CFA Level 1 - Ethics and Standards
Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another's independence and objectivity.
Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another's independence and objectivity.
Reasoning behind Standard I-B
This Standard addresses the integrity of the investment process and revisits the dangers inherent in a conflict of interest.
In the investment industry, portfolio managers and analysts are subject to temptation in the form of perks and favors such as lavish gifts, additional compensation and bonuses, tickets to sporting events or sold-out shows, luxury hotel and resort accommodations and so on. These favors are provided as a quid pro quo (either explicit or implicit) by which the analyst or manager is pressured into buying a particular security or changing a recommendation to the provider of the money or gifts. These arrangements (those that have been uncovered) have given the money management profession an unsavory reputation, and it is the goal of the CFA Institute to promote higher ethical standards.
Pressures from Other Departments
Another common practice that violates this Standard, but which seems somewhat less egregious on the surface (as it doesn't explicitly involve money), is the pressure placed on research and investment professionals by sources from other departments within the same company. For example, a large financial services outfit is likely to have an investment research wing, as well as a corporate finance wing that is primarily interested in facilitating relationships with companies for underwriting new issuances of debt or equity (as an example). When the research department is carrying a sell recommendation (or even a hold or anything less than a strong buy) on that company, the underwriting department wants to know why its "brothers and sisters in arms" are not doing more to "help the company's cause". Such a situation can be stressful and uncomfortable, as everyone feels the sense of duty to employer.
Conflicts Between Standard I-B and IV
An entire section (all of the ideals under Standard IV) of the Standards of Professional Conduct is devoted to the responsibilities we owe to our employer. However, Standard I-B highlights the responsibility to craft investment recommendations and maintain investment processes that are not subject to any such outside influences. As those two ideals are in conflict with each other, CFA Members and Candidates are guided in their conduct by a recommended course of action that strikes an appropriate balance.
The discussion under Standard IV-B, "Additional Compensation Arrangements", discusses the inherent conflict of interest in receiving gifts and entertainment from external sources. At the same time, a total and complete ban on accepting anything from anyone seems excessively cautious. The Handbook suggests that members may accept modest gifts, which it specifically defines as being anything worth less than US$100, as long as they do not affect objectivity.
More on Gifts and Perks
Another important note to remember about gifts and perks is that they are viewed differently depending on the source. In particular, gifts and perks from companies or other entities that could be seeking to influence the actions of the CFA member are seen as a direct challenge to independent and objective conduct, and they are thus generally regarded as a potentially more serious violation. Gifts from a client, by contrast, are seen as less likely to affect one's independence and objectivity. To be sure, even these gifts are enough of a concern to have necessitated the creation of Standard III-D, requiring full disclosure in these matters (if the gift exceeds US$100 in value). In any case, the CFA member or candidate must ask whether receipt of the gift will compromise the ability to remain objective and make independent judgments.
This Standard addresses the integrity of the investment process and revisits the dangers inherent in a conflict of interest.
In the investment industry, portfolio managers and analysts are subject to temptation in the form of perks and favors such as lavish gifts, additional compensation and bonuses, tickets to sporting events or sold-out shows, luxury hotel and resort accommodations and so on. These favors are provided as a quid pro quo (either explicit or implicit) by which the analyst or manager is pressured into buying a particular security or changing a recommendation to the provider of the money or gifts. These arrangements (those that have been uncovered) have given the money management profession an unsavory reputation, and it is the goal of the CFA Institute to promote higher ethical standards.
Pressures from Other Departments
Another common practice that violates this Standard, but which seems somewhat less egregious on the surface (as it doesn't explicitly involve money), is the pressure placed on research and investment professionals by sources from other departments within the same company. For example, a large financial services outfit is likely to have an investment research wing, as well as a corporate finance wing that is primarily interested in facilitating relationships with companies for underwriting new issuances of debt or equity (as an example). When the research department is carrying a sell recommendation (or even a hold or anything less than a strong buy) on that company, the underwriting department wants to know why its "brothers and sisters in arms" are not doing more to "help the company's cause". Such a situation can be stressful and uncomfortable, as everyone feels the sense of duty to employer.
