.

II. Verbal discussions about an investment are not subject to the same stringent rulesgoverning written research reports.

III. If a member comes across information that she deems to be unimportant, she may omitthat fact from her research report.

IV. A research report must contain the basic characteristics of an investment that is beingrecommended.

Answer:I, III, and IV only.

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Explanation: (II) is incorrect because the definition of a research report does include verbal recommendations,

be it in person or over the phone. Therefore, verbal discussions about an investment are subject tothe same stringent rules that govern written research reports.

Question: Billy Joe is an analyst primarily responsible for coverage of the defense industry and thecompanies that operate within that industry. Which of the following must he keep in mind inorder to comply with Standard IV(A.2) - Research Reports?

I. Take into account the objectives and experience of the clients who will most likely invest based on the research.

II. Distinguish between fact and opinion.

III. Indicate the basic characteristics of the investment if the report being circulated includes

a recommendation for that particular security.IV. State the limitations of the analysis and the forecasted conclusions.

Answer:II, III, and IV only.

Explanation: (I) is incorrect because the job of the analyst is to just give an objective report about thecompanies that are being analyzed. Instead, it is the job of the investment manager to decide ifsecurities recommended by analysts are suitable to the client.

IV(A.3) - Maintaining Independence and Objectivity

A covered person may be deemed as having impaired his independence and objectivity if he:

a) accepts expensive gifts from entities that aren't clients of the firm, b) allows his compensation schedule to weigh in on his advise,c) purchases some shares of an oversubscribed IPO, ord) allows his firm's business relations with an issuer to affect his recommendation of that

issuer's securities.

In order to comply with this standard, a covered person should:a) disclose any underwriting or market making relationship that his firm might have with

the issuer whose securities are being recommended, b) disclose if he personally owns any of the securities that are being recommended,c) refuse to accept from non-client firms any gifts whose value exceeds $100USD,d) disclose to his employer gifts of any amount given by clients, so long as the employer

consents to it,e) avoid purchasing shares of an oversubscribed IPO or a private placement,

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f) pay for his own transportation and lodging when conducting a research of the underlyingissuer,

g) only provide factual information about an issuer if the covered person's firm is unwillingto disseminate any recommendations, and

h) ensure that his compensation schedule does not interfere with his recommendations.

Question: When it comes to maintaining independence and objectivity, which of the following duties aremembers expected to carry out in order to comply with Standard IV: Relationship with andresponsibility to clients and prospects?

I. Regardless of the employer's consent, members should not accept gifts from clients thatexceed a value of $100.

II. If an IPO is oversubscribed, an analyst may only take an allocation of shares that isreasonable compared to her previous trading patterns.

III. When making a recommendation for a particular stock, members must disclose if theirspouse or a close relative holds those shares.

IV. A restricted list should be constructed if the member's firm is unwilling to issue anegative rating for some particular stocks.

Answer:III and IV only.

Explanation: (I) is incorrect because it is acceptable to be in receipt of a gift from a client that is worth morethan a $100. What is not allowed is the acceptance of gifts worth more than a $100 given by non-clients (ex. Getting gifts from companies being analyzed is a big no-no).

(II) is incorrect because if an IPO is oversubscribed, an analyst should avoid taking any allocationof shares, since this would be placing her own interests above those of her clients.

Question: Johnny B. Good is an analyst with a major U.S. brokerage firm. Currently, he is working at thefirm's branch in the country of Yorkland. Yorkland explicitly forbids analysts to receive any formof benefits from companies that they cover. At a recent analyst's convention, one of the firmsJohnny covers had placed nominal gifts (worth $150) at the table for each of the analysts. It'sworth noting that this firm was not actually present at the convention and thus would have no wayof knowing which of the analysts accepted the gifts. Johnny should:

A) Accept the gift as long as Johnny insists that his firm reimburse the issuer for the entire cost ofthe gift.

B) Not accept the gift whatsoever.

C) Accept the gift as long as Johnny insists that his firm reimburse the issuer $50 in order toreduce the nominal value of the gift to below $100.

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D) Accept the gift unconditionally since there is no way the issuer will know which analysts aremore receptive to their persuasions.

Answer:B

Explanation: Since in this particular case, Yorkland's rules are stricter than AIMR's Code of Ethics andStandards of Professional Conduct, the analyst must reject the gift outright.

Question: Joanne Bume, CFA, is the head of research at large brokerage firm. Currently, her airline analysthas a market-underperform rating on Universal Airline Company. Joanne is contacted by BillSmith, who is not only the head of the corporate finance department for the firm, but he is alsovice-chairman. It seems that Bill is soliciting some business from Universal. However, thecurrent rating imposed by the airline analyst is hampering his efforts. Bill asks Joanne to persuade

her airline analyst to revisit the facts about Universal, since "there is so much at stake here". Inorder not to violate the AIMR Standards of Professional Conduct, Joanne should:

A) go ahead and ask the airline analyst to revisit the facts again, so long as no pressure is appliedin order to influence the rating.

