CFA Level 2 v1.0

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Exam contains 555 questions

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
Which of Baldw in's first-day instructions to Blackwell is consistent with the New Prudent Investor Rule?

  • A. Instruction 1.
  • B. Instruction 2.
  • C. Instruction 3.


Answer : C

Explanation:
Instruction 3 is consistent with the new Prudent Investor Rule, because avoidance of excessive trading costs is one of its principles. The other statements are consistent with the old Prudent Man Rule. (Study Session 2, LOS lO.c)

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
When updating the proxy-voting policy to conform to CFA Institute recommendations, which of the following recommendations is least appropriate for Blanchard to adopt?

  • A. Determine the economic impact of non-routine proxy votes.
  • B. Follow the same proxy-voting procedures regardless of the nature of the proposal.
  • C. If the proxy voter's preference differs from the preference of a client who has delegated his voting powers, go with the client's preference.


Answer : B

Explanation:
Standard III(A) Loyalty, Prudence, and Care. Unusual proposals, such as hostile takeovers and executive changes, may require more review than routine matters such as renewing stock-repurchase agreements. Money managers should provide a means to review complex proxies. Establishing evaluation criteria and disclosing the firm's proxy voting policies and procedures to clients are basic elements of a proxy-voting policy. Client wishes regarding proxy voting should always be followed. (Study Session 1, LOS2.a)

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
A CFA charterholder who wishes to follow Standard VI(B) Priority of Transactions must:

  • A. maintain loyalty to pension-plan beneficiaries.
  • B. limit IPO investments in client and personal accounts.
  • C. give both clients and employers preference over the charterholder's own accounts.


Answer : C

Explanation:
The priority of transaction Standard holds that a financial professional's personal transactions must wait until both her employer and her clients have had a chance to act. The Standard holds that all client accounts should be treated equally, regardless of whether the client is a family member. Members and candidates should limit personal participation in IPOs in order to give preference to clients who wish to participate. There is no need to limit client participation to satisfy Standard VI
(B). It is quite possible to be loyal to pension-plan beneficiaries without following Standard VI(B) (Study Session 1, LOS 2.a)

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
Are Thaddeus Baldwin's statements on the soft dollar standards correct?

  • A. Both statements are correct.
  • B. Only Statement I is correct.
  • C. Only Statement 2 is correct.


Answer : B

Explanation:
Commissions from both internal and external brokerage operations are considered soft dollars, so Statement 2 is false. Statement 1 is true. CFA Institute Soft
Dollar Standards are voluntary, though firms that wish to claim compliance with the Standards must follow them completely. Client brokerage can be used to pay for mixed-use research with the caveat that the research must be reasonable, justifiable, and documcntable, and that the client brokerage is only used to pay for the portion of the research that will be used in the investment decision-making process. While research paid for by client brokerage should directly benefit the client, it does not have to do so immediately. (Study Session 1, LOS 3-b)

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
It Walters wants the manual to satisfy the requirements and recommendations of the Code and Standards, which of the following instructions is least appropriate to include in the section on fair dealing?

  • A. Whenever possible, disseminate investment recommendations to all clients at the same time.
  • B. Execute all clients1 requested trades promptly and without comment, regardless of the company's opinion on the stock being traded.
  • C. Members of the investment-policy committee should not discuss possible changes in investment recommendations with anyone else in the firm until after an official decision has been made.


Answer : B

Explanation:
Standard III(B) Fair Dealing requires firms to notify clients of changes in investment advice before executing trades that go counter to that advice. While equal dissemination is usually impossible, it is an admirable goal. Firms should establish dissemination guidelines that are fair to all clients. Trading disclosures and confidentiality regarding investment rating changes are sensible precautions that meet the spirit of the fair dealing Standard. Maintaining client lists that detail client holdings will simplify the process of deciding how to best disseminate a change in investment recommendation. (Study Session 1, LOS 2.a)

Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter,
Baldwin tells her she is the "perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI
(B) Priority of Transactions." Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for
Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux
Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for
Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
Which method for dealing with the trading error is most consistent with the Code and Standards?

  • A. Method 1.
  • B. Method 2.
  • C. Method 3.