Conflicts Between Standard I-B and IV
An entire section (all of the ideals under Standard IV) of the Standards of Professional Conduct is devoted to the responsibilities we owe to our employer. However, Standard I-B highlights the responsibility to craft investment recommendations and maintain investment processes that are not subject to any such outside influences. As those two ideals are in conflict with each other, CFA Members and Candidates are guided in their conduct by a recommended course of action that strikes an appropriate balance.
The discussion under Standard IV-B, "Additional Compensation Arrangements", discusses the inherent conflict of interest in receiving gifts and entertainment from external sources. At the same time, a total and complete ban on accepting anything from anyone seems excessively cautious. The Handbook suggests that members may accept modest gifts, which it specifically defines as being anything worth less than US$100, as long as they do not affect objectivity.
More on Gifts and Perks
Another important note to remember about gifts and perks is that they are viewed differently depending on the source. In particular, gifts and perks from companies or other entities that could be seeking to influence the actions of the CFA member are seen as a direct challenge to independent and objective conduct, and they are thus generally regarded as a potentially more serious violation. Gifts from a client, by contrast, are seen as less likely to affect one's independence and objectivity. To be sure, even these gifts are enough of a concern to have necessitated the creation of Standard III-D, requiring full disclosure in these matters (if the gift exceeds US$100 in value). In any case, the CFA member or candidate must ask whether receipt of the gift will compromise the ability to remain objective and make independent judgments.
Applying Standard I-B
Complying with standards of independence and objectivity seems simple and straightforward in theory, but in practice there are many scenarios that could potentially conflict with one's objectivity - or create the appearance of doing so. In many cases it is not so easy to define the proper course of action. Here are some of the situations that are more likely to appear on the exam:
Complying with standards of independence and objectivity seems simple and straightforward in theory, but in practice there are many scenarios that could potentially conflict with one's objectivity - or create the appearance of doing so. In many cases it is not so easy to define the proper course of action. Here are some of the situations that are more likely to appear on the exam:
- A company sponsors an analyst conference and picks up all the expenses. Consider a situation where a firm invites all Wall Street analysts who are actively covering its company to go on an all-expenses-paid trip to tour facilities, play golf, stay in a swanky resort and so forth, all in the hopes of promoting itself and earning more favorable coverage. For analysts bound by the Code and Standards, would this sort of outing compromise their objectivity? The answer is that it just might. This Standard requires CFA members to assess if such an outing is possible while still maintaining objectivity - would they still be able to write an unfavorable opinion, if warranted by independent analysis? Many firms have created policies that require attendance at such affairs to be paid by the firm and require the itinerary to be substantially business-related as a condition of attending. No specific checklist of right and wrong is written into this Standard, but the mere appearance of conflict is a real issue in today's environment and one must be sensitive to perception.
- A financial firm promises to provide research coverage of a company's stock in return for a potential business relationship. This agreement is acceptable so long as there is absolutely no requirement to make the recommendation a favorable one. This standard requires that any conclusions be made in an independent and objective manner.
- In the previous example, the relationship manager asks for a favorable recommendation for the new corporate client. This case would violate Standard I-B. If the relationship manager is concerned that an unfavorable research opinion will adversely affect the cultivation of this relationship, the research department would need to restrict the company from analyst coverage and only provide factual information without any specific recommendation. Under no circumstances can the corporate client be seen as "buying" a favorable analyst opinion.
- A research analyst assigned to a new sector is told by the director of research not to change the investment opinion on a certain company. This type of supervision would violate the analyst's requirement to reach an independent conclusion. If the analyst is a CFA Member or Candidate, he or she should proceed by informing the supervisor that he or she is bound by the Code and Standards, and that such a restriction is not permitted by the Standard on Independence and Objectivity. Another approach would be to study the company, reach an independent conclusion and share this opinion with the director of research, but leave it to the supervisor to decide the appropriate course of action.
- A portfolio manager receives an expensive vacation package from a brokerage as a sign of gratitude for all the business. Accepting such a perk is a violation, as it compromises the manager's objectivity in regards to choosing brokers that suit the best interests of the clients and the firm (the broker offering the best execution, for example). This manager would be in compliance with Standards if he or she disclosed the perk in writing to his or her immediate supervisor. If the firm required this manager to refuse the vacation package, he or she would be required to abide by the decision of the firm.
- A portfolio manager is sent two extra tickets to a local baseball game (face value $30 each), complements of the same brokerage. Given the rule of thumb that gifts lower than US$100 are perceived as sufficiently modest and are thus acceptable from both clients and business partners, the portfolio manager would not be violating Standard I-B, even if the perk went unreported. At the same time, it's a sensible practice to disclose even gifts of this nature - the Standards of Professional Conduct describe minimum standards, but staying in the habit of full disclosure should always be the preferred course of action.
- A CFA member who is also a member of the local society of financial analysts solicits corporate financial support for an investor conference and issues research reports on some of those same firms. Research opinions must be unbiased. However, when an analyst takes on an outside role, how will these secondary activities influence the research? If a firm pledges generous support to this analyst, will the analyst's future research reports become more favorable? If another firm declines support, will a report on that company be less favorable? The best course of action would be to trade the coverage of those firms with a colleague, or to ask to be excused from seeking sponsors.
How to Comply
The Standards of Practice Handbook provides a number of operational suggestions that one should recommend for adoption by the compliance department.
The Standards of Practice Handbook provides a number of operational suggestions that one should recommend for adoption by the compliance department.
- Establish that research opinions reflect unbiased opinions, and include this wording on all written reports. Salary and bonuses should be independent of any factors that might compromise the degree of independence - i.e. don't tie a quarterly bonus to the fees collected from corporate relationships (which can be affected by a stock recommendation).
- Highlight the integrity of the research
- Disclose conflicts of interest - For example, a directorship in a public company would need to be acknowledged by the employer, as this fact may affect research opinions of that company and of competitors. Research reports should disclose whether the analyst owns shares in a company and whether the analyst's firm makes a market in that security or has underwritten the security.
- Limit direct investments in equity or equity-related IPOs - Investment firms should establish formal policies relative to employee purchase of equity and equity-related IPOs and require prior approval.
- Report holdings - Report holdings in all personal accounts, those of one's immediate family and those over which the analyst has formal discretion (e.g. trusts).
- Establish a restricted list - This is to limit research on those firms that have a business relationship with that company. If an adverse opinion would hurt this business relationship, the company stock should be restricted from the research universe, and only factual information on the company should be disseminated.
- Cost reimbursement procedures - Identify what is acceptable and what is unacceptable practice in order to avoid the appearance of a conflict. While there is no specific checklist in the Standards, the general rule of thumb is that air transport, ground transport and hotel accommodations should be the responsibility of the individual and his or her company, and should not be covered by (for example) the issuer of a security that an analyst has started to cover. The reason that no checklist has been developed is that there are always exceptions - for example, if the issuer of a preferred security is an energy company that is headquartered in a sparsely populated area (near its coal mines) and commercial transport is not available, and the only practical way to arrange a face-to-face meeting is by using a corporate jet, then an analyst can accept such an arrangement without violating this Standard.
- Limit gifts - Gifts should be limited to a maximum value of US$100.
- Periodically review guidelines - This is to reinforce dos and don'ts for all employees and determine whether additional guidelines are sensible.
- Compliance Officer - Firms should appoint a senior-level compliance officer who ensures the code of ethics and all regulations are upheld.
(See more) Standard I-C: Misrepresentation
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