Eduzan

Eduzan / MODULE 01 — Ethics (Ethical and Professional Standards)

ETH 10 Application of the Code and Standards: Level I

A guided walk through applied cases that test conduct against the Code and Standards, standard by standard. Check-yourself items are study aids.

This module contains almost no new theory. Instead it is a collection of short scenarios, each one dropping you into a situation faced by an investment professional and asking a single question: does the conduct comply with the CFA Institute Code of Ethics and Standards of Professional Conduct, or does it breach one of the Standards? Working through cases is how ethical judgement is actually built, because the hard part is rarely reciting a rule; it is spotting which rule the facts have quietly triggered.

A simple four-stage framework keeps that judgement disciplined. It does not have to be run strictly in order, but a closing review should always cap the process.

Identify. Pin down the relevant facts, the stakeholders and the duties owed to each, the ethical principles in play, and any conflicts of interest.
Consider. Weigh the situational pressures acting on the decision maker, seek out additional guidance (a supervisor, compliance, the Standards themselves), and lay out the alternative courses of action.
Decide and act.
Reflect. Afterward, revisit the outcome. Did it turn out as anticipated? Why or why not? That review is the stage most easily skipped, yet it is what sharpens judgement for the next decision.

The Standards themselves fall into seven groups. The cases that follow are organised the same way, so the group tells you which duty is under the microscope before you even read the facts.

The seven Standard areas

ETH 10 Application of the Code and Standards: Level I
Standard	Area	What it polices
I	Professionalism	Law, independence, honesty, conduct, competence
II	Integrity of Capital Markets	Nonpublic information and market manipulation
III	Duties to Clients	Loyalty, fair dealing, suitability, reporting, confidentiality
IV	Duties to Employers	Loyalty, extra compensation, supervision
V	Investment Analysis, Recommendations, and Actions	Diligence, client communication, records
VI	Conflicts of Interest	Disclosure, transaction priority, referral fees
VII	Responsibilities as a CFA Member or Candidate	Program integrity and correct use of the designation

Check yourself

Name the four stages of the framework, and say which one is most often left out.

Identify, Consider, Decide and act, and Reflect. The reflect stage is the one most people skip, yet reviewing how a decision played out is exactly what improves future judgement.

Standard I gathers the foundations: obeying the law, protecting your independence, avoiding misrepresentation and misconduct, and keeping your skills current. Most breaches here are not exotic; they are small compromises that a professional talks himself into.

Knowledge of the Law: Standard I(A)

Members must understand and follow every law, rule, and regulation that governs their work, including the Code and Standards, and must apply the stricter rule when two conflict. They must not knowingly take part in a violation and must step away from one they discover.

Example 1 · Worked

SBS Bank acts as a custody bank, charging clients an asset-based fee and passing through out-of-pocket costs such as SWIFT messaging fees. The pass-through is not clean: SBS marks the SWIFT charge up above its actual cost. Mandracken, CFA, a vice president overseeing client service, spots the markup and emails his supervisor, noting that although the fee schedule discloses a SWIFT charge, the amount has always carried a margin over cost. The supervisor tells him to lower the rate for new clients and to revisit it for existing clients only when their contracts renew.

1. What must Mandracken do to meet his obligations under the Code and Standards?

Solution. He must refuse to take part in any client interaction that relies on the current fee schedule until the bank resets the SWIFT charge to actual cost. Standard I(A) Knowledge of the Law bars members from knowingly assisting in a violation and requires them to dissociate from it. SBS is overcharging its custody clients by misstating a reimbursable expense. The supervisor’s fix is inadequate on three counts: it helps only new clients, it delays relief for existing clients, and it does nothing for clients already overcharged. Simply carrying out the supervisor’s instructions is not enough, because continuing to work alongside the misconduct can itself count as assisting it. Escalating to the board or a regulator, or even leaving the bank, may eventually be needed, but Mandracken should first exhaust interim steps such as pressing his supervisor or compliance on why the correction falls short. What he cannot do is keep dealing with clients under a schedule he knows to be false.