Answer : B

Explanation:
Method 2 is the best answer. Quintux should cover the cost of the trading error, and if Borchard is willing to accept investment research in lieu of cash, that's all the better for Quintux. If Quintux compensates Borchard with extra trades, its clients are covering the costs of the error, which may violate Standard III (A) Loyalty,
Prudence, and Care if directing future trades to Borchard is not in the clients' best interest. By accepting the CBX shares it did not request and allocating the shares to all client accounts rather than paying for the error, Quintux is violating Standard 111(C) Suitability, since the shares are not likely to be appropriate for all of its client accounts and may not be suitable for any accounts since the shares were obtained as a result of a trading error, not an intentional investment action.
Passing on client names is a violation of Standard III(E) Preservation of Confidentiality. (Study Session 1, LOS 2.a)

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
By executing Transaction A, Connor is:

  • A. violating the Standards because his option trading can be reasonably expected to affect the price of Stock A.
  • B. violating the Standards because the option position creates a profit opportunity in conflict with Biogene's clients.
  • C. not violating the Standards.


Answer : C

Explanation:
There is no violation of the Standards in Transaction A. Connor is basically hedging any potential loss from a decline in the price of Stock A prior to the completion of his sale transaction. There is no apparent attempt to manipulate the market in this transaction.

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
By executing Transaction B, Connor is:

  • A. violating the Standards because his option trading can be reasonably expected to affect his quarterly performance.
  • B. not violating the Standards because the option position creates a profit opportunity consistent with Biogene's clients interests.
  • C. not violating the Standards because he believes there is significant appreciation potential in Stock B.


Answer : A

Explanation:
A critical factor in assessing any violation of Standard 11(B) Integrity of Capital Markets - Market Manipulation is the intent of the parties involved. In this case,
Connor is hoping that his options transaction drives up the price of Stock B, which would improve the reported performance of the Biogene Fund. This type of manipulation would be a violation of the Standard.

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
By executing Transaction C, Connor is:

  • A. violating the Standards by executing a transaction for tax reasons only.
  • B. violating the Standards by executing a transaction that provides tax benefits to the Biogene Fund.
  • C. not violating the Standards.


Answer : C

Explanation:
Transactions meant to minimize tax liabilities are not prohibited by the Standards. If the Biogenc Fund benefits, the investors in the fund will presumably benefit also.

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
By offering Biogene the opportunity to participate in the IPO of Stock D, Apple Investments has violated CFA Institute Standards relating to:

  • A. priority of transactions but not independence and objectivity.
  • B. independence and objectivity but not priority of (ransactions.
  • C. neither priority of transactions nor independence and objectivity.


Answer : C

Explanation:
Connor was not pressured co cake che IPO, and he believed ic was a good investment. Connor received no confidential information. The IPO had been made available to all Apple clients prior to Biogene. There is no evidence of a violation of either of these Standards.

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
Arnold's arguments for limiting Biogene's share to 2% suggest that Apple:

  • A. may engage in a liquidity pumping strategy that would be acceptable given that Biogene is a related entity.
  • B. may engage in transaction-based manipulation of Stock D in the future, in violation of Standards relating to market manipulation.
  • C. is violating Standards related to priority of transactions by ofTering the IPO to Biogene before it is fully subscribed.


Answer : B

Explanation:
By suggesting that Biogene might need to acquire more shares to support the price in the future, Arnold is suggesting that Apple would be willing to manipulate the market by creating false trading volume. This is transaction-based manipulation in violation of Standard 11(B) Integrity of Capital Markets - Market Manipulation.

Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC. Apple is a U.S.-based firm offering a wide spectrum of investment products and services.
Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding.
The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A.
The Biogene Fund owns 5% of the outstanding stock of Company B. Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department.
Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus.
Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
"With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up."
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the
IPO. Arnold responded a few hours later with the following message:
"I have just spoken with Ms. D, the CFO of Stock D. Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%""you won't be sorry!"
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
Based upon Connor's acceptance of the 2% limitation after receiving the e-mail from Arnold:

  • A. Connor has violated Standards relating to material nonpublic information, and Arnold has violated Standards relating to preservation of confidentiality.
  • B. Connor has not violated Standards relating to material nonpublic information, but Arnold has violated Standards relating to preservation of confidentiality.
  • C. Connor has not violated Standards relating to material nonpublic information, but Arnold has violated Standards relating to preservation of confidentiality and material nonpublic information.


Answer : A

Explanation:
By changing his previous decision and accepting the 2% based on Arnold s e-mail, Connor has violated the Standards related to material nonpublic information.
He has acted based upon the receipt of inside information. Arnold has violated the Standards related to both material nonpublic information and preservation of confidentiality. Arnold violated Standard III(E) - Duties to Clients - Preservation of Confidentiality by revealing information he received based upon a special relationship with Stock D. By passing that information to another area of Apple, Arnold has violated Standard 11(A) Integrity of Capital Markets - Material
Nonpublic Information as well.

