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CFA3: Ethics

Code of Ethics

  1. Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets.
  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 investment 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 of, and uphold the rules governing, capital markets.
  6. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

Standards of Professional Conduct

I. Professionalism

A) Knowledge of the Law

  • Members must understand and comply with laws, rules, regulations, and Code and Standards of any authority governing their activities. In the event of a conflict, follow the more strict law, rule, or regulation. Do not knowingly participate or assist in violations, and disassociate from any known violation.
  • Members must know the laws and regulations relating to their professional activities in all countries in which they conduct business. Members must comply with applicable laws and regulations relating to their professional activity. Do not violate Code or Standards even if the activity is otherwise legal. Always adhere to the most strict rules and requirements (law or CFA Institute Standards) that apply.
  • Members should disassociate, or separate themselves, from any ongoing client or employee activity that is illegal or unethical, even if it involves leaving an employer (an extreme case). While a member may confront the involved individual first, he must approach his supervisor or compliance department. Inaction with continued association may be construed as knowing participation.

B) Independence and Objectivity

  • Use reasonable care to exercise independence and objectivity in professional activities. Members and Candidates are not to offer, solicit, or accept any gift, benefit, compensation, or consideration that would compromise either their own or someone else’s independence and objectivity.
  • Do not let the investment process be influenced by any external sources. Modest gifts are permitted. Allocation of shares in oversubscribed IPOs to personal accounts is NOT permitted. Distinguish between gifts from clients and gifts from entities seeking influence to the detriment of the client. Gifts must be disclosed to the member’s employer in any case.
  • Do not be pressured by sell-side firms to issue favorable research on current or prospective investment-banking clients. It is appropriate to have analysts work with investment bankers in "road shows" only when the conflicts are adequately and effectively managed and disclosed. Be sure there are effective "firewalls" between research/ investment management and investment banking activities.
  • Analysts should not be pressured to issue favorable research by the companies they follow. Do not confine research to discussions with company management, but rather use a variety of sources, including suppliers, customers, and competitors.
  • Buy-side clients may try to pressure sell-side analysts. Portfolio managers may have large positions in a particular security, and a rating downgrade may have an effect on the portfolio performance. As a portfolio manager, there is a responsibility to respect and foster intellectual honesty of sell-side research.
  • Remember that this type of issuer-paid research is fraught with potential conflicts. Analysts’ compensation for preparing such research should be limited, and the preference is for a flat fee, without regard to conclusions or the report’s recommendations.

C) Misrepresentation

  • Do not misrepresent facts regarding investment analysis, recommendations, actions, or other professional activities.
  • Trust is a foundation in the investment profession. Do not make any misrepresentations or give false impressions. This includes oral and electronic communications. Misrepresentations include guaranteeing investment performance and plagiarism. Plagiarism encompasses using someone else’s work (reports, forecasts, charts, graphs, and spreadsheet models) without giving them credit.

D) Misconduct

  • Do not engage in any professional conduct which involves dishonesty, fraud, or deceit. Do not do anything that reflects poorly on one’s integrity, good reputation, trustworthiness, or professional competence.
  • CFA Institute discourages unethical behavior in all aspects of members’ and candidates’ lives. Do not abuse CFA Institute’s Professional Conduct Program by seeking enforcement of this Standard to settle personal, political, or other disputes that are not related to professional ethics.

II. Integrity of Capital Markets

A) Material Nonpublic Information

  • Members and Candidates in possession of nonpublic information that could affect an investment’s value must not act or induce someone else to act on the information.
  • Information is "material" if its disclosure would impact the price of a security or if reasonable investors would want the information before making an investment decision. Ambiguous information, as far as its likely effect on price, may not be considered material. Information is "non-public" until it has been made available to the marketplace. An analyst conference call is not public disclosure. Selectively disclosing information by corporations creates the potential for insider-trading violations.
  • Mosaic theory: There is no violation when a perceptive analyst reaches an investment conclusion about a corporate action or event through an analysis of public information together with items of non-material non-public information.