Example 2 · Worked

Pellie, CFA, leads Kwaume Investment Group as its chief executive; the adviser is wholly owned by Kwaume Bank. A long-standing bank customer, known personally to Pellie and some board members, opens an account with a stated objective of earning income. Over the next year the account shows a few investments but hundreds of banking transactions: roughly $90 million deposited and $84 million withdrawn, including transfers to and from bank secrecy havens and countries flagged for money-laundering risk. Pellie knows the client runs international ventures with elevated corruption and bribery risk, yet he assumes the flows are legitimate, accepts vague labels such as “consulting fees” and “commissions,” and signs off the daily anti-money-laundering (AML) reports without inquiry.

1. Are Pellie’s actions consistent with the Code and Standards?

Solution. No. Pellie violates Standard I(A) Knowledge of the Law, which requires compliance with the laws that govern his activities. The pattern practically screams for scrutiny: huge cash turnover against almost no investing is flatly inconsistent with an income mandate, and the counterparties sit in high-risk jurisdictions. Rather than investigate as the law demands, Pellie waves the AML reports through because of the client’s ties to the bank. A duty of loyalty and the confidentiality owed to clients cannot be stretched into a licence to let a client break the law or damage market integrity. Nor can he offload the job onto the account’s clearing firm; reviewing the activity for suspicious flows is his own responsibility.

Check yourself

Mwangi, CFA, sells insurance products. Three clients ask to switch from a Class A product to a cheaper Class B product, which by law requires their signatures on new documents. The clients cannot be reached in time, and a manager threatens to cancel the exchange, which would overdraw the accounts and force asset sales. Mwangi signs the documents on the clients’ behalf to protect them. Acceptable?

No. This breaches Standard I(A). The law required the clients’ own signatures, so signing for them is forgery, and a legal violation is an ethical one here. General prior approval of the switch does not satisfy the signature requirement, and even explicit permission to sign on their behalf would not, because the law demands the clients’ genuine signatures. Good intentions do not let her sidestep the legal requirement.

Independence and Objectivity: Standard I(B)

Members must use reasonable care to stay independent and objective, and must neither offer nor accept any gift or benefit that could reasonably be expected to compromise their own or another person’s independence and objectivity.

Example 3 · Worked

Myers, CFA, is a partner at the $3 billion hedge fund Corboba, which focuses on environmental, social, and governance (ESG) investing. He wants to donate $10,000 personally to a candidate for public office, DeFrietas, whose environmental platform Myers genuinely supports. Myers also recognises that DeFrietas, if elected, could influence which hedge funds receive allocations from the state pension plans.

1. What is Myers’s best course of action?

Solution. The safest course is to refrain from donating to DeFrietas. Standard I(B) Independence and Objectivity forbids offering any benefit that could reasonably be expected to compromise another party’s independence and objectivity, and the facts show Myers hopes the gift may sway DeFrietas toward steering pension money to Corboba. That is precisely the “pay-to-play” concern the standard targets. The source of the money and its size relative to the fund are beside the point; $10,000 may well be meaningful in a campaign, and what matters is whether the gift is crafted to sway the official improperly for Myers’s benefit. The standard is not meant to bar professionals from political participation, so Myers can support environmental causes in other ways, but here the appearance of buying influence makes abstaining the better choice.

Misrepresentation: Standard I(C)

Members must not knowingly misrepresent anything tied to their analysis, their recommendations, the actions they take, or the rest of their professional work. Staying silent can mislead just as effectively as a false statement.

Example 4 · Worked

Brodeur, CFA, is CEO of LeTour, an electric-car maker. The company has disclosed that Brodeur’s personal social media account is an official channel for company information. After the press reports production and delivery problems, Brodeur posts that he is “considering taking LeTour private,” puts the price at $420 a share, and adds that “funding is secure.” In reality he had only a vague expression of interest from a sovereign wealth fund, with no agreement and no price discussed, and no advisers formally retained. He later admitted the $420 figure was a joke. Following the post, the stock jumped more than 6% on heavy volume and closed at $380, some 10% above the prior day.

1. How should Brodeur’s post be judged?

Solution. The post is inappropriate because it misrepresents the facts, violating Standard I(C) Misrepresentation. Brodeur described funding as “secure” and named a price when, on his own admission, no deal existed, no price had been discussed, and no advisers were engaged. He knew or should have known the statement was false and misleading. Using a social channel does not dilute the duty to be honest; distribution methods must reach the market effectively, but they do not excuse misleading content. And the information was material, not idle speculation, because it came from the CEO, concerned a dramatic corporate event, and was exactly the kind of thing investors would want before trading, as the price reaction confirms.