B) cease rating Universal Airlines and instead only provide factual statements about the company.

C) ask Bill to submit, in writing, what he is instructing Joanne to do, and then execute hisinstructions.

D) assign a different analyst to prepare a new report on Universal.

Answer:B

Explanation: The proper course of action would simply be to place Universal Airlines on a restricted list untilthe investment banking relationship with that company comes to an end. However, during the

period in which that relationship is active, the research department may only release factualinformation about Universal. No ratings should be released.

IV(B.1) - Fiduciary Duties

GENERAL

In general, all covered persons are required to carry out the following fundamental fiduciaryduties:

1. Loyalty: covered persons must at all times act in the best interests of the clients. This prohibits the covered person from buying and selling securities to clients or borrowing and lending to them.

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2. Care: must take all precautionary steps to ensure that any recommendation is suitablefor the client.

3. Prudence: must at all times ensure that the preservation of capital supercedes anyeffort to earn a potentially higher rate of return.

4. Impartiality: must ensure that all clients are treated fairly. For instance, anoversubscribed IPO should be allocated at the same price and on a pro rata basis toall investors for whom the security is suitable for.

5. Discretion: must ensure that all client matters are kept confidential.

While the above are general fiduciary duties, covered persons who have discretionary authorityover client assets must also comply with fiduciary duties as set out in legal statutes, governingrules and regulations, employer compliance manuals, and AIMR's Code and Standards.

To ensure compliance with all the rules and regulations, a covered person should allow anindependent audit to be conducted at least once a year, and provide itemized statements to clientsat least quarterly.

Question: When it comes to fiduciary duties, which of the following duties are members expected to carryout in order to comply with Standard IV: Relationship with and responsibility to clients and

prospects?

I. The generation of a reasonable rate of return on the assets is of greater importance thanensuring that the asset values are consistently preserved.

II. Members with discretion over client assets should submit to an independent audit at least

once a year.III. Members should submit an itemized list of the holdings in a client's account at least once

a year.

IV. Members would fulfill this standard by simply following the rules as set out by thegoverning agency whose jurisdiction the member works in.

Answer:II only.

Explanation: (I) is incorrect because the generation of a reasonable rate of return on the assets is of a secondary

concern. The primary objective of the fiduciary is to ensure that asset values are consistently preserved.

(III) is incorrect because members should submit an itemized list of the holdings in a client'saccount at least once a "quarter".

(IV) is not exactly correct because members must follow the rules of the body that has the highestset of standards. Hence, a member must be familiar with the rules as set out by legal statutes,

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governing agencies, employer compliance manuals, and the AIMR Code of Ethics and Standardsof Professional Conduct.

FIDUCIARY DUTIES OF TRUSTEES

In the U.S., fiduciary duties for trustees are set out two separate standards: The Prudent Man Ruleand the Prudent Investor Rule. The following question illustrates the similarities and differences

between these two standards:

Question: Which of the following duties must a member fulfill while managing a trust account, in order tocomply with Standard IV: Relationship with and responsibility to clients and prospects?

I. The Prudent Man Rule mandates that the prime objective in managing a trust is to preserve the value of the corpus of the trust, and only then to focus on generating a

reasonable return.II. The Prudent Man Rule and the Prudent Investor Rule are similar in that they both view an

investment in the context of a bigger portfolio.

III. As long as a manager adopts a conservative stance in order to preserve capital, even arelatively inferior performance would meet the requirements of the Prudent Man Rule.

IV. Paying above-average commissions to a broker for research and other services is strictly prohibited under any condition.

Answer:I only.

Explanation: (II) is incorrect because only the Prudent Investor Rule views an investment in the context of a

bigger portfolio. The Prudent Man Rule, on the other hand, would view an investment only basedon its merits as a stand-alone instrument.

(III) is incorrect because being very conservative is not an excuse for under-performance; in otherwords, the manager did not fulfill her duties.

(IV) is incorrect because paying above-average commissions to a broker for research and otherservices may be justified if the fiduciary can prove that the value provided from these serviceswarrant the extra costs associated with it.

FIDUCIARY DUTIES OF PENSION MANAGERS

In the U.S., fiduciary duties for managers of qualifying retirement plans are set out in theEmployee Retirement Income Securities Act (ERISA). The following question illustrates therequirements of this Act:

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Question: Which of the following duties must a member fulfill while managing a qualified privateretirement plan, in order to comply with ERISA (the Employee Retirement Income SecuritiesAct), and consequently Standard IV: Relationship with and responsibility to clients and

prospects?

