ETHICS

Case 1:
Mr. A is a manager in a stock broking firm. He has 100 clients. The team of Mr. A is responsible to
conduct stock analysis and provide recommendations to the clients.
Their research shows that Shares of Co. XYZ, now trading at a price of 200, will appreciate to
400 within a period of 3 months.

Mr. A purchases 100,000 shares of XYZ in his account and allows his employees to buy this share too.
Together they drive the price up to 250.
Now they recommend this stock to their clients and encourage them to buy as many shares as
possible. They declare – “Your investment WILL double within 3 months.”

Case 2:

An Analyst is angry on his employer for cutting down his bonus. The analyst had to prepare a
research recommendation on a particular stock. He conducts an extensive research and feels
that the stock is an AVOID. He however wants to hurt the image of his employer, and hence issues
a BUY recommendation. Is he in violation?
Case 3:

2 managers are discussing – “Our Company will likely post negative earnings for this Quarter end.”
An employee, Mr. B overhears them and decides to sell his shares of the Company.
Who is in violation?

Case 4:

A sell-side analyst is invited to visit the business premises of a client seeking to raise capital from
investors. The client explains the business model and how the business plans to utilize the funds
raised. He also provides luxurious travel and accommodation to the analyst.
The analyst is now documenting his findings and submitting a research report. He feels that the
investment is risky and is not suitable for everyone. He however feels obliged towards the client for
the treatment offered. He concludes the report by stating that – this investment is suitable only for
individuals with high risk appetite. Has he maintained due diligence?
Sell-side Analyst
• Creation, promotion, and selling of securities of Corporations to public
• Consists of banks, advisory firms and others who sell the securities on behalf of their clients
• E.g. A Co. that needs money to build a new factory will call the investment banker and take their
help to raise either equity or debt to finance the project.
• Bankers will analyze the project, prepare a finance model and determine the net worth of the
project. They will then prepare a variety of promotional materials (prospectus) to be distributed to
potential investors.

Buy-side Analyst
• Invests money of clients in securities sold by the sell-side analysts
• Securities could be equity, preference shares, bonds, derivatives or other exotic instruments
• E.g. AMC that runs a fund that invests the money of HNIs in IT Cos. The Portfolio Manager will
look for investment opportunities. One day, the VP of equity sales at a major investment bank calls the
portfolio manager and notifies them of an upcoming initial public offering (IPO) of the company in
the software manufacturing space. The PM decides to invest and buy the securities, which flows the
money from the buy side to the sell side.
▪ Ethics is a set of shared beliefs about what is good or acceptable behavior and what is not.
It specifies a minimum level of acceptable conduct.
▪ Benefits and balances the interest of stakeholders.
▪ Is important because clients do not have significant knowledge about financial securities.
Investment professionals are entrusted with the client’s wealth and it is their fiduciary
duty to act in the best interests of the client.

▪ Financial services industry acts as an intermediary between lenders and borrowers of

capital.
▪ A lack of trust in financial advisors increases cost of capital.

▪ Suitability Standard = match client’s return requirement with risk tolerance and
determine if the security is suitable for the client.
▪ Fiduciary standard (stronger) = professionals should use their knowledge and expertise to
act in the best interest of the client.
Challenges to ethical behavior –
• Situational influence
• Social pressure
• Loyalty towards employer, organization and coworkers is greater than towards clients
• Self-interest
• Prefer short-term results over longer-term
• Greed

Ethical principles set a higher standard of behavior compared to laws and regulation.
Complying with code of ethics involves more judgement as compared to complying with
laws and regulations.

Not all unethical actions are illegal and not illegal actions are unethical.
• Whistle-blowing is illegal but ethical
• Recommending a stock without proper research or disclosure can be legal but unethical.
CFA CODE OF ETHICS AND
STANDARDS OF
PROFESSIONAL CONDUCT
Major Standards of Professional Conduct

1. Professionalism

2. Integrity of Capital Markets

3. Duties to Clients

4. Duties to Employers

5. Investment Analysis, Recommendations, and Actions

6. Conflicts of Interest

7. Responsibilities as a CFA Institute Member or CFA Candidate

I) PROFESSIONALISM

A. Knowledge of the law

• Understand and comply with all applicable laws and CFA Code of conduct
• If laws conflict, follow the stricter one.
• Knowingly don’t participate in any violations and dissociate yourself from any violations.

B. Independence and objectivity

• Use reasonable care and judgement while performing all professional activities.
• Do not offer, ask, or accept any gift, benefit or compensation that will compromise your or
other’s independence and objectivity.

C. Misrepresentation
• Knowingly do not make any misrepresentations related to analysis, recommendations or actions

D. Misconduct
• Not engage in acts involving fraud or deceit that reflects poorly on professional integrity,
reputation or competence.
Examples:

1. Country ABC allows trading based on insider-information. Will you follow local rules or CFA Code
of Ethics?

2. Mr. A recommends service of Co. X over Y because Co. X provides him with premium tickets of
a soccer game.

3. Mr. B has joined a research firm. He has cleared CFA Level 2 and has enrolled for the Level 3
exams. In the promotional material of the research firm, he is stated as a CFA Charter
holder. What actions are necessary?

4. Mr. C has used the projected financial statements prepared by his colleague to prepare a
research report. He presents the projections as his own.

5. Mr. D is preparing a research report for his firm. He sells a copy of that to an outsider
without the knowledge of the firm for a compensation.
II) INTEGRITY OF CAPITAL MARKETS

A. Material Non-public information

• If possessing such information that could affect value of investment, do not act or cause others to act.

B. Market manipulation
• Don’t engage in activities that distort prices or artificially inflate trading volume, with an intent to
mislead the participants.
Material Non-public Not Allowed to Used
Material Public Allowed
Non-material Public Allowed
Non-material Non-public Allowed

Material info = valuable info that can affect investment decisions.

Non-material info = information that is not valuable or does not affect final decisions. It might be
supplementary or can even be overlooked.
Public = info that is known to all, or has been disclosed openly.
Non-public = that is not disclosed to general public, but is known only by a few people.
Examples:

1. Mr. A is on the BOD of Co. X. The BOD has discussed a potential takeover of Co. Y next
month. Mr. A discloses this news to his close friend Mr. B who is a doctor by profession. Mr. B
calls his broker and buys the share of Co. Y. The takeover happens, and the share of Co. Y increases
by 30%.

2. Suppose the takeover didn’t happen and the share of Co. Y does not increase, but decreases
casually by 5%. Is Mr. A still in violation?

3. A portfolio manager sells 100,000 shares of a Co. as directed by a client. He also places buy order
for a total of 80,000 shares in the accounts of 3 other clients. These transactions have resulted
in a high volume for this thinly-traded stock. Has he violated the standards?

4. A stakeholder declares that he is planning to sell some % of his holdings in a particular Co. This
causes panic and a lot of retail investors sell the investments. He doesn’t actually sell, and his wife
secretly buys most of the shares sold by the public at the current low prices.
III) DUTIES TO CLIENTS

A. Loyalty, Prudence and Care

• Loyalty towards clients is primary. Always act for their benefit.
• Place interest of client above employer.
• Act with reasonable care and exercise prudent judgement.

B. Fair Dealing
• Treat all clients fairly and objectively when providing investment analysis, making
recommendations, taking action or engaging in other professional activities

C. Suitability
• Understand risk and return objectives of clients, their investment experience, and financial
constraints before making any recommendation or taking any action.
• Create an Investor Policy Statement, re-assess the information and update it regularly.
• Judge the suitability of the investment in context of the total portfolio.
• If managing investments as per a specific mandate or style, only make investments consistent to
the stated objectives and constraints.
D. Performance presentation
• Communicate investment performance that is fair, accurate and complete.

E. Preservation of Confidentiality
• Keep info of current, former and prospective clients confidential unless it is illegal, required
by law or client permits disclosure.
Examples:

1) Mr. A buys securities for himself first, and then buys it for the clients.

2) Mr. B informs his client Mr. X first about the new products/securities her firm is promoting because he is
wealthy and well-connected. He then informs other clients about the same.

3) Mr. C is a retired individual. He does not want to take risk with his money and wants to invest only in Bonds.
His portfolio manager is aware of the same, but buys equity shares of Co. P in his account because he feels
that this stock will give a 200% return this year.

4) An investment firm manages 5 different pool of funds. The returns on 2 accounts were negative for 2017.
While presenting the performance of the Co. to prospective investors, the firm excludes the 2 poorly
performed funds and presents an inflated net return.