Check yourself

Lee, CFA, is paid on the number of AKC products she sells. She advises a couple to move $125,000 of retirement savings into a single AKC large-cap equity fund, disclosing a $30,000 early-closure penalty but assuring them that stronger returns from the AKC product will make up the loss. Does full disclosure of the penalty save her?

No. Lee breaches Standard I(C) by effectively promising a specific outcome on a volatile investment. Equity returns are unpredictable, so guaranteeing that future gains will offset a $30,000 penalty is a misrepresentation. Disclosing the penalty does not cure the misleading promise, and suitability plus her compensation-driven conflict are also in question. Even if the fund were suitable, the return promise is still improper.

Check yourself

Andersen, CFA, pitches to manage a pension plan and, at the plan’s request, lists the key people who would run the account. While the decision is pending, one of those named team members, who also joined the presentation, resigns. What must Andersen do?

He must promptly tell the pension plan that the key staff member has left. Withholding it would be a misrepresentation by omission under Standard I(C), because the plan specifically asked who would manage its money, making that information central to its hiring decision. Doing nothing, or quietly waiting to hire a replacement first, is too late. Had the departing person been junior or not identified as key, an update might not be needed.

Misconduct: Standard I(D)

Members must not act, in their professional lives, with dishonesty, fraud, or deceit, and must not commit any act that damages how others see their reputation, integrity, or competence. What the standard reaches is professional conduct, not every stumble in a person’s private life.

Example 5 · Worked

Hanse, CFA, manages an ESG fund at a global investment bank. In her own time she joins nonviolent Extinction Rebellion protests about climate and ecological collapse. At demonstrations in the financial district she is arrested for unlawful assembly, obstructing transit, and disorderly conduct, and is ultimately convicted of several minor offences. Her employment contract lets the bank fire any employee convicted of a crime.

1. Do Hanse’s actions violate the Code and Standards?

Solution. No. Standard I(D) Misconduct is aimed at dishonesty, fraud, or deceit and at acts that reflect poorly on professional reputation, integrity, or competence. It is generally not meant to capture minor legal transgressions arising from acts of civil disobedience undertaken for personal beliefs, because such conduct does not speak to a member’s professional trustworthiness. The contract merely gives the bank discretion to terminate her; a breach of an employment contract does not automatically breach the Code and Standards unless the conduct itself is the kind the Standards address. Her arrest in the financial district does not forge a close enough tie to her professional work to turn a personal act into a violation.

Example 6 · Worked

Mang, CFA, advises discretionary, fee-based accounts at a regional bank. Bank policy lets an adviser correct a missed trade within 30 days by buying or selling at the current price, with the price gap borne by the adviser through the firm’s internal error account. Mang exploits this. When a client is unhappy with performance, he finds a security whose price has risen over the past 30 days, tells the trade desk he had forgotten to buy it earlier at the lower price, and lets the correction go through, absorbing the difference himself. He then sells to lock in a profit for the client and describes it as a “gift” or a “no-risk” trade.

1. Are Mang’s actions acceptable because they benefit clients?

Solution. No. Mang violates Standard I(D) Misconduct by running a deceptive, fraudulent scheme. There was never a genuine trade error; he fabricates one to inflate his clients’ returns and to disguise his real skill and the true performance of their accounts, effectively paying clients out of his own pocket to mislead them. That the trades help clients does not rescue the conduct, and the fact that the bank suffers no loss does not make the deception any less fraudulent.

Competence: Standard I(E)

Members must act with, and maintain, the competence needed to carry out their professional responsibilities. When a role changes, the duty to be competent changes with it.

Example 7 · Worked

Mahajan, CFA, a strong research analyst covering renewable energy, moves to a boutique ESG research firm. The new role adds two things: he will supervise several junior analysts for the first time, and his coverage widens to include transportation and construction. To prepare, he enrols in the CFA Institute Certificate in ESG Investing, attends webinars on green construction, reads widely on electric transportation, and joins an ESG analyst trade body.