I. A manager may not direct more than 20% of plan assets towards the shares or properties belonging to the sponsor.

II. A manager may receive normal benefits if she is a plan beneficiary.

III. Acquiring the securities of the sponsor and voting against a lucrative takeover that isotherwise hostile to management is permitted.

IV. A fiduciary can be held jointly responsible for the actions of another if the task that thefiduciary delegated to another party could have been reasonably performed by thefiduciary herself.

Answer:

II and IV only.

Explanation: (I) is incorrect because unless the plan allows for a higher limit, a manager may not direct morethan "10%" of plan assets towards the shares or properties belonging to the sponsor.

(III) is incorrect because acquiring the securities of the sponsor and voting against a lucrativetakeover that is otherwise hostile to management, is "not" allowed. Remember, the fiduciary'ssole loyalty is towards the plan beneficiaries. Hence, if the takeover deal is lucrative to theemployees, but hostile towards the employer, the fiduciary is well advised to vote in favor of thetakeover.

FIDUCIARY DUTIES OF MANAGERS OF INSTITUTIONAL FUNDS

In the U.S., fiduciary duties for managers of charitable or endowment funds are set out in theUniform Management of Institutional Funds Act (UMIFA). The following question illustrates therequirements of this Act:

Question: Which of the following statements is (are) true with respect to managing assets for charities orendowments, in order to comply with UMIFA (the Uniform Management of Institutional FundsAct), and consequently Standard IV: Relationship with and responsibility to clients and

prospects?

I. The standards set out for fiduciaries under this act not as high as the standards set down by the Prudent Man Rule.

II. Under UMIFA, the burden of proof lies on the fiduciary to justify his or her actions.

III. The board of trustees may delegate the responsibility of setting overall policy, only ifthey do so in a prudent manner.

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IV. The duties of a fiduciary in this case more so resemble that of corporate directors asopposed to a trustee.

Answer:I and IV only.

Explanation: (II) is incorrect because under UMIFA, the burden of proof lies on the accusers to prove that thefiduciary breached his or her duty towards the plan.

(III) is incorrect because the board of trustees are not allowed to delegate the responsibility ofsetting overall policy, that is their duty alone.

OTHER FIDUCIARY DUTIES

1. Social Investing: involves the investing in securities of issuers that engage in good socialcauses and avoiding the securities of issuers which hinder these good social causes. For instance,social investing usually involves the shunning of tobacco and arms manufacturers.

It should be pointed out that under some statutory laws, such as those set forth by the EmployeeRetirement Income Security Act (ERISA), the social behavior of an issuer must only be given asecondary consideration when choosing securities. The investment characteristics of the securitymust always dominate any such secondary issues. However, social investing may be allowed solong as the following conditions are met:

a) the portfolio's risk-return structure is not dramatically altered, b) diversification is not reduced,c) the costs involved are not excessive.

2. Relationship Investing: involves investing in a security so that the fiduciary may take an activerole in the affairs of the issuer. Such an act may only be allowed if the benefits outweigh therisks to the beneficiaries that the fiduciary is looking after. However, a fiduciary must be awarethat relationship investing might result in dual fiduciary roles, the first being to the beneficiariesof the plan that the fiduciary is managing, and second, to the shareholders of the firm that thefiduciary is actively taking a part in.

3. Proxy Voting: A manager has a duty to vote on behalf of the plan beneficiaries so that theirinterests may be served as best as possible. Therefore, a manager should:

a) cast a vote after carefully considering all the details, b) document the reasons for the way that the vote was cast,

4. Soft Dollars: The issue of soft dollars arises when trades for client accounts are executedthrough brokers who charge full service commissions, but who also provide research to themanager. In effect, the manger is paying for research information through client accounts. Such

procedures are allowed so long as:

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a) the research transmitted to the manager helps her make better decisions for that clientaccount,

b) the services received from the broker justifies the commission fees paid, andc) the soft dollar practice is disclosed to the client.

Question: Andy Price, CFA, is a portfolio manager with an investment counseling firm. Andy executesmost of his client trades through Alpha Securities. Alpha's commission rates are higher than theindustry norm, however, its analysts are consistently ranked in the top 5. Andy was recentlysolicited by Theta Securities, a deep discount brokerage firm. In order to comply with the AIMRCode and Standards, Andy:

A) does not have to do anything if he can justify paying the higher commissions in return for theresearch that Alpha provides.

B) is obligated to re-negotiate the commission schedule that he and Alpha had agreed upon previously.

C) should switch his trading business to Theta Securities, while attempting to obtain Alpha'sresearch second hand.

D) obligated to disclose to his clients that while a cheaper medium of trading does exist, he hasopted not to use it.

Answer:A

Explanation: AIMR does not mandate that the absolute cheapest medium of trading be chosen. In this case, ifthe value derived from the research justifies the higher commission costs, then Andy is fulfillinghis fiduciary duty by staying with Alpha Securities.