5) Mr. X has a client who invests in antiques. He passes on the contact info of his client to a friend who is a
dealer in antiques. Has Mr. X violated the standards?

6) Suppose that client is also a friend and during a social meet, he states his interest in antiques and X passes on
the info. Is he in violation?
IV) DUTIES TO EMPLOYER

A. Loyalty
• Act for the benefit of the employer using your skills, do not divulge confidential info or cause
any other harm.

B. Additional compensation arrangements

• Not accept gifts, benefits or compensation that might create conflict of interest between
self-interest and interest of the employer, unless they obtain a written consent from all parties
involved.

C. Responsibilities of Supervisors
• Make reasonable efforts to ensure that anyone subject to your supervision complies with
applicable laws, rules and Code of standards.
Example:

1. An Analyst is angry on his employer for cutting down his bonus. The analyst had to prepare a
research recommendation on a particular stock. He conducts an extensive research and feels
that the stock is an AVOID. He however wants to hurt the image of his employer, and hence
issues a BUY recommendation. Is he in violation?

2. A client has gifted Mr. X his investment advisor an expensive watch for his good
recommendations. X does not inform his employer and decides to keep this a secret. He exhibits
favoritism for this client thereon.

3. Mr. Z is responsible for supervising his investment advisory team. He wants to be employee-
friendly and hence decides to let his employees participate in IPO along with the clients.
V) INVESTMENT ANALYSIS, RECOMMENDATIONS AND ACTIONS

A. Diligence and Reasonable Basis

• Exercise diligence, independence and thoroughness in analyzing investments, making
recommendations and taking actions.
• Support your actions and recommendations with proper documentation and research.

B. Communication with Clients and Prospective Clients

• Disclose basic structure followed to take investment decisions and immediately disclose if any
changes are made to the process
• Disclose limitations and associated risks.
• Identify which factors are important for investment analysis and include those communicate the
same to clients.
• Distinguish between fact and opinion in any presentation.

C. Record Retention
• Develop and maintain records that support investment analysis, actions and all investment
related communications made with the client and prospective clients.
Example:

1. Mr. A has to prepare a research recommendation for a stock and submit it today. To meet the
deadline, he reads a similar report prepared by an analyst working for a different firm
and submits the same recommendation. Is his research independent and thorough?

2. A Co. has sent a research report to their clients based on certain assumptions about exchange
rates and Interest rates. Recent market scenarios has caused the Co. to revise the assumptions
used. The Co. makes revisions and re-calculates the figures. There is only a minor change in
expected return and hence the Co feels there is no need to update the clients.

3. Because the net profit in 2017 was 15%, it will grow to be 20% in 2018 - Data of 2017 is a fact,
but data of 2018 is an opinion.
VI) CONFLICTS OF INTEREST

A. Disclosure of Conflicts
• Disclose all matters that could reasonably impair your independence and objectivity to
clients, prospective clients and employer.

B. Priority of transactions
• Transactions of clients and employer have priority over transactions in which member is a
beneficial owner.

C. Referral fees
• Disclose to employer, clients and prospects, any compensation or benefit received or paid
for recommending products or services.
Examples:

1. Mr. A recommends clients to invest in Mutual funds of Co. X over Y because he receives a higher
commission.

2. Mr. B has recently inherited a 2% stake in a Public Co. from his grandparents estate. He has been
asked to prepare a research report on that same Co. and present it to clients. This is a conflict of
interest and must be mentioned in the research.

3. Mr. C is preparing a research report on a firm in which his father is the CEO. There is a conflict of
interest.
VII) RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CANDIDATE

A. Conduct as participants in CFA Institute Programs

• Not engage in any conduct that compromises the reputation or integrity of the Institute,
designation or validity and security of CFA Program.

B. Reference to CFA Institute, Designation and the Program

• When referring to Institute, membership, designation or candidacy, do not exaggerate or
misrepresent your competencies.
Example:

1. Cheating in the CFA exam or any other exam, continuing to write when asked to stop, making
gestures or any kind of verbal/non-verbal communication with a fellow candidate, unnecessary
arguments with the proctor, etc.

2. Claiming superior analytical skills after clearing CFA (any levels) or clearing all exams in 1st attempts.

3. Promoting oneself as Mr. XYZ, CFA without having a valid charter.