1. Do Mahajan’s preparations satisfy Standard I(E)?

Solution. Not fully. Standard I(E) Competence requires him to build competence across all responsibilities of the new role. His self-study clearly extends his subject-matter competence to the new sectors, but it does nothing to prepare him for his brand-new supervisory duties over the junior analysts. To close that gap he could take management or compliance courses, earn compliance credentials, or complete internal supervisory training. Note that the standard does not require enrolment in a formal continuing-education program; that is one way to stay competent, not a rule. The shortfall is the neglected supervisory skill set, not the format of his learning.

Standard II protects the market itself. Two duties dominate: never trade or cause others to trade on material nonpublic information, and never distort prices or trading volume to mislead other participants.

Material Nonpublic Information: Standard II(A)

A member who holds material nonpublic information that could affect an investment’s value must not act on it or cause others to act. Information is material if reasonable investors would want it before trading; it stays nonpublic until it has been made available to the market at large.

Example 8 · Worked

Khatri, who is sitting the CFA Program, plays weekend cricket with friends, including his brother-in-law Patel, an attorney, and Ahuja, who owns a software firm called ZeroPower (ZP). Patel does ZP’s legal work and is helping a large information technology company, GIT, with due diligence on a proposed acquisition of ZP at a rich premium. Khatri, Patel, and others in the group have invested in ZP. During a tournament, Khatri overhears Patel on the phone repeatedly saying “GIT,” and sees Patel and Ahuja huddling privately. He infers a deal is near, and on Monday buys 5,000 more ZP shares. A week later the acquisition is announced and ZP jumps 30%.

1. Are Khatri’s actions consistent with the Code and Standards?

Solution. No. Khatri comes into material nonpublic information by overhearing Patel and reading the private meetings, then trades on it, violating Standard II(A) Material Nonpublic Information. Patel should have guarded his calls, but his carelessness does not entitle Khatri to use what he learned. The fact that Khatri had to make an inference does not turn this into mosaic-theory analysis; mosaic reasoning combines nonmaterial and public pieces, whereas here he knew or should have known the information was confidential, nonpublic, and material. And overhearing it in a public place does not make the information itself public.

Example 9 · Worked

Kwame, CFA, is CFO of PH3D, a biotech developing women’s-health drugs. After the regulator postpones two meetings over unspecified deficiencies, the public news drops the stock 10%. When the meeting finally happens, PH3D shows unpublished, favourable preliminary test data, and the regulator grants provisional approval subject to further study. Afterward, several sell-side analysts ask Kwame how it went. By email he replies that the meeting had been “very positive and productive” and that the firm was “pleasantly surprised” by how the regulator reacted, though he keeps the test data to himself. The stock then rises 19%.

1. Are Kwame’s responses appropriate because he withheld the actual test data?

Solution. No. This is selective disclosure of material nonpublic information, which Standard II(A) prohibits because it causes others to act on such information. Even without handing over the raw data, Kwame told a select group of analysts that the meeting went very well and that approval had moved forward, which is material (it moves the price and reasonable investors would want it) and nonpublic (an email to chosen analysts is not public dissemination). It does not matter that he was only answering questions; PH3D ought to have put out a public announcement about the meeting before, or at the same moment as, any disclosure to the analysts.

Market Manipulation: Standard II(B)

Members must not take part in schemes that distort security prices or pump up trading volume in order to fool other market participants. Such manipulation can be transaction-based or, as in the case that follows, information-based.

Example 10 · Worked

Abbha, CFA, helps Superior Energy (SE) list on the Regional Security Exchange (RSX). In its filed prospectus, SE offers up to 5 million shares at $2 each, seeking to raise $10 million. RSX rules require a “minimum spread” of at least 300 shareholders to qualify for listing. In the application, SE reports that it has met the 300-shareholder threshold, but that count includes 31 people or entities arranged by Abbha who are not real buyers; Abbha even supplies false names and addresses for them. The sale brings in over $3.5 million and places more than 1.75 million shares into the market. SE is listed, its shares later rise steadily, it attracts hundreds of genuine investors, and early buyers do well.

1. Do Abbha’s actions violate the Code and Standards?

Solution. Yes. Abbha engages in information-based manipulation, violating Standard II(B) Market Manipulation, by padding the initial shareholder count to fake the liquidity and investor interest that the listing rule is meant to verify. That SE later turned out to be a genuine, well-performing company does not cure the deceit. And the falsification is not a mere technicality: the minimum-spread rule exists to ensure real liquidity at listing and to keep out issuers that cannot attract genuine interest, so manufacturing 31 fictitious holders defeats the rule’s whole purpose.