Question: Johnson Counselors routinely uses soft dollar brokers to execute trades for one of its biggestclients. Which of the following actions should the firm take so as to not violate Standard IV(B.1)- Fiduciary Duty?

I. Avoid soft dollar payments all together since they are a violation of securities laws.

II. Disclose the practice to clients.

III. Document that the services paid helped the manager make better informed decisions with

regards to all managed accounts at the firm.IV. Document that the manager sought out the best reasonable price given the services that

were provided.


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Explanation: (I) is incorrect because soft dollar trading is permitted so long as the soft dollars earned solely

benefit the accounts that generated the commissions. Thus (III) is a violation as well since thecommissions generated by one plan are benefiting a multitude of plans.

IV(B.2) - Portfolio Investment Recommendations and Actions.

This standard requires a covered person to:

a) know the client's objectives and level of risk aversion, b) propose only trades or strategies that suit part (a),c) separate opinion from fact when proposing a strategy, andd) disclose the methods that were used in order to select the recommended securities.

To best fulfill these requirements, the covered person should construct an "Investment Policy

Statement" (IPS) for the client and then reviewing it with the client once per year. The IPS is avery important document since it will incorporate all of the client's objectives and constraints.

Question: Which of the following duties must a member fulfill in order to comply with Standard IV(B.2):Relationship with and responsibility to clients and prospects - Portfolio InvestmentRecommendation and Actions?

I. Information with respect to the client's objectives and constraints should be updated atleast once every three years.

II. The security selection process should be disclosed to the client.

III. A written authorization should be obtained before making changes to the portfolio.

IV. The client's investment experience should not have an impact on what investments themember thinks is suitable to the client's objective.


Explanation: (I) is incorrect because information with respect to the client's objectives and constraints should

be updated at least "once" a year.

(IV) is incorrect because the client's investment experience should have a major impact on whatinvestments the member thinks is suitable to the client's objective. A client's experience is atestament to how much risk can be tolerated, a factor that is very important in makingrecommendations.

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IV(B.3) - Fair Treatment of Clients

While it is impossible to contact all of the firm's clients at once, it is imperative that an attempt bemade to reach the clients as simultaneously as possible for which a security recommendation issuitable. At the same time, a firm must ensure that these clients have a higher priority in

executing these trades than their own employees or in-house accounts. Therefore, a firm must:a) limit the number of employees who are privy to pending investment recommendations,

(these employees are referred to as "access persons") b) reduce the lag as much as possible between the time that an analyst concludes a report

and the time that it is disseminated,c) monitor the trading activities of employees to ensure that there is no "front-running (the

act of placing a trade knowing that a much bigger trade will hitting the market soonafterwards),

d) keep a customized list of clients who might be affected by a change in recommendationfor each particular security, and

e) ensure that in a block trade for oversubscribed security, the shares are distributed on a prorata basis (based on order sizes) and that each client is given the same price and chargedthe same trading fee rate.

Access persons have a very high degree of responsibility. A pending recommendation is a veryhighly sensitive piece of information. Therefore, it is important that they restrict trading for theiraccount until clients have had an opportunity to react to the new recommendation. However,access persons must also restrict trading for accounts in which they have an interest. Thisincludes the accounts of immediate family members such as spouse, children, and relatives wholive with the access person. On the other hand, the accounts belonging to other family memberswho don't reside with the access person, may be treated as a regular client account, and wouldtherefore be free to trade as soon as a recommendation is disseminated.

Question: Which of the following compliance procedures should be implemented in order to meet therequirements of Standard IV(B.3): Relationship with and responsibility to clients and prospects -Fair Treatment of Clients?

I. An investment recommendation should be communicated to all the firm's clients as

simultaneously as possible.

II. Even within the firm, the number of people who are aware of pending recommendationsshould be kept to a minimum.

III. If there is a change in opinion, it is very important to only release one comprehensivereport, even if it does take longer than just a summary report.

IV. A disclosure should be made to clients with respect to differences that may exist in thelevels of service provided.


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Explanation: (I) is not entirely correct because an investment recommendation should be communicatedsimultaneously to all the firm's clients who have a known interest in such an investment andwhose risk tolerance allows for such an investment into their portfolios.

(III) is incorrect because if there is a change in opinion, it would be very wise to first issue a briefsummary report and then follow that up at a later date with a comprehensive report. In this case,timing is by far the greater issue.

Question: Jamie Stone has been hired by Trump Securities in order to implement procedures that willimprove the firm's dealing with clients. Which of the following procedures would be incompliance with Standard IV(B.3)- Fair Dealing with Clients?

I. Shorten, as much as possible, the length of time between when the recommendation is

formed by the research department and the time that this news is actually disseminated.II. Set a pre-determine formula that will be used to allocate a portion of future private

placements over to the firm and its employees.