Pat Wilson, CFA, is the chief compliance officer for Excess Investments, a global asset management and investment banking services company. Wilson is reviewing two investment reports written by Peter Holly, CFA, an analyst and portfolio manager who has worked for Excess for four years. Holly's first report under compliance review is a strong buy recommendation for BlueNote Inc., a musical instrument manufacturer. The report states that the buy recommendation is applicable for the next 6 to 12 months with an average level of risk and a sustainable price target of $24 for the entire time period. At the bottom of the report, an e- mail address is given for investors who wish to obtain a complete description of the firm's rating system. Among other reasons supporting the recommendation,
Holly's report states that expected increases in profitability as well as increased supply chain efficiency provide compelling support for purchasing BlueNote.
Holly informs Wilson that he determined his conclusions primarily from an intensive review of BlueNote's filings with the SEC but also from a call to one of
BlueNote's suppliers who informed Holly that their new inventory processing system would allow for more efficiency in supplying BlueNote with raw materials.
Holly explains to Wilson that he is the only analyst covering BlueNote who is aware of this information and that he believes the new inventory processing system will allow BlueNote to reduce costs and increase overall profitability for several years to come.
Wilson must also review Holly's report on BigTirae Inc., a musical promotions and distribution company. In the report, Holly provides a very optimistic analysis of
BigTime's fundamentals. The analysis supports a buy recommendation for the company. Wilson finds one problem with Holly's report on BigTime related to Holly's former business relationship with BigTime Inc. Two years before joining Excess, Holly worked as an investment banker and received 1,000 restricted shares of
BigTime as a result of his participation in taking the company public. These facts are not disclosed in the report but are disclosed on Excess Investment's Web site. Wilson decides, however, that the timeliness of the information in the report warrants overlooking this issue so that the report can be distributed.
Just before the report is issued. Holly mentions to Wilson that BigTime unknowingly disclosed to him and a few other analysts who were wailing for a conference call to begin that the company is planning to restructure both its sales staff and sales strategy and may sell one of its poorly performing business units next year.
Three days after issuing his report on BigTime, which caused a substantial rise in the price of BigTime shares, Holly sells all of the BigTirne shares out of both his performance fee-based accounts and asset-based accounts and then proceeds to sell all of the BigTime shares out of his own account on the following day. Holly obtained approval from Wilson before making the trades.
Just after selling his shares in BigTime, Holly receives a call from the CEO of BlueNote who wants to see if Holly received the desk pen engraved with the
BlueNote company logo that he sent last week and also to offer two front row tickets plus limousine service to a sold-out concert for a popular band that uses
BlueNote's instruments. Holly confirms that the desk pen arrived and thanks the CEO for the gift and tells him that before he accepts the concert tickets, he will have to check his calendar to see if he will be able to attend. Holly declines the use of the limousine service should he decide to attend the concert.
After speaking with the CEO of BlucNote, Holly constructs a letter that he plans to send by e-mail to all of his clients and prospects with e-mail addresses and by regular mail to all of his clients and prospects without e-mail addresses. The letter details changes to an equity valuation model that Holly and several other analysts at Excess use to analyze potential investment recommendations. Holly's letter explains that the new model, which will be put into use next month, will utilize Monte Carlo simulations to create a distribution of stock values, a sharp contrast to the existing model which uses static valuations combined with sensitivity analysis. Relevant details of the new model are included in the letter, but similar details about the existing model are not included. The letter also explains that management at Excess has decided to exclude alcohol and tobacco company securities from the research coverage universe. Holly's letter concludes by stating that no other significant changes that would affect the investment recommendation process have occurred or are expected to occur in the near future.
According to CFA Institute Research Objectivity Standards (ROS), which of the following statements is most accurate with regard to the rating system used by
Holly in his investment report on BlueNote Inc.? The rating system:

  • A. has appropriately incorporated the three recommended rating system elements from the ROS.
  • B. should not have included a price target as it makes an implicit guarantee of investment performance.
  • C. should not have included a time frame, as it misrepresents the level of certainty of the recommendation.


Answer : A

Explanation:
CFA Institute Research Objectivity Standards recommend that rating systems include the following three elements: the recommendation or rating category, time horizon categories, and risk categories. Holly's report on BIueNote provides all three elements (strong-buy, 6-to 12-montb time horizon, average level of risk) and also includes the recommended disclosure on how investors can obtain a complete description of the firms rating system.

Pat Wilson, CFA, is the chief compliance officer for Excess Investments, a global asset management and investment banking services company. Wilson is reviewing two investment reports written by Peter Holly, CFA, an analyst and portfolio manager who has worked for Excess for four years. Holly's first report under compliance review is a strong buy recommendation for BlueNote Inc., a musical instrument manufacturer. The report states that the buy recommendation is applicable for the next 6 to 12 months with an average level of risk and a sustainable price target of $24 for the entire time period. At the bottom of the report, an e- mail address is given for investors who wish to obtain a complete description of the firm's rating system. Among other reasons supporting the recommendation,
Holly's report states that expected increases in profitability as well as increased supply chain efficiency provide compelling support for purchasing BlueNote.
Holly informs Wilson that he determined his conclusions primarily from an intensive review of BlueNote's filings with the SEC but also from a call to one of
BlueNote's suppliers who informed Holly that their new inventory processing system would allow for more efficiency in supplying BlueNote with raw materials.
Holly explains to Wilson that he is the only analyst covering BlueNote who is aware of this information and that he believes the new inventory processing system will allow BlueNote to reduce costs and increase overall profitability for several years to come.
Wilson must also review Holly's report on BigTirae Inc., a musical promotions and distribution company. In the report, Holly provides a very optimistic analysis of
BigTime's fundamentals. The analysis supports a buy recommendation for the company. Wilson finds one problem with Holly's report on BigTime related to Holly's former business relationship with BigTime Inc. Two years before joining Excess, Holly worked as an investment banker and received 1,000 restricted shares of
BigTime as a result of his participation in taking the company public. These facts are not disclosed in the report but are disclosed on Excess Investment's Web site. Wilson decides, however, that the timeliness of the information in the report warrants overlooking this issue so that the report can be distributed.
Just before the report is issued. Holly mentions to Wilson that BigTime unknowingly disclosed to him and a few other analysts who were wailing for a conference call to begin that the company is planning to restructure both its sales staff and sales strategy and may sell one of its poorly performing business units next year.
Three days after issuing his report on BigTime, which caused a substantial rise in the price of BigTime shares, Holly sells all of the BigTirne shares out of both his performance fee-based accounts and asset-based accounts and then proceeds to sell all of the BigTime shares out of his own account on the following day. Holly obtained approval from Wilson before making the trades.
Just after selling his shares in BigTime, Holly receives a call from the CEO of BlueNote who wants to see if Holly received the desk pen engraved with the
BlueNote company logo that he sent last week and also to offer two front row tickets plus limousine service to a sold-out concert for a popular band that uses
BlueNote's instruments. Holly confirms that the desk pen arrived and thanks the CEO for the gift and tells him that before he accepts the concert tickets, he will have to check his calendar to see if he will be able to attend. Holly declines the use of the limousine service should he decide to attend the concert.
After speaking with the CEO of BlucNote, Holly constructs a letter that he plans to send by e-mail to all of his clients and prospects with e-mail addresses and by regular mail to all of his clients and prospects without e-mail addresses. The letter details changes to an equity valuation model that Holly and several other analysts at Excess use to analyze potential investment recommendations. Holly's letter explains that the new model, which will be put into use next month, will utilize Monte Carlo simulations to create a distribution of stock values, a sharp contrast to the existing model which uses static valuations combined with sensitivity analysis. Relevant details of the new model are included in the letter, but similar details about the existing model are not included. The letter also explains that management at Excess has decided to exclude alcohol and tobacco company securities from the research coverage universe. Holly's letter concludes by stating that no other significant changes that would affect the investment recommendation process have occurred or are expected to occur in the near future.
Did Holly violate any CFA Institute Standards of Professional Conduct with respect to his report on BlueNote or BigTime, as it relates to potential use of material nonpublic information?

  • A. Holly has violated Standard on material nonpublic information in the case of both reports.
  • B. There is a violation regarding the Blue Note report, but no violation with the Big Time report.
  • C. There is a violation regarding the Big Time report, but no violation with the Blue Note report.


Answer : C

Explanation:
Standard 11(A). Holly has utilized public information to conduct an intensive analysis of BlueNote and has also utilized information obtained from a supplier that, while nonpublic, is not by itself material. When combined with his knowledge of BlueNote s material public information, however, the information from the supplier allows Holly to make a significant and material conclusion that would not be known to the public in general. This situation falls under the Mosaic Theory. Holly is free to make recommendations based on her material nonpublic conclusion on BlueNote since the conclusion was formed using material public information combined with nonmaterial nonpublic information. Thus, the BlueNote report did not violate Standard 11(A) Integrity of Capital Markets - Material Nonpublic
Information, and since there appears to be a reasonable and adequate basis, does not appear to violate any other Standards either. Holly's report on BigTime, however, is based in part on a conversation that he overheard between executives at BigTime. The information he overheard related to the sale of one of
BigTimes business units was both material and nonpublic. The fact that several other analysts overheard the conversation as well does not make the information public. Because Holly is in possession of material nonpublic information, he is prohibited by Standard 11(A) from acting or causing others to act on the information.
Therefore, his report on BigTime violates the Standard.