B) Market Manipulation

  • Do not engage in any practices intended to mislead market participants through distorted prices or artificially inflated trading volume.
  • This Standard applies to transactions that deceive the market by distorting the price-setting mechanism of financial instruments or by securing a controlling position to manipulate the price of a related derivative and/or the asset itself. Spreading false rumors is also prohibited.

III. Duties To Clients

A) Loyalty, Prudence, and Care

  • Members must always act for the benefit of clients and place clients’ interests before their employer’s or their own interests. Members must be loyal to clients, use reasonable care, exercise prudent judgment, and determine and comply with their applicable fiduciary duty to clients.
  • Client interests always come first.
    • Exercise the prudence, care, skill, and diligence under the circumstances that a person acting in a like capacity and familiar with such matters would use.
    • Manage pools of client assets in accordance with the terms of the governing documents, such as trust documents or investment management agreements.
    • Make investment decisions in the context of the total portfolio.
    • Vote proxies in an informed and responsible manner. Due to cost benefit considerations, it may not be necessary to vote all proxies.
    • Client brokerage, or "soft dollars" or "soft commissions" must be used to benefit the client.

B) Fair Dealing

  • Members must deal fairly and objectively with all clients and prospects when providing investment analysis, making investment recommendations, taking investment action, or in other professional activities.
  • Do not discriminate against any clients when disseminating recommendations or taking investment action. Fairly does not mean equally. In the normal course of business, there will be differences in the time emails, faxes, etc. are received by different clients. Different service levels are okay, but they must not negatively affect or disadvantage any clients. Disclose the different service levels to all clients and prospects, and make premium levels of service available to all who wish to pay for them.
  • Give all clients a fair opportunity to act upon every recommendation. Clients who are unaware of a change in a recommendation should be advised before the order is accepted.
  • Treat clients fairly in light of their investment objectives and circumstances. Treat both individual and institutional clients in a fair and impartial manner. Members and Candidates should not take advantage of their position in the industry to disadvantage clients.

C) Suitability

  • When in an advisory relationship with client or prospect, Members and Candidates must:
      • Make reasonable inquiry into clients’ investment experience, risk and return objectives, and constraints prior to making any recommendations or taking investment action. Reassess information and update regularly.
      • Be sure investments are suitable to a client’s financial situation and consistent with client objectives before making recommendation or taking investment action.
      • Make sure investments are suitable in the context of a client’s total portfolio.
    1. When managing a portfolio, investment recommendations and actions must be consistent with stated portfolio objectives and constraints.
  • In advisory relationships, be sure to gather client information at the beginning of the relationship, in the form of an investment policy statement (IPS). Consider client’s needs and circumstances and thus the risk tolerance. Consider whether or not the use of leverage is suitable for the client.
  • If a member is responsible for managing a fund to an index or other stated mandate, be sure investments are consistent with the stated mandate.

D) Performance Presentation

  • Presentations of investment performance information must be fair, accurate, and complete.
  • Members must avoid misstating performance or misleading clients/prospects about investment performance of themselves or their firms, should not misrepresent past performance or reasonably expected performance, and should not state or imply the ability to achieve a rate of return similar to that achieved in the past.

E) Preservation of Confidentiality.

  • All information about current and former clients and prospects must be kept confidential unless it pertains to illegal activities, disclosure is required by law, or the client or prospect gives permission for the information to be disclosed.
  • If illegal activities by a client are involved, members may have an obligation to report the activities to authorities. The confidentiality Standard extends to former clients as well.
  • The requirements of this Standard are not intended to prevent Members and Candidates from cooperating with a CFA Institute Professional Conduct Program (PCP) investigation.