Standard III sets out what a client is entitled to expect: loyalty and prudent care, fair treatment, suitable advice, honest performance reporting, and confidentiality. Several of these cases turn on the exact nature of the client relationship.

Loyalty, Prudence, and Care: Standard III(A)

Members owe clients a duty of loyalty, must act with reasonable care and prudent judgement, and must put client interests ahead of their employer’s and their own. What that requires in practice depends on the type of relationship the client has agreed to.

Example 11 · Worked

Gaini, CFA, is a commodities trader. His client Laube opens a self-directed foreign-exchange account on which Gaini gives no advice. She signs the standard agreement, which lets Gaini liquidate positions without notice if margin is insufficient. Laube buys a pair of USD/CHF contracts of 100,000 US dollars each and sets margin at $4,000, then places two more USD/CHF pending limit orders at different prices. She leaves on a long vacation. While she is away, the first limit order fills and margin rises to $6,000; the second then fills and margin rises to $8,000. Her balance falls to $6,900. Without notice, Gaini liquidates everything, realising a $37,000 loss.

Laube’s margin as orders fill

ETH 10 Application of the Code and Standards: Level I
Event	Required margin
Initial two contracts	$4,000
First limit order fills	$6,000
Second limit order fills	$8,000
Account balance at liquidation	$6,900

1. Does Gaini breach his duty of loyalty, prudence, and care by liquidating without notice?

Solution. No; his actions are appropriate under Standard III(A). The conduct that satisfies this duty depends on the relationship, and here Laube self-directs her trades while Gaini merely executes them and gives no advice. She freely contracted for the margin and no-notice liquidation terms, which are set out clearly, and nothing suggests Gaini misled her. Those terms do not waive her right to good faith, but they are not an attempt by Gaini to escape his duty; they simply define a relationship the two were free to negotiate. His need to protect his own and other clients’ positions when she defaults on margin outranks any duty to actively monitor an account he did not agree to watch, and he was not obliged to choose the gentler route of closing only one contract. Liquidating per the agreement even helps protect market integrity.

Example 12 · Worked

A regional government retains Braung, CFA, and his firm as advisers on a series of general obligation bond issues, funding projects that include a detention facility and two schools. Braung travels to New York City to meet ratings agencies, deliberately scheduling on a Monday or Friday because weekend rates are cheaper. His wife joins him and they spend the surrounding weekend enjoying sporting events, theatre, and museums. He also often makes train and hotel changes after booking so he can see other clients on the same trip. He submits all his expenses to his supervisor, who strips out anything unrelated to the business purpose before billing the municipality.

1. Which of these expenses can most reasonably be charged to the bond-issuing government?

Solution. The weekend accommodation and meals can most likely be billed, and the standard at work is III(A) Loyalty, Prudence, and Care. If staying over a weekend makes the whole trip cheaper than midweek travel, choosing that schedule actually lowers the client’s cost and meets Braung’s duty of loyalty. By contrast, personal theatre and sporting tickets are not chargeable; the Code permits only small gifts and entertainment that arise in the normal run of business, not lavish personal outings dressed up as a client expense. Change fees incurred to visit other clients are Braung’s own overhead, not the municipality’s cost. Best practice is to agree in writing at the outset which expenses are reimbursable.

Check yourself

Maste, CFA, sole director of Dov Services, makes advisers include a “Client Protection Policy” in client contracts. Despite its reassuring name, it waives Dov’s liability for any failure to serve the client’s best interests, drops the duty to run suitability analyses, and implies clients cannot sue for securities-law breaches. Full disclosure of these terms is made. Acceptable?

No. Disclosure cannot be used to sign away fundamental duties. The policy breaches Standard III(A) Loyalty, Prudence, and Care, and also implicates III(B) Fair Dealing (suitability), V(A) Diligence and Reasonable Basis, and I(C) Misrepresentation, since the document is deceptive about clients’ legal rights. Parties may negotiate advisory terms, but not to gut the core obligations of loyalty, prudence, and care.

Why “disclosure fixes everything” is a trap

Several cases tempt you with the idea that telling the client makes anything permissible. It does not. Disclosure is required for conflicts and service tiers, but it cannot license illegal acts (Pellie), cannot rescue a misleading return promise (Lee), and cannot waive a fundamental duty of care (Maste). Ask first whether the underlying conduct is proper; only then does disclosure of a legitimate arrangement do its job.