Pat Wilson, CFA, is the chief compliance officer for Excess Investments, a global asset management and investment banking services company. Wilson is reviewing two investment reports written by Peter Holly, CFA, an analyst and portfolio manager who has worked for Excess for four years. Holly's first report under compliance review is a strong buy recommendation for BlueNote Inc., a musical instrument manufacturer. The report states that the buy recommendation is applicable for the next 6 to 12 months with an average level of risk and a sustainable price target of $24 for the entire time period. At the bottom of the report, an e- mail address is given for investors who wish to obtain a complete description of the firm's rating system. Among other reasons supporting the recommendation,
Holly's report states that expected increases in profitability as well as increased supply chain efficiency provide compelling support for purchasing BlueNote.
Holly informs Wilson that he determined his conclusions primarily from an intensive review of BlueNote's filings with the SEC but also from a call to one of
BlueNote's suppliers who informed Holly that their new inventory processing system would allow for more efficiency in supplying BlueNote with raw materials.
Holly explains to Wilson that he is the only analyst covering BlueNote who is aware of this information and that he believes the new inventory processing system will allow BlueNote to reduce costs and increase overall profitability for several years to come.
Wilson must also review Holly's report on BigTirae Inc., a musical promotions and distribution company. In the report, Holly provides a very optimistic analysis of
BigTime's fundamentals. The analysis supports a buy recommendation for the company. Wilson finds one problem with Holly's report on BigTime related to Holly's former business relationship with BigTime Inc. Two years before joining Excess, Holly worked as an investment banker and received 1,000 restricted shares of
BigTime as a result of his participation in taking the company public. These facts are not disclosed in the report but are disclosed on Excess Investment's Web site. Wilson decides, however, that the timeliness of the information in the report warrants overlooking this issue so that the report can be distributed.
Just before the report is issued. Holly mentions to Wilson that BigTime unknowingly disclosed to him and a few other analysts who were wailing for a conference call to begin that the company is planning to restructure both its sales staff and sales strategy and may sell one of its poorly performing business units next year.
Three days after issuing his report on BigTime, which caused a substantial rise in the price of BigTime shares, Holly sells all of the BigTirne shares out of both his performance fee-based accounts and asset-based accounts and then proceeds to sell all of the BigTime shares out of his own account on the following day. Holly obtained approval from Wilson before making the trades.
Just after selling his shares in BigTime, Holly receives a call from the CEO of BlueNote who wants to see if Holly received the desk pen engraved with the
BlueNote company logo that he sent last week and also to offer two front row tickets plus limousine service to a sold-out concert for a popular band that uses
BlueNote's instruments. Holly confirms that the desk pen arrived and thanks the CEO for the gift and tells him that before he accepts the concert tickets, he will have to check his calendar to see if he will be able to attend. Holly declines the use of the limousine service should he decide to attend the concert.
After speaking with the CEO of BlucNote, Holly constructs a letter that he plans to send by e-mail to all of his clients and prospects with e-mail addresses and by regular mail to all of his clients and prospects without e-mail addresses. The letter details changes to an equity valuation model that Holly and several other analysts at Excess use to analyze potential investment recommendations. Holly's letter explains that the new model, which will be put into use next month, will utilize Monte Carlo simulations to create a distribution of stock values, a sharp contrast to the existing model which uses static valuations combined with sensitivity analysis. Relevant details of the new model are included in the letter, but similar details about the existing model are not included. The letter also explains that management at Excess has decided to exclude alcohol and tobacco company securities from the research coverage universe. Holly's letter concludes by stating that no other significant changes that would affect the investment recommendation process have occurred or are expected to occur in the near future.
According to CFA Institute Research Objectivity Standards (ROS), which of the following statements is most accurate with regard to Holly's disclosure of his ownership of BigTime restricted shares and past investment banking relationship with BigTime? The disclosure:

  • A. is not required or recommended by the ROS since the shares are restricted.
  • B. complies with the ROS recommended procedures for disclosing conflicts of interest.
  • C. should have been made in the research report itself and not just on Excess's Web site.


Answer : C

Explanation:
CFA Institute Research Objectivity Standards (ROS) require disclosures of conflicts of interest such as beneficial ownership of securities of a covered firm. The
ROS recommend that such disclosure be made either in the supporting documents or on the firms Web site. It is further recommended that the disclosure, or a page reference to the disclosure, be made in the report itself. Holly owns shares of BigTime that may potentially benefit from his recommendation. His best course of action would be to disclose the conflict on both the firms Web site and in the report.

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