THROUGH 12 RELATE TO ETHICAL AND PROFESSIONAL STANDARDS....
Questions 7 through 12 relate to Ethical and Professional Standards.
Capital Market Advisors (CMA)Case Scenario
Capital Market Advisors (CMA) is an asset management firm established in Houston,
Texas. The firm has been providing investment management services for more than ten
years now, and has managed to earn a reputable standing in the investment community.
Portfolio managers at the firm are not only considered to be technically proficient, they
are also known to follow the highest standards of ethical and professional conduct. For
these reasons, CMA also provides investment firms wanting to adopt adequate
compliance procedures regarding professional conduct, with consultants and qualified
compliance officers. Eric Green, a portfolio manager at CMA, was hired as a consultant
by Dominick Tavella, the CEO of Growth Equity Management (GEM). During a
conversation with Green, Tavella mentioned that their firm had recently adopted and
implemented the Asset Manager Code of Professional Conduct. To confirm the accurate
implementation of the Code, Green gathered the following information:
1.
Many portfolio managers at GEM maintain multiple business relationships with
their clients, and such relationships are adequately disclosed.
2.
Instead of establishing an independent compliance department, GEM has
designated one of its employees as a compliance officer, who has complete
authority with regards to the implementation of the Code.
3.
GEM creates a restricted list of securities. Employees need to seek approval prior
to trading in these securities. However, employees at GEM are not required to
provide their compliance officer with copies of trade confirmations each quarter.
In addition to the above information, Green also reviewed the firm’s methods of
determining end-of-period valuations and returns for portfolio assets. Green evaluated the
valuation procedures for their private wealth funds managed as separate accounts, as well
for the pooled institutional funds. He found out that GEM hires competent and qualified
managers for the management of their private wealth funds, who perform thorough
analysis and due diligence before making recommendations. In addition, the managers
use widely accepted valuation methods to appraise portfolio holdings and apply them on
a consistent basis. GEM’s pooled accounts are supervised by a board of directors
consisting of the firm’s most senior and experienced portfolio managers. The board is
responsible for approving the asset valuation policies and procedures and reviewing
valuations.
As a part of his comprehensive analysis of the firm, Green held a meeting with Tavella to
discuss the firm’s disclosure policies. One of the disclosures related to costs made to
existing clients stated:
“A base fee equal to 2% of assets under management is charged annually. In addition,
investors will also have to pay an incentive fee of 25% on all profits, realized and
unrealized, above the threshold return. The threshold return will be determined at the start
of the client relationship, in the investment policy statement. In addition, the incentive fee
will be recouped by investors if subsequent to the payment, the portfolio incurs losses.”
In addition, GEM also disclosed to each client the actual fees and other costs charged to
them, but did not disclose the itemizations of such charges.
As their discussion continued, Green found out that as part of their risk management
process, GEM hires an independent third-party to verify portfolio information provided to
clients. The confirmation of portfolio information is done for their pooled vehicles, and
takes the form of an audit performed by the third party verifier. Since such an audit is
carried out to help portfolio managers at GEM identify potential problems, and not for
their clients, GEM does not disclose to its clients the results of the audit. However, it does
regularly inform them about the dates of the review process, and how such a process
helps the managers at the firm identify problems as early as possible. GEM believes this
will enhance their credibility.
Tavella then made the following comments:
Statement 1: “GEM ensures that no client bears a financial loss by the misallocation of
transactions by any GEM’s employee. To ensure this, GEM credits short-
term interest to all accounts for which shares were incorrectly allocated,
and removes short-term interest from those accounts that should have
received shares and in which shares are put on a back-dated basis.”
Statement 2: “Before allocating trades, GEM determines clients’ investment objectives.
Those with similar investment objectives receive similar allocations when
new purchases are made, no matter what the size of the portfolio.”
7.
Are the procedures at Growth Equity Management in accordance with the Asset
Manager Code of Professional Conduct?
A.
Yes.
B.
Only procedure 1 is in accordance with the Code.
C.
None of the procedures are in accordance with the Code.
8.
With respect to the asset valuation procedures, is Growth Equity Management in
accordance with the Asset Manager Code of Professional Conduct?
A.
No.
B.
Only with respect to the private wealth accounts.
C.
Only with respect to the pooled accounts.
9.
Is GEM’s disclosure related to costs most likely in accordance with the Asset
B.
No, because it does not disclose the itemizations of fees and costs.
C.
No, because it did not disclose the average or expected expenses or fees
clients are likely to incur.
10. Is GEM’s policy regarding the audit of their pooled accounts most likely in
accordance with the Asset Manager Code of Professional Conduct?
B.
No, because GEM will need to seek approval of the particular clients
whose funds are submitted for the audit, prior to the start of such a
process.
C.
No, because GEM’s disclosure policy regarding the audit is inadequate.
11. Which of Tavella’s statements is most likely in accordance with CFA Institute
Code of Ethics and Standards of Professional Conduct?
A.
Statement 1 only.
B.
Statement 2 only.
C.
Neither Statement 1 nor statement 2.
12. Which of the following is most likely a requirement to be in compliance with
Standard I(A) ‘Knowledge of Law’ of the CFA Institute Standards of Professional
Conduct?
A.
A member of candidate should have knowledge of and be aware of all the
facts giving rise to violations of applicable laws, rules or the Code and
Standards.
B.
A member or candidate has to leave his or her employer if all intermediate
steps of reporting and disassociating from an unethical activity fail to
work.
C.
When dissociating from a violation, a member of candidate should
document the violation and urge his or her firm to bring a stop to the
activity.