Fair Dealing: Standard III(B)

Members must treat every client fairly and even-handedly when they provide analysis, make recommendations, or take investment action. Fair does not mean identical, since tiered service levels are permitted within limits.

Check yourself

Scherzer, CFA, emails a monthly “Recommendation Update Report” to all clients simultaneously, then posts it publicly the following Monday. Only one recommendation change is allowed per month, through that report. She also sells a weekly report, hinting at possible future changes, to any client willing to pay $1,000 a year, fully disclosed. Must she change anything?

No; she complies with Standard III(B) Fair Dealing. All clients get the monthly report at the same time, and a premium weekly service is permitted provided every client may buy it, the tiers are disclosed, and no recommendation change disadvantages clients who receive only the monthly report. She need not post the report publicly, and she need not give the weekly service away for free.

Suitability: Standard III(C)

In an advisory relationship, members must learn a client’s experience, objectives, and constraints, keep that picture current, and ensure recommendations fit the client’s situation and total portfolio before acting.

Example 13 · Worked

Marte, CFA, manages assets in Puerto Rico, where residents get significant tax breaks for investing in local securities. His firm offers a closed-end fund, set up under local law, that keeps a minimum of 67% in local securities and may borrow against as much as 50% of its assets; in practice it runs at the highest leverage the law allows. Many of Marte’s clients have modest wealth and conservative or moderate objectives, yet he persuades them to put 85% or more of their assets into this one fund.

1. Do Marte’s recommendations comply with the Code and Standards?

Solution. No. Standard III(C) Suitability requires that an investment fit the client’s situation and written objectives. Given his clients’ modest means and conservative goals, an 85%-plus stake in a single leveraged fund is unsuitable because it abandons diversification. A single market event hitting the fund would slash the whole account, and the fund’s internal leverage would magnify the damage. The tax advantage might justify some exposure, but not a concentration this extreme, and disclosing the risks does not remove the need for the position itself to be suitable.

Check yourself

Duri, CFA, helps clients move retirement assets into self-managed superannuation funds (SMSFs) holding direct residential property. She accepts their stated wish to invest in property, assumes they have the time and expertise to run an SMSF, relabels their objective “growth,” and recommends her own accounting firm to do their SMSF tax returns. Is any of this a problem?

Yes. Duri breaches Standard III(C) Suitability by skipping a real inquiry: she does not test their reasons, financial goals, diversification, liquidity needs in retirement, expertise to manage a rental, or resilience if income or occupancy falls. Reclassifying everyone as “growth” to justify the SMSF is not genuine analysis, and a client’s request does not remove her duty to confirm suitability. Steering the tax work to her own firm also raises a III(A) conflict that must at least be disclosed.

Performance Presentation: Standard III(D)

When communicating performance, members must make reasonable efforts to keep it fair, accurate, and complete. Accurate numbers can still mislead if the context is missing.

Check yourself

Jergenn, CFA, runs the VIM fund, a collective investment scheme (CIS) registered in South Africa in 2021. Its 2022 marketing shows accurate annual returns for 2014 to 2020, but that history is really a composite of separate accounts run in the same strategy before the assets moved into the CIS. The numbers are calculated correctly. Any issue?

Yes. Correct numbers are not enough under Standard III(D) Performance Presentation if the presentation is misleading. Showing the 2014 to 2020 record without flagging that it predates the CIS could fool investors into thinking the fund has a long track record. Jergenn should disclose that the earlier history belongs to a prior but similar vehicle with the same strategy and that the CIS has existed only since 2021. Whether returns are net or gross of fees is a separate matter that just needs clear explanation.

Preservation of Confidentiality: Standard III(E)

Members must hold in confidence what they know about present, past, and prospective clients, with three exceptions: the information points to illegal activity, the law compels disclosure, or the client agrees to release it.

Example 14 · Worked

Giddings, CFA, is the compliance chief at GWH, a sizable broker/dealer and adviser holding personally identifiable client data (names, addresses, phone numbers, account numbers, balances, holdings). He adopts policies and a code of conduct restricting how staff access this data. Marsh, CFA, a client-services associate, downloads client data to a personal server at home to make telecommuting easier. His server is hacked, and some of the client data he copied is put up for sale online.

