Ethical and Professional Standards

Study Guide

Ethics and Trust in the Investment Profession

Ethics refers to a set of moral principles or rules of conduct that guide behavior. In the investment profession, ethics is the foundation of trust. Without trust, the industry cannot function effectively.

• Why Ethics Matter:
  • Promotes trust and confidence from clients.
  • Maintains the integrity of capital markets.
  • Fosters a reputation of professionalism, benefiting all market participants.
• Relationship with Regulations: Laws and regulations establish minimum standards of conduct. The Code and Standards set a higher, principles-based bar for ethical behavior. Simply complying with the law may not be sufficient to be considered "ethical."
• Ethical Decision-Making Framework: A structured approach helps navigate ethical dilemmas.
  1. Identify: Facts, stakeholders, ethical principles, and conflicts of interest.
  2. Consider: Situational influences, alternative actions, and potential consequences.
  3. Decide and Act: Make a judgment and act on it.
  4. Reflect: Evaluate the outcome of the decision.

Code of Ethics and Standards of Professional Conduct

The Code of Ethics is a set of principles that all CFA Institute members and candidates must adhere to. The Standards of Professional Conduct are the specific rules that flow from these principles.

The Code of Ethics (6 Principles):

1. Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues, and other investment professionals.
2. Place the integrity of the investment profession and the interests of clients above their own personal interests.
3. Use reasonable care and exercise independent professional judgment when conducting investment analysis, making recommendations, taking investment actions, and engaging in other professional activities.
4. Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession.
5. Promote the integrity and viability of the global capital markets for the ultimate benefit of society.
6. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

The Standards of Professional Conduct (7 Standards):

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

Guidance for Standards I–VII

This section details the specific requirements of each of the seven Standards.

Standard I: Professionalism

• I(A) Knowledge of the Law: You must understand and comply with all applicable laws, rules, and regulations (including the Code and Standards). In cases of conflict, you must follow the more strict law, rule, or regulation. You must not knowingly participate or assist in any violation and must dissociate from any illegal or unethical activity.
• I(B) Independence and Objectivity: You must use reasonable care and judgment to achieve and maintain independence and objectivity. You must not offer, solicit, or accept any gift, benefit, or compensation that could reasonably be expected to compromise your own or another’s independence and objectivity.
• I(C) Misrepresentation: You must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. This includes plagiarism and guaranteeing specific investment returns.
• I(D) Misconduct: You must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on your professional reputation, integrity, or competence.

Standard II: Integrity of Capital Markets

• II(A) Material Nonpublic Information: You must not act or cause others to act on material nonpublic information.
  • Material: Information whose disclosure would likely impact a stock's price or that a reasonable investor would want to know before making a decision.
  • Nonpublic: Information that has not been disseminated to the general marketplace.
  • Firewall: A set of procedures to prevent the flow of material nonpublic information between departments is a recommended compliance tool.
• II(B) Market Manipulation: You must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants. This includes both information-based manipulation (spreading false rumors) and transaction-based manipulation (e.g., securing a controlling position to manipulate asset prices).

Standard III: Duties to Clients

• III(A) Loyalty, Prudence, and Care: You have a duty of loyalty to your clients and must act with reasonable care and exercise prudent judgment. You must place your clients' interests before your employer's or your own interests.
• III(B) Fair Dealing: You must deal fairly and objectively with all clients when providing investment analysis, making recommendations, or taking investment action. Do not disadvantage any clients when disseminating recommendations or taking action.
• III(C) Suitability: When in an advisory relationship with a client, you must make a reasonable inquiry into their investment experience, risk/return objectives, and financial constraints. You must then ensure that any investment action is suitable for their financial situation and consistent with their written objectives, mandates, and constraints. Suitability must be judged in the context of the client's total portfolio.
• III(D) Performance Presentation: When communicating investment performance information, you must make reasonable efforts to ensure that it is fair, accurate, and complete.
• III(E) Preservation of Confidentiality: You must keep information about current, former, and prospective clients confidential unless:
  1. The information concerns illegal activities on the part of the client.
  2. Disclosure is required by law.
  3. The client or prospective client permits disclosure.

