CFA Level 2 - Ethical and Professional Standards Session 1 - Reading 4 (Practice Questions, Sample Questions) 1. When designing policies and procedures to implement the CFA InstituteResearch Objectivity Standards, all of the following are objectives, EXCEPT: A)put the client’s interest before the firm’s interest, minimize possible conflictsthat may adversely affect the independence and objectivity of research, andsupport self-regulation. B)fully disclose conflicts of interest, put the client’s interest before the firm’sinterest, and reference CFA Institute membership in a dignified and judiciousmanner. (While important, referencing CFA Institute membership in adignified and judicious manner is not an objective of the Research ObjectivityStandards.) C)provide a work environment conducive to ethical behavior, fully discloseconflicts of interest, and put the client’s interest before the employees’interest. 2. Bill Williams, CFA, has been tasked by his firm, Null Investments, to ensurethat the firm’s policies and procedures allow its research department tomaintain its independence and objectivity. One of the objectives Williams hasoutlined for Null’s policies and procedures is that they should promote theestablishment of a non-governmental regulatory body. This body will beresponsible for creating standards that assure that research firms produceindependent and objective research. Is this objective for Null’s policies andprocedures consistent with the objectives of the CFA Institute ResearchObjectivity Standards (ROS)? A) No, the ROS are intended to promote self-regulation to assureindependent and objective research. (Among the objectives of the CFAInstitute Research Objectivity Standards is the goal of promoting industry
self-regulation through the voluntary adoption of standards that promoteand reward independent and objective research.) B)No, the ROS support the establishment of laws to assure independent andobjective research but do not support a regulatory body. C)Yes. 3. In a meeting with her firm’s research director, Janice Mitchell, a proponentof the CFA Institute Research Objectivity Standards (ROS), stated that two ofthe key objectives of the ROS were to: ● Assist in meaningful, fair, specific, and complete disclosure of both possible and real conflicts of interest. ● Create voluntary reporting of research practices that promote independent and objective research to CFA Institute on an annual basis. Determine whether Mitchell is correct or incorrect with regard to herstatements about the objectives of the ROS. Objective 1 Objective 2 A Correct Correct B Incorrect Correct C Correct Incorrect Mitchell’s first statement is correct. Objectives of the CFA Institute ResearchObjectivity Standards include assisting in full, fair, meaningful, and specificdisclosure of potential and actual conflicts of interest. Mitchell’s secondstatement is incorrect. The ROS do not intend to create any sort of reporting toCFA Institute on the research practices of any firm. 4.At Brown Investment Analysis Inc., all analysts are required to submit a draftcopy of all research reports before certain approved portions of the reports are
shared or discussed with the company that is the subject of the report. Anychanges that are made to research reports after the reports have beenreviewed by subject companies must be approved by the compliancedepartment after it receives a written statement from the responsible analystjustifying the changes. Brown also requires documentation of the process totake place at each step to ensure a review of any report would demonstrateclear justification for alterations in reports that have been partially disclosed tosubject companies. Which of the following statements regarding the researchpolicies at Brown Investment Analysis Inc. is CORRECT? The policies are: A) recommended by CFA Institute Research Objectivity Standards. (CFAInstitute Research Objectivity Standards (ROS) prohibit analysts from sharingwith subject companies any sections of a report that may communicate therecommendation, rating, or price target prior to the report’s publication. It isrecommended by the ROS that firms institute policies that require approvalfrom the firm’s compliance department before an analyst shares anyinformation with the subject company. It is also recommended that the firmdocument and maintain records of information that is shared with subjectcompanies prior to the publication of a research report and any changes thatoccur subsequent to the information exchange.) B) recommended by CFA Institute Standards of Professional Conduct. C) required by CFA Institute Research Objectivity Standards. 5. All of the following procedures are recommended to comply with CFAInstitute Research Objectivity Standards, EXCEPT: A) restrict employee trades 30 calendar days before and 5 calendar days afterthe release of a research report. B) update research recommendations annually. (Research reports should beupdated regularly. Quarterly updates are recommended by the CFA InstituteResearch Objectivity Standards.)