III. Implement a system that will notify all the clients of the firm if there is a new investment product or opportunity.

IV. Set some guidelines that may be used in the future to determine whether a change in theunderlying investment warrants a change in recommendation.

Answer:I and IV only.

Explanation: (II) is incorrect because the clients get the first opportunity to buy as many shares as they want.Hence, a pre-set method of allocating some future issues to non-clients would be a violation ofthis Standard.

(III) is not exactly correct because a conservative client need not be notified if a high-growthcompany is issuing some more shares. Hence, only those clients who might find the investment to

be suitable must be contacted as soon as possible.

Question: John Booth, CFA, is the compliance officer at a large brokerage firm. Through the underwritingdepartment, a given sum of shares became available for distribution to clients as a result of a veryrecent initial public offering. To ensure compliance:

A) these shares should only be distributed to institutional clients because the inherent conflict ofinterest in selling shares that became available through he firm's own underwriting department,would not qualify these block of shares for public distribution.

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B) these shares should be sold on a first come first serve basis to clients.

C) these shares should be distributed on a pro-rata basis only to the clients who have inquiredabout this issue.

D) these shares should be distributed on a pro-rata basis to all the client account for which these

shares would be appropriate for.

Answer:D

Explanation: Investment professionals have a fiduciary duty towards all of their clients. Consequently, allclients, for whom these shares would be suitable for, should have an equal opportunity at

purchasing them. First come first serve basis does not create an atmosphere of equality among theclient base. Finally, it is a very common practice to sell shares underwritten by the same firm.

IV(B.4) - Priority of TransactionsTo ensure fair treatment to all clients, a firm should:

a) limit the number of access persons who would have an advanced knowledge of a pendingrecommendation,

b) build firewalls around departments in order to stop the flow of any restricted information,c) disallow employees from subscribing to IPOs, thus allowing for the shares to be available

to the firm's clients instead,d) impose a waiting period from the time that a recommendation is made to the time that

employees become able to trade,e) require employees to obtain prior approval for certain securities before trading them for

their personal account, andf) review the accounts of employees and for those accounts that the employees have an

interest at least on a quarterly basis.

Question: Which of the following compliance procedures should be implemented in order to meet therequirements of Standard IV(B.4): Relationship with and responsibility to clients and prospects –Priority of Transactions?

I. The access person's sibling's accounts should be treated just like other regular clientaccounts.

II. While stocks on a restricted list cannot be traded, the same restriction would not hold onoptions related to those stocks.

III. Restrictions should be placed on members' ability to participate in IPOs and private placements.

IV. Blackout periods should follow the time an investment recommendation is disseminatedto clients.

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IV(B.6) - Prohibition against Misrepresentation.

A covered person is prohibited from making a misrepresentation with respect to:

a) his credentials and qualifications, or

b)

his firm's range of services.

This standard covers all forms of communication: written, oral, electronic, or media. Thisstandard also covers communication that's intended for internal use as well. To ensure that thisstandard does not become violated, a firm should:

a) prohibit employees from making any guarantees with respect to the performance of anyinvestment,

b) have a ready made list of all the services that it provides, andc) have a list of its employees and their qualifications.

Question:

Werner Johnson, CFA, is the vice president for sales of a regional brokerage firm. At a local golftournament, he is asked by one of the participants if Werner's firm covers the Asian market.Werner responds that his firm covers the globe and that the participant should stop by one dayand see what the firm could do for him. The fact is though, Werner's firm only covers regionalover- the-counter stocks. Werner's comments:

A) are not a violation since the comment was made on a person to person basis.

B) are a violation of Standard IV(B.6) - Prohibition against misrepresentation.

C) are not a violation since his comments were simply an effort to invite the participant to explorehis company's services.

D) are not a violation since Werner spoke of this matter during his leisure time.Answer:B

Explanation: Standard IV(B.6) is fairly clear. Misrepresentation of company services or individual

qualifications is not allowed, irrespective of the circumstances. In addition, Werner's statementsmay also be deemed as a violation of the Code, since his "lie" is counter to the duty to act withintegrity.

Question: Patricia Hayes, CFA, is the manager of sales at a regional bank. This bank has had one of themost successful aggressive small cap fund performances in the market. However, this fund onlyrepresents 2% of the bank's mutual fund assets. In fact, the majority of the bank funds have beenunder performing fixed income funds. During sales meetings, Patricia only emphasizes the

performance of the small cap fund, adding "the return figures of this fund speaks volumes aboutwhat we potentially can do for you". According to the AIMR Standards, Patricia:

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A) violated Standard IV(B.6)-Prohibition against misrepresentation.

B) covered herself by stating that past returns are simply an indication of what "potentially" couldhappen in the future.