Standard IV: Duties to Employers

• IV(A) Loyalty: In matters related to your employment, you must act for the benefit of your employer and not deprive them of your skills, divulge confidential information, or otherwise cause harm. Independent practice for compensation is allowed only with written consent from your employer.
• IV(B) Additional Compensation Arrangements: You must not accept gifts, benefits, or compensation that competes with, or might create a conflict of interest with, your employer’s interest unless you obtain written consent from all parties involved.
• IV(C) Responsibilities of Supervisors: You must make reasonable efforts to ensure that anyone subject to your supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.

Standard V: Investment Analysis, Recommendations, and Actions

• V(A) Diligence and Reasonable Basis: You must exercise diligence, independence, and thoroughness in analyzing investments, making recommendations, and taking investment actions. You must have a reasonable and adequate basis, supported by appropriate research and investigation, for any analysis, recommendation, or action.
• V(B) Communication with Clients and Prospective Clients: You must disclose the basic format and general principles of the investment processes you use. You must use reasonable judgment in identifying which factors are important to your analyses and include those in communications. You must distinguish between fact and opinion.
• V(C) Record Retention: You must develop and maintain appropriate records to support your investment analysis, recommendations, actions, and other investment-related communications with clients. The firm's records are the firm's property. If no regulatory guidance exists, a 7-year retention period is recommended.

Standard VI: Conflicts of Interest

• VI(A) Disclosure of Conflicts: You must make full and fair disclosure of all matters that could reasonably be expected to impair your independence and objectivity or interfere with respective duties to your clients, prospective clients, and employer. Disclosures must be prominent and clear.
• VI(B) Priority of Transactions: Investment transactions for clients and employers must have priority over investment transactions in which you are the beneficial owner. Do not act on personal investments until clients and your employer have had an adequate opportunity to act on a recommendation.
• VI(C) Referral Fees: You must disclose to your employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.

Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate

• VII(A) Conduct as Participants in CFA Institute Programs: You must not engage in any conduct that compromises the reputation or integrity of CFA Institute or the CFA designation or the integrity, validity, or security of the CFA Institute programs.
• VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program: When referring to CFA Institute, membership, the designation, or candidacy, you must not misrepresent or exaggerate the meaning or implications of membership, holding the designation, or candidacy in the CFA Program.
  • Correct: "I am a CFA charterholder."
  • Incorrect: "I am a CFA." or "I am one of the best portfolio managers because I am a CFA charterholder."

Introduction to the Global Investment Performance Standards (GIPS)

The GIPS standards are a set of ethical principles for standardized calculation and presentation of investment performance. The goal is to ensure fair representation and full disclosure of a firm's performance history, allowing for meaningful comparisons.

• Key Characteristics:
  • GIPS compliance is voluntary and applies to investment management firms, not individuals.
  • Firms must define their "firm," which is the distinct business entity held out to clients.
  • Compliance is a firm-wide process; a firm cannot claim to be "in compliance with GIPS on a single product."
  • To claim compliance, a firm must meet all GIPS requirements.
• Composites: A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. All actual, fee-paying, discretionary portfolios must be included in at least one composite.
• Verification: Firms can hire an independent third party to verify their claim of GIPS compliance. Verification is optional but recommended as it enhances credibility.
• Objectives of GIPS:
  • Promote investor interests and instill investor confidence.
  • Ensure accurate and consistent performance data.
  • Obtain worldwide acceptance of a single standard for calculating and presenting performance.
  • Promote fair competition among investment firms.

Ethics Application

The CFA exam will test your ability to apply the Code and Standards to real-world scenarios, not just memorize them. The most common question format presents a short vignette and asks you to identify which standard, if any, has been violated.

Recommended Approach for Ethics Questions:

1. Identify the actors: Who are the individuals involved (member/candidate, client, employer, supervisor)?
2. Identify the potential conflict/violation: What action or situation seems questionable? (e.g., receiving a gift, making a trade, preparing a report).
3. Map to the Standards: Systematically review the seven Standards to determine which one(s) apply to the action.
   • Is it about honesty/legality? -> Standard I
   • Is it about market integrity? -> Standard II
   • Is it about a client relationship? -> Standard III
   • Is it about an employer relationship? -> Standard IV
   • Is it about the investment process? -> Standard V
   • Is it about a conflict of interest? -> Standard VI
   • Is it about the CFA designation? -> Standard VII
4. Determine if a violation occurred: Based on the specific rules of the applicable standard(s), decide if the conduct was a violation. Pay close attention to key phrases like "written consent," "disclose," "reasonable basis," and "more strict law."

Example Scenario Analysis: