6 RELATE TO ETHICAL AND PROFESSIONAL STANDARDS. SHIRLEY RI...

Questions 1-6 relate to Ethical and Professional Standards.

Shirley Riley, CFA, has just been promoted from vice president of trading to chief investment

officer (CIO) at Crane & Associates, LLC (CA), a large investment management firm. Riley

has been with CA for eight years, but she has much to learn as she assumes her new duties as

CIO. Riley has decided to hire Denny Simpson, CFA, as the new compliance officer for CA.

Riley and Simpson have been reviewing procedures and policies throughout the firm and

have discovered several potential issues.

Communications with Clients

Portfolio managers are encouraged to communicate with clients on a regular basis. At a

minimum, managers are expected to contact clients on a quarterly basis to review portfolio

performance. Each client must have an investment policy statement (IPS) created when their

account is opened, specifying the objectives and constraints for their portfolio. IPSs are

reviewed at client request at any time. When market conditions or client circumstances

dictate a change in the investment style or strategy of a client portfolio, the client is notified

immediately by phone or email and the client's IPS is revised as necessary before any

changes are made.

Employee Incentive Program

CA offers several incentive programs to employees. One of the most popular of these

programs is the CA IPO program. Whenever CA is involved in an initial public offering

(IPO), portfolio managers are allowed to participate. The structure is simple-for every 100

shares purchased on behalf of a client, the manager is awarded five shares for his own

account. The manager is thus rewarded for getting an IPO sold and at the same time is able to

share in the results of the IPO. Any time shares are remaining 72 hours before the IPO goes

public, other employees are allowed to participate on a first-come, first-serve basis.

Employees seem to appreciate this opportunity, but CA does not have exact numbers on

employee participation in the program.

Private Equity Fund

CA has a private equity fund that is internally managed. This fund is made available only to

clients with more than $5 million in assets managed by CA, a policy that is fully disclosed in

CA's marketing materials. Roughly one-third of the fund's assets are invested in companies

that are either very small capitalization or thinly traded (or both). The pricing of these

securities for monthly account statements is often difficult. CA support staff get information

from different sources-sometimes using third party services, sometimes using CA valuation

models. In some instances, a manager of the private equity fund will enter an order during the

last trading hour of the month to purchase 100 shares of one of these small securities at a

modest premium to the last trade price. If the trade gets executed, that price can then be used

on the account statements. The small size of these trades does not significantly affect the

fund's overall position in any particular company holding, which is typically several thousand

shares.

Soft Dollar Usage

Several different managers at CA use independent research in developing investment ideas.

One of the more popular research services among CA managers is "Beneath the Numbers

(BTN)," which focuses on potential accounting abuses at prominent companies. This service

often provides early warnings of problems with a stock, allowing CA managers the

opportunity to sell their clients' positions before a negative surprise lowers the price. Stocks

covered by BTN are typically widely held in CA client accounts. Managers at CA have been

so happy with BTN that they have also subscribed to a new research product provided by the

same authors-"Beneath the Radar (BTR)." BTR recommends small capitalization securities

that are not large enough to attract much attention from large institutional investors. The

results of BTR's recommendations are mixed thus far, but CA managers are willing to be

patient.

As they discuss these issues, Riley informs Simpson that she is determined to bring CA into

full compliance with the CFA Institute's "Asset Manager Code of Professional Conduct." The

following questions should be answered with the Asset Manager Code as a guide.

...

Indicate whether CA's policies related to investment policy statement (IPS) reviews and

notification of changes in investment style/strategy are consistent with the Asset Manager

Code of Professional Conduct.

A) Both policies are inadequate.

B) Both policies are consistent with the Asset Manager Code of Professional Conduct.

C) The IPS review policy is inadequate, but the policy on communicating changes in style/strategy is

adequate.

Question #2 of 60

Indicate whether CA's policies related to its IPO program, specifically allowing portfolio

manager participation and employee participation, are consistent with the Asset Manager

A) Policies on both portfolio manager and employee participation in IPOs are not consistent with

the Asset Manager Code of Professional Conduct.

B) The employee participation in IPOs policy is consistent with the Asset Manager Code, as is the

portfolio manager's policy on participation in IPOs.

C) The portfolio manager's policy on IPOs is not consistent with the Asset Manager Cod; however,

the employee policy on IPOs is consistent with the Asset Manager Code.

Question #3 of 60

Participation in CA's private equity fund is limited to clients with $5 million under

management. This policy:

A) does not violate the Asset Manager Code of Professional Conduct.

B) would be acceptable so long as a similar investment vehicle was made available to all clients.

C) is not consistent with the Asset Manager Code of Professional Conduct.

Question #4 of 60

In discussing the pricing of thinly traded securities in the private equity fund, Riley suggested

that CA should choose one pricing method and apply it consistently, thus avoiding the need

to disclose specific pricing methods to clients. Simpson responded that using third party

sources or internal valuation models was acceptable, so long as the pricing sources are fully

disclosed to clients. Indicate whether Riley's comment and/or Simpson's responses

are correct or incorrect.

A) Both Riley's comment and Simpson's response are correct.

B) Riley's comment is not correct; however, Simpson's response is correct.

C) Riley is correct, while Simpson is not correct.

Question #5 of 60

Trading stocks during the last trading hour of a month to establish a fair market price:

B) is acceptable so long as the trade is not material relative to the overall CA position in the security.

Question #6 of 60

Simpson has verified that CA has adequate disclosures of its soft dollar usage. Given that full

disclosure is made to clients, indicate whether CA's use of soft dollars for BTN and BTR are

consistent with the Asset Manager Code of Professional Conduct.

A) Given the adequate disclosures, use of soft dollars for both BTN and BTR is acceptable.

B) Use of soft dollars for BTN is acceptable, but not for BTR.

C) Neither of these publications provide direct benefit to the client; thus, neither may be paid for

with soft dollars.

Question #7 of 60