C) violated Standard IV(A.1)-Reasonable basis and representation.

D) covered herself by simply stating facts and not opinions.

Answer:A

Explanation: While it is tempting to only report the firm's star performing funds, in this case is crossed the lineof misrepresentation. The performance of the small cap fund is being used to represent the

performance potential of the bank's funds at large. Had small caps been the specialty of the bank,and thus comprising most of its fund offerings, then Patricia would have done nothing wrong. Butthat clearly wasn't the case here.

IV(B.7) - Disclose Conflicts of Interest to Clients andProspects.

A client must be informed whenever a covered person finds himself in a situation whereby hemight have a number of conflicting interests. For instance, a covered person must disclose to aclient:

a) if his firm has any special relationship with the issuer whose securities are beingrecommended,

b)

if his firm acts as the underwriter or market maker for the issuer's securities,c) if he or his firm have material ownership in the securities being recommended, andd) if his compensation structure might favor a trade or a strategy that might be detrimental

to the client.

In order to comply with this standard, a covered person should obtain prior approval from seniormanagement before engaging in activities that might be in conflict with the client's best interest.For instance, personally trading securities that are being traded for clients, being on the board ofan issuer, or doing some consulting work for an issuer are all activities that should be pre-approved.

Question: Matthew Smith, CFA, is an airline analyst with Fuzzy Securities. The chairman of Fuzzy, BillGross, also sits on the board of directors of Universal Airlines. Bill has asked Matthew to pick upcoverage on Universal Airlines, and thus issue a report. In order not to violate any of the Codes orStandards, Bill should:

A) refuse to issue a report because of the blatant conflict of interest that exists between Fuzzy andUniversal Airlines.

B) issue a report, however, clearly disclosing of the special relationship between the chairman of

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Fuzzy and Universal Airlines.

C) issue a report that consists entirely of facts and does not include any ratings.

D) issue the report only after having asked Bill, in writing, to resign his post as a director ofUniversal Airlines.

Answer:B

Explanation: Conflicts of interest situations are many in this industry. Therefore, it is impractical to avoidthem. So, the solution is to simply disclose these conflicting situations to the affected parties andlet them decide on the analyst's objectivity.

IV(B.8) - Disclose Referral Fees

A covered person must disclose to a prospect, in writing, if a fee was paid in order for the referralto have been made. In other words, when a third party refers a prospect to a covered person, the

prospect must be made aware that the fee paid by the covered person to the third party might have been a possible motivations for the referral having been made. To meet this standard, a covered person should forward to the prospect a written memo of the terms of any such referralarrangement.

Question: Stacey Jones, an investment counselor, recently had a client inquire about her services as a resultof being referred to her by an insurance broker. Last year, Stacey had set up a referralarrangement with this broker whereby Stacey would pay this broker a nominal amount for every

client that was sent to her. Which of the following courses of action should Stacey take so thatshe would be in compliance with Standard IV(B.8)- Disclosure of Referral Fees?

I. Since the referral fees paid by Stacey are fixed amounts, and not dependent upon the sizeof the business, there is absolutely no conflicts and hence disclosure of the referralarrangement to the client is not required.

II. A disclosure must be made whenever any form of compensation is transferred as a resultof the referral.

III. Stacey must consult with the firm's compliance officer to ensure that all her outstandingreferral arrangements are acceptable.

IV. Disclosure of the existence of the referral fees need only be made once a formalagreement is drafted with the client.


Explanation: (I) is incorrect because regardless of whether these fees are fixed or dependent on the size of the

business, it must be disclosed to the client.

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(IV) is incorrect because the disclosure of referral fees must be made before a formal agreementis drafted with the client.

V(A) - Do Not Use Material Nonpublic Information.There are two theories that may be used in prosecuting an act of securities fraud: TraditionalTheory and Misappropriation Theory.

1. TRADITIONAL THEORY

Under this theory, securities fraud would have been committed if the person taking orrecommending a trade was in possession of inside information and at the same time had orinherited a fiduciary duty towards the issuer.

A number of factors are used in order to determine if the information was in fact inside

information and that it shouldn't have been traded upon:

a) Materiality: information is regarded as material if:

(i) It's regarding a tender offer,(ii) it would have an impact on the security price if it was know, and(iii) it was a specific fact, as opposed to an opinion.

b) Non-Public: even after inside information is made public, insiders must allow themarket some time in order to absorb this information before they can trade for their

personal accounts.

c) Insider Source: the individual from whom the information is obtained from is in a position to receive confidential information and has a duty not to disclose it.

In the event that a covered person acts upon some inside information, it would only be deemed aviolation if the covered person was given the information as part of a work arrangement with theissuer or the covered person knew that such information was obtained illegally.

An insider (the tipper) is deemed to have breached his fiduciary duties if the reason for thedisclosing material nonpublic (insider) information, was to make a personal gain.