IV. Duties to Employers

A) Loyalty

  • In matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.
  • Members must not engage in any activities which would injure the firm, deprive it of profit, or deprive it of the advantage of employees’ skills and abilities. Always place client interests above interests of employer. There is no requirement that the employee put employer interests ahead of family and other personal obligations; it is expected that employers and employees will discuss such matters and balance these obligations with work obligations.
  • Independent PracticeIndependent practice for compensation is allowed if a notification is provided to the employer fully describing all aspects of the services, including compensation, duration, and the nature of the activities and if the employer consents to all terms of the proposed independent practice before it begins.
  • Leaving an EmployerMembers must continue to act in their employer’s best interests until resignation is effective. Activities which may constitute a violation include:
  • Misappropriation of trade secrets.
  • Misuse of confidential information.
  • Soliciting employer’s clients prior to leaving.
  • Self-dealing.
  • Misappropriation of client lists.
Once an employee has left a firm, simple knowledge of names and existence of former clients is generally not confidential. Also there is no prohibition on the use of experience or knowledge gained while with a former employer.
  • Whistleblowing There may be isolated cases where a duty to one’s employer may be violated in order to protect clients or the integrity of the market, and not for personal gain.
  • Nature of Employment The applicability of this Standard is based on the nature of the employment—employee versus independent contractor. If Members and Candidates are independent contractors, they still have a duty to abide by the terms of the agreement.

B) Additional Compensation Arrangements

  • No gifts, benefits, compensation, or consideration are to be accepted which may create a conflict of interest with the employer’s interest unless written consent is received from all parties.
  • Compensation includes direct and indirect compensation from a client and other benefits received from third parties. Written consent from a member’s employer includes email communication.

C) Responsibilities of Supervisors.

  • All Members and Candidates must make reasonable efforts to detect and prevent violations of laws, rules, regulations, and the Code and Standards by any person under their supervision or authority.
  • Members must take steps to prevent employees from violating laws, rules, regulations, or the Code and Standards and make reasonable efforts to detect violations.
  • Understand that an adequate compliance system must meet industry standards, regulatory requirements, and the requirements of the Code and Standards. Members with supervisory responsibilities have an obligation to bring an inadequate compliance system to the attention of firm’s management and recommend corrective action. While investigating a possible breach of compliance procedures, it is appropriate to limit the suspected employee’s activities.

V. Investment Analysis, Recommendations, and Actions

A) Diligence and Reasonable Basis

  1. When analyzing investments, making recommendations, and taking investment actions use diligence, independence, and thoroughness.
  2. Investment analysis, recommendations, and actions should have a reasonable and adequate basis, supported by research and investigation.
  • The application of this Standard depends on the investment philosophy adhered to, members’ and candidates’ roles in the investment decision-making process, and the resources and support provided by employers. These factors dictate the degree of diligence, thoroughness of research, and the proper level of investigation required.
  • Using Secondary or Third-Party Research See that the research is sound. Examples of criteria to use to evaluate:
    • Review assumptions used.
    • How rigorous was the analysis?
    • How timely is the research?
    • Evaluate objectivity and independence of the recommendations.
  • Group Research and Decision Making Even if a member does not agree with the independent and objective view of the group, he does not necessarily have to decline to be identified with the report, as long as there is a reasonable and adequate basis.

B) Communication with Clients and Prospective Clients

  1. Disclose to clients and prospects basic format and general principles of investment processes used to analyze and select securities and construct portfolios. Promptly disclose any process changes.
  2. Use reasonable judgment in identifying relevant factors important to investment analyses, recommendations, or actions, and include factors when communicating with clients and prospects.
  3. Investment analyses and recommendations should clearly differentiate facts from opinions.
  • Proper communication with clients is critical to provide quality financial services. Members must distinguish between opinions and facts and always include the basic characteristics of the security being analyzed in a research report.
  • Members must illustrate to clients and prospects the investment decision-making process utilized. The suitability of each investment is important in the context of the entire portfolio.
  • All means of communication are included here, not just research reports.

C) Record Retention.

  • Maintain all records supporting analysis, recommendations, actions, and all other investment-related communications with clients and prospects.
  • Members must maintain research records that support the reasons for the analyst’s conclusions and any investment actions taken. Such records are the property of the firm. If no other regulatory standards are in place, CFA Institute recommends at least a seven-year holding period.

VI. Conflicts of Interest

A) Disclosure of Conflicts

  • Members and Candidates must make full and fair disclosure of all matters which may impair their independence or objectivity or interfere with their duties to employer, clients and prospects. Disclosures must be prominent, in plain language, and effectively communicate the information.
  • Members must fully disclose to clients, prospects, and their employers all actual and potential conflicts of interest in order to protect investors and employers. These disclosures must be clearly stated.
  • The requirement that all potential areas of conflict be disclosed allows clients and prospects to judge motives and potential biases for themselves. Disclosure of broker/dealer market-making activities would be included here. Board service is another area of potential conflict.
  • The most common conflict which requires disclosure is actual ownership of stock in companies that the member recommends or that clients hold.
  • Members must give the employer enough information to judge the impact of the conflict. Take reasonable steps to avoid conflicts, and report them promptly if they occur.

B) Priority of Transactions

  • Investment transactions for clients and employers must have priority over those in which a Member or Candidate is the beneficial owner.
  • Client transactions take priority over personal transactions and over transactions made on behalf of the member’s firm. Personal transactions include situations where the member is a "beneficial owner." Personal transactions may be undertaken only after clients and the member’s employer have had an adequate opportunity to act on a recommendation. *Note that family-member accounts that are client accounts should be treated just like any client account; they should not be disadvantaged.

C) Referral Fees.

  • Members and Candidates must disclose to their employers, clients, and prospects any compensation consideration or benefit received by, or paid to, others for recommendations of products and services.
  • Members must inform employers, clients, and prospects of any benefit received for referrals of customers and clients, allowing them to evaluate the full cost of the service as well as any potential impartiality. All types of consideration must be disclosed.

VII. Responsibilities as a CFA Institute member or CFA Candidate

A) Conduct as Members and Candidates in the CFA Program

  • Members and Candidates 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 exams.
  • This Standard applies to conduct which includes:
    • Cheating on the CFA exam or any exam.
    • Not following rules and policies of the CFA program.
    • Giving confidential information on the CFA program to Candidates or the public.
    • Improperly using the designation to further personal and professional goals.
    • Misrepresenting information on the Professional Conduct Statement (PCS) or the CFA Institute Professional Development Program.
  • Members and candidates are not precluded from expressing their opinions regarding the exam program or CFA Institute.

B) Reference to CFA Institute, the CFA designation, and the CFA Program

  • Members and Candidates must not misrepresent or exaggerate the meaning or implications of membership in CFA Institute, holding the CFA designation, or candidacy in the program.
  • Members must not make promotional promises or guarantees tied to the CFA designation. Do not:
    • Over-promise individual competence.
    • Over-promise investment results in the future (i.e., higher performance, less risk, etc.).
  • CFA Institute Membership Members must satisfy these requirements to maintain membership:
    • Sign PCS annually.
    • Pay CFA Institute membership dues annually.
    • If they fail to do this, they are no longer active members.
  • Using the CFA Designation
    • Do not misrepresent or exaggerate the meaning of the designation.
  • Referencing Candidacy in the CFA Program
    • There is no partial designation. It is acceptable to state that a Candidate successfully completed the program in three years, if in fact they did, but claiming superior ability because of this is not permitted.
  • Proper Usage of the CFA MarksThe Chartered Financial Analyst and CFA marks must always be used either after a charterholder’s name or as adjectives, but not as nouns, in written and oral communications.

Asset Manager Code of Professional Conduct

  1. Loyalty to clients
    • Always put the client’s interests before your own by designing appropriate compensation arrangements for managers.
    • Determine how confidential client information should be collected, utilized, and stored.
    • Determine the amount of which token gifts can be accepted.
  2. Investment process and actions
    • Take reasonable care when dealing with client accounts.
    • Don’t engage in market manipulation.
    • Deal fairly with all clients.
    • Have a reasonable basis for all investment recommendations.
  3. Trading
    • Do not trade on material nonpublic information.
    • Always place client trades before your own.
    • Use soft-dollars to aid the manager in the investment decision-making process.
    • Seek best execution and allocate trades equitably among all clients.
  4. Compliance and support
    • Ensure compliance with the Asset Manager Code and legal and regulatory requirements.
    • Appoint a compliance officer.
    • Disseminate portfolio information in an accurate manner.
    • Have an independent third party review client accounts.
    • Appropriately maintain records.
    • Hire qualified staff with sufficient resources.
    • Have a contingency plan in place.
  5. Performance and valuation: Report results in an accurate manner using fair-market values.
  6. Disclosures deal with any kind of material information disclosed to the client, such as conflicts of interest, regulatory disciplinary actions, the investment decision-making process, and strategies including inherent risks, fee schedules, calculation of performance results, proxy voting issues, allocating shares of stock, and the results of any audits.

Behavioral Finance

7-9. General Psychology

  • Heuristic-driven biases
    1. Representativeness: subjective expectations based upon past experience, stereotypes
      • relating outperformer to good future performance
    2. Overconfidence: narrows prediction, based insufficient information, leads to overtrading
    3. Anchoring-and-adjustment: inability to digest in the impact of new information, conservatism
    4. Aversion: fear of unknown
  • Loss aversion: reluctance to accept loss, letting losses run, increases risk
    • momentum strategy: up-trending markets lead to overpriced demand
    • Frame dependence: decisions according to individual circumstances and media
    • Self control: controlling own emotions
    • Regret: after making a bad decision
    • Money illusion: thinking in terms of nominal returns, ignoring inflation and real returns

10/12. Emotions and Biases

  • Fear and hope; tradeoff between security, potential gain and aspirations
  • Pyramid structure: consider necessity prior to building upto highly speculative investments, not diversification perspective
  • Optimism: individual trait neglecting odds of bad occurrence as very low
  • Overconfidence: cognitive dissonance between actual abilities and perceptions
  • Forecaster defense mechanisms: analysts' blame on other factors to defend inaccurate forecasts
    1. "if-only" defense: external force e.g. Fed announcement
    2. Ceteris-paribus defense: un-considered variables
    3. "almost right", "it hasn't happened yet"
    4. single predictor defense: on wrong predictor does not affect the whole
  • Familiarity: tendency to invest on familiar products, e.g. employer stock(to be kept <10%), domestic securities(home bias)
  • Anchoring: inaccurate forecasts may kept used due to subconscious need to grab onto anything when faced with uncertainty

11. Investment Decision Making

  • bounded rationality: making decisions with a combinations of mean-variance analysis and heuristics
  • Failure of defined-contribution pension plans caused by limited knowledge, misalignment in interest
    1. Status quo bias: tendency to not amend original allocation
    2. Myopic loss aversion: aversion to losses when viewing short-term performance
    3. 1/n diversification: equal amounts to the n investment alternatives
    4. Endorsement effect: misconception considering suggested investment product as good investments
    5. Familiarity: investment in employers' stock

13. Market Inefficiencies

  • Acute market inefficiency: transient in nature, exploited by arbitrage strategy
  • Chronic market inefficiency: longer-term in nature, resistant to mispricing identifying strategies
  • Herding (convoy) behavior: keeping in line with mass, peer group
  • Rigid views (Bayesian rigidity): behavioral bias onto old views despite contrary new information, anchoring
  • Price target revisions: greed/overconfidence → increase price target
  • Emotional correlation (Ebullience cycle): disinclination to evaluate performance in downward market, exuberance and excess trading in upward market
  • Holders: tend not to adjust portfolio allocations
  • Rebalancers: have rigid portfolio allocations
    • Valuators: rebalancing decisions on relative pricings
    • Shifters: rebalancing in response to non-market value related event (e.g. Fed announcement, economic cycle)
    • Formulaic rebalancing: optimal asset allocation setting and rebalancing to target weights