C) prohibit communication between the research employees and investmentbanking employees before the publication of a research report. 6.Greg Hibbert, CFA, is working with his firm’s compliance department toimplement policies and procedures that comply with the requirements of theCFA Institute Research Objectivity Standards (ROS). Hibbert has informed thecompliance officer that in order to meet the ROS requirements, the firm mustrequire a written annual update of personal investments held by coveredinvestment personnel or their families, and must provide a list of activities thatviolate the firm’s policies and the accompanying disciplinary actions to all ofthe firm’s clients and prospects. Are Hibbert’s statements regarding personalinvestments and the disclosure of violating activities CORRECT? Personal Investments Violating Activities A No No B Yes No C Yes Yes A (Neither of Hibbert’s recommendations to his compliance officer are specific requirements of the ROS. They are recommended policies designed to achievecompliance. While the ROS requires a firm claiming compliance to “managecovered employee’s’ personal investments and trading activities’ effectively”,there is no specific requirement related to reporting personal holdings. Inaddition, firms claiming compliance with the ROS are not explicitly required todisclose to clients and prospects activities that are violations and the resultingpunishment for such activities. It is recommended, however, that firms disclosethis information to clients and prospects.) 7.Perry Smith is a research analyst for Hugley Financial Corp. For the pastseveral weeks, Smith has diligently researched the economic condition of BNSInc., an international pharmaceuticals manufacturer. Smith has determinedthat the BNS’ secondary common stock offering is a strong buy and hasdisseminated this opinion to Hugley’s research subscribers. One month afterissuing the recommendation, the price of BNS’ stock had risen by over 13
percent. The director of Hugley’s investment banking division, whichunderwrote BNS’ secondary offering, called to thank Smith for his participationin the offering and to notify him he will receive a stock option bonus next weekas a result of the outstanding performance of BNS’ stock. Has Hugley FinancialCorp. violated any CFA Institute Research Objectivity Standards? A) Yes, since the performance of the secondary offering led to a bonus for theanalyst. (CFA Institute Research Objectivity Standards (ROS) require that ananalyst’s compensation not be directly linked with any investment bankingactivities on which the analyst collaborated. The stock option bonus wasinappropriately based upon the performance of the secondary offering ofBNS stock and is a violation of the ROS. The ROS have also been violated byHugley’s lack of procedures to separate the research and investment bankingfunctions of the firm.) B) No. C) Yes, since the analyst’s bonus was inappropriately structured as stockoptions. 8. Alexis Capital is a full service investment banking and advisory firm. JasonBeech, head of Alexis’ investment banking division, has just received a reportfrom Alexis’ research division on a national supply-chain management firmwhich has used Alexis as the underwriter in several public debt offerings. Whilereading through the report Beech realizes that the sales projections for the firmhave been substantially overestimated in the short-term forecast. Beech callsthe author of the report, Steve Henderson, a sell-side equity analyst, to informhim of the error. Henderson confirms that there was a slight error in theforecasting model and agrees to change the sales forecast before publishingthe report the following day. Do Alexis Capital’s policies violate any CFAInstitute Research Objectivity Standards? A) No, since the firm is able to objectively ensure the accuracy of investmentresearch.
B) Yes.(CFA Institute Research Objectivity Standards require firms to instituteprocedures that prevent investment banking divisions from having directauthority over the research department to review, modify, approve, or rejectits research as this poses a threat to the independence and objectivity of afirm’s research.) C) No, since the firm provides multiple layers of review before making researchpublicly available. 9. Kevin Bryan is a financial analyst for Summit Investments. Bryan recentlycompleted a research report recommending the stock of IndependenceMedical Company. Bryan failed to disclose that he has a material ownershipinterest in Independence Medical through a family trust.Kim Scott, a CFA Charterholder with Overland Associates, is invited to attend aninvestment management conference in the Cayman Islands. The sponsor, oneof Scott’s clients, has offered to reimburse Scott for all of her expenses. Scottaccepts the sponsor’s offer and discloses the arrangement to her employer inwriting. Based on the CFA Institute Research Objectivity Standards, which ofthe following statements is CORRECT? A) Both Summit and Overland are in violation of the Research ObjectivityStandards. B) Neither Summit nor Overland is in violation of the Research ObjectivityStandards. C) Summit is in violation of the Research Objectivity Standards but Overlandis not in violation. (Summit is in violation because policies and procedureswere not in place to prevent Bryan from recommending a stock withoutdisclosing a potential conflict of interest. Overland is not in violation. Scottcan accept reimbursement since the sponsor is a client and thereimbursement was disclosed to Overland.)