Question:

Which of the following statements is (are) true with respect to the Traditional Theory ofdetermining whether securities laws have been violated along with Standard V(A): Relationshipswith and responsibilities to the investing public - Do not use material nonpublic information?

I. Securities fraud will have been committed only if the individual trading on material nonpublic information had a fiduciary duty towards the company whose shares are beingtraded.

II. An individual, who does not have a fiduciary duty towards either the acquiring company

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IV. The misappropriation theory is less restrictive than the traditional theory.


Explanation: (I) is incorrect because with the Misappropriation Theory, a violation occurs even if the covered

person did not owe a fiduciary duty towards a company.

(IV) is incorrect because the misappropriation theory is much more restrictive than the traditionaltheory. Under the traditional theory, securities fraud only takes place if the covered person whotraded on inside information, had a fiduciary duty towards the company whose shares are beingtraded. Under the misappropriation theory a violation would have taken place regardless if thecovered person had or had not any fiduciary duties towards the company whose shares are beingtraded.

Question: An analyst comes to the possession of some material nonpublic information. The analyst should

be aware that according to the misappropriation theory:

I. Insider trading restrictions only apply to tippees.

II. Insider trading restrictions apply to even those who owe no fiduciary duty towards theshareholders of that particular issuer.

III. Trading would still be possible, so long as the information was not obtained illegally.

IV. Insider trading restrictions only apply to those who owe a fiduciary duty towards theshareholders of that particular issuer.

Answer:II only.

Explanation: According to the misappropriation theory, even those who owe no fiduciary duty towards theshareholders of that particular issuer will have committed securities fraud, if they traded on insideinformation obtained from sources to which they owed a duty of trust and confidence.

(I) and (IV) is incorrect then because the restrictions extend way beyond just the tippee and thosewho owe a fiduciary duty to the shareholders.

(III) is incorrect because violations would have occurred even if the inside information wasn'tobtained illegally.

In contrast to the above two theories, "Mosaic Theory" stipulates that if the covered person wereto piece together non-material inside information along with publicly available information and

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reach a conclusion similar to what would have been the case had he had inside information, then aviolation is not deemed to have occurred.

Question: Brian Adair, CFA, has developed a very comprehensive network among the parts suppliers of the

auto industry. Over the last two weeks, through his contacts, he found out that Specific Motorshas been signing huge deals to outsource most of its high cost operations. Taking this as a signthat Specific Motors will soon begin to report much more favorable earnings, Brian buys a seriesof call options on its stock. According to the AIMR Standards:

A) Brian violated the Standards by not encouraging Specific Motors to immediately disseminatethis new information.

B) Brian did absolutely nothing wrong.

C) Brian violated the Standards because he neither conducted a due diligence nor have a sound basis for making this trade.

D) Brian violated the Code and Standards because his conduct lacked integrity and would likelydiscredit the profession.

Answer:B

Explanation: Brian, in effect, conducted "front-line" research. The information he gained was clearly nonpublicsince many contacts were involved in obtaining this information. Remember, what distinguishesnonpublic information from public information is timing. So by the time vendors start gettingorders from Specific Motors, the information is no longer nonpublic. Brian did nothing wrong.

Question: Bill Houston, CFA, is a research analyst working at a hedge fund company. His "up" ratingsresult in longing a security and his "down" ratings result in "shorting" a security. His research isquite unorthodox in that he actively seeks nonmaterial private information about the issues that hefollows. His supervisors are well aware of his methods. According to the AIMR Standards ofProfessional Conduct:

A) Bill would only be violating the Traditional Theory is the information was being obtainedthrough an insider.

B) Bill's supervisors are in direct violation of Standard III(E)-Responsibility of Supervisors.

C) both Bill and his supervisor are violating insider trading rules.D) Bill is simply applying the mosaic theory; there are no violations.

Answer:D

Explanation: A violation of the Traditional Theory would take place only if the information was private and

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"material". This was not the case here. Instead, Bill simply pieces together nonmaterial privateinformation, which under the mosaic theory, is an allowable practice.

To ensure that employees do not violate Standard V(A), a firm should:

a) establish firewalls between its corporate finance department (temporary insiders) and therest of the departments (analysts, trading, etc.)

b) restrict, monitor, and review the trading activities of all employees and for all theaccounts that they have an interest in,

c) should encourage an issuer to disseminate any information that was leaked via a breachof duty by an insider.

Question: Helen Carter, CFA, is a portfolio manager working for a large multi-service financial servicesfirm. The investment banking division of her firm was recently hired by Mega Corp. in order to

assess the feasibility of conducting a large share buy-back program. Which of the followingactions should be taken in order not to violate the AIMR Standards of Professional Conduct?

A) The investment banking division should turn down offering their services to Mega Corp.

B) Simply impose a Fire Wall between these two departments.

C) Helen should immediately cease trading in any of Mega Corp.'s securities.

D) Helen, along with all the other investment managers, must sign a confidentiality agreement notto release any information that they may obtain through the investment banking division.

Answer:B

Explanation: It is very important for information not to flow outside the boundaries of the investment bankingdivision. Most information found in this department is material and nonpublic. Therefore, aneffective Fire Wall must be erected around this department. If in fact, Helen did cease trading in

Mega Corp., then she may breach her fiduciary duty to her own clients either by not selling Megashares when she should of, or not buying Mega shares when she should of.

Question: Which of the following compliance procedures would be effective in enforcing insider tradingrules?

I. A member who comes to the possession of insider information must inform a supervisorof that fact before doing any trading in that security.

II. There should be firewall between the analysts' department and the sales division of a brokerage firm.

III. There should be no overlap of even support personnel between the corporate finance

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department and the brokerage side.

IV. If a member comes into the possession of inside information by way of a breach of duty by a tipper, than the member's only duty is inform his or her supervisor and refrain fromtrading.


Explanation: (II) is incorrect because the analysts and the sales people are effectively the same department.Think of the analysts as the broker’s library. Brokers are supposed to have access to all the publicinformation that analysts possess. The firewall should be between the corporate financedepartment and the brokerage side.

(IV) is incorrect because if a member comes into the possession of inside information by way of a breach of duty by a tipper, than the member's duties not only include informing his or hersupervisor and refrain from trading, but as well, the member must make a reasonable effort to

have this inside information made public.

Question: Mike Garraway is a junior analyst in the corporate finance department. During his usual factfinding research on one of the firm's pharmaceutical clients, he discovers that the Food and DrugAdministration just approved their experimental drug. What must Mike do so that he is not inviolation of Standard V(A) - Prohibition Against the use of Nonpublic Information?

A) Cease coverage of this client.

B) Encourage the firm to disseminate this information as soon as possible.

C) Seek the advise of legal counsel with respect to how to disassociate from this situation.

D) Neither take any action, nor communicate this fact to anyone other than the direct supervisor.

Answer:D

Explanation: Mike received this information in the course of his duty. Therefore, unless this disclosureconstitutes a breach of duty towards the shareholders, Mike need not do anything.

V(B) - Performance Presentation.

In an effort to facilitate a fair comparison among investment managers, AMIR developed both thePerformance Presentation Standards (PPS) and the more recent Global Investment PresentationStandards (GIPS). Both standards are similar in terms of the procedures required to constructingcomposites. However, PPS requires a 10-year history be presented in terms of asset class, whileGIPS only requires a 5-year history without the need to breakdown performance by asset class.

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PROCEEDINGS RELATED TO PROFESSIONAL CONDUCT

A. THE PROFESSIONAL STANDARDS AND POLICY COMMITTEE (PSPC)

The PSPC is made up of 2 subcommittees:

a) The Disciplinary Review Subcommittee: which enforces the Code and Standards, and

b) The Standards and Policy Subcommittee: which promotes and makes revisions to theCode and Standards.

B. GROUNDS FOR DISCIPLINE

Sanctions may be imposed on a covered person for any of the following reasons:

a) violation of the Code, the Standards, or any applicable rules, b) a sanction imposed by a regulator,c) a felony or any conviction that results in a jail time of greater than a year,d) barred indefinitely from registration,e) failure to sign and submit the annual Professional Conduct Statement (PCS),f) falsifying information to AIMR, org) any good cause.

C. SANCTIONS

There are a number of sanctions that may imposed upon a covered person:

a) Private censure: is the lightest of all possible sanctions. It involves a publication of the

violation without mentioning the name of the violator. b) Public censure: involves the publication of both the violation and the violator's name.c) Timed suspension of membership with AIMR and member societies.d) Timed suspension of the right to use the CFA designation.e) Revocation of membership with AIMR and member societies.f) Revocation of the right to use the CFA designation.g) Summary suspension: automatically revokes the violator from membership with AIMR

and member societies along with the revocation of the right to use the CFA designation.h) Suspension or revocation of the candidate from further participation in the CFA Program.

D. REINSTATMENT AFTER A TIMED SUSPENSION

A covered person's membership with AIMR or his right to use the CFA designation may bereinstated after the suspension period only if a new PCS is submitted indicating that there havenot been any new sanctions imposed upon the covered person since the suspension was imposed.

E. REINSTATMENT AFTER A REVOCATION

A covered person may apply for reinstatement into AIMR membership or the right to use theCFA designation under the following conditions:

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a) at least 5 years have lapsed since the revocation date, b) the covered person can demonstrate to the PSPC that he is fit to be a member again, andc) the covered person accepts any reinstatement conditions imposed by the PSPC.

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