1. Did Marsh, Giddings, or both violate the Code and Standards?

Solution. Both violated Standard III(E) Preservation of Confidentiality. Assuming he lacked permission, Marsh misappropriated client data for his own convenience, and although he did not post it, his action set up the breach; he needed to follow the firm’s information-handling procedures. Giddings, as compliance officer, is responsible for building safeguards strong enough to protect client data and to block unauthorised access. The fact that Marsh could copy files to a home server, and that the data leaked, calls the adequacy of those safeguards into question, and nothing shows Giddings tested whether the controls actually worked. Members need not be security experts, but they must make reasonable efforts to prevent accidental disclosure.

Standard IV governs the employment relationship: loyalty while you are there, transparency about outside pay, and diligent supervision of those beneath you. Loyalty to an employer, though, never overrides the duty to protect clients or the law.

Loyalty: Standard IV(A)

In matters of employment, members must act for the employer’s benefit and must not deprive it of their skills, divulge confidential information, or otherwise cause it harm. Preparing to leave is allowed; undermining the employer on the way out is not.

Example 15 · Worked

Kuznetsov, CFA, is pushed by his firm to sell proprietary products to clients, and he becomes the top seller, earning praise and a large bonus. He then realises the products underperform and cost more than suitable external options. He stops selling them and refuses his supervisor’s pressure to resume. He complains repeatedly to management that he is being told to put the firm ahead of clients, secretly records some conversations with his supervisor, and copies client records documenting the conduct. When management ignores him and his reviews sour, he files a complaint with the regulator, handing over the recordings and files as evidence. The firm then fires him.

1. Are Kuznetsov’s actions a breach of his duty of loyalty to his employer?

Solution. No; his actions are appropriate. Standard IV(A) Loyalty tells members to act for the employer and not to harm it, but occasionally protecting clients requires acting against the employer’s interests. By pressuring him to sell overpriced, unsuitable products, the firm was serving itself, not clients, and Kuznetsov was defending clients by alerting the regulator. Making copies of client records to hand to the regulator is a defensible move to safeguard client interests, so it does not count as an improper disclosure here. His whistle-blowing is justified, though he should note that recording conversations without consent is illegal in some jurisdictions; that legal wrinkle aside, reporting the misconduct does not violate the Code and Standards.

Example 16 · Worked

Clemence, CFA, advises more than 400 retail clients at DeLaurier Strategic Advisers, many met through her attorney spouse and physician sister. She leaves for a role focused on research and management, where she will not need to bring clients, and she departs on good terms, handing her supervisor everything needed for a smooth transition. Not all her clients would even qualify at the new firm. On her last day, she pulls down a spreadsheet listing DeLaurier’s current, prospective, and former clients, complete with names, assets, addresses, and phone numbers, and emails it to her personal account, intending only to send a courtesy note thanking clients and reassuring them that DeLaurier will serve them well.

1. Are Clemence’s actions acceptable given her good intentions?

Solution. No. Clemence breaches Standard IV(A) Loyalty by taking the client list for use after she leaves. The list is DeLaurier’s property and holds confidential client information she is now using for her own ends, however well meant. She could instead have sought her employer’s approval to send a farewell note before departing, which would have removed any need to take data at all. Even framed as protecting clients, she worked for DeLaurier, and she took far more than needed, including data on former and prospective clients. She may contact personal friends through personal channels, but she cannot use the firm’s property to do it.

Check yourself

Nickoli, CFA, decides to move from HHI to Vesuvius. In the weeks before she resigns, she tells her HHI clients she is leaving and, when asked why, disparages HHI’s leadership, direction, and treatment of staff. Several clients express interest in Vesuvius. After resigning, she shares their names with Vesuvius and, in the new year, solicits them. Is she in the clear because she waited to solicit until after leaving?

No. Nickoli breaches Standard IV(A) Loyalty. Until her resignation took effect she owed HHI her loyalty, yet she disparaged the firm to its own clients and promoted Vesuvius while still employed. Waiting to formally solicit does not help, because she used her final HHI weeks to identify interested clients and then pursued them. Believing clients are better off with her does not entitle her to harm HHI while representing it; if HHI’s practices truly harmed clients, her route was to resign first, then contact them.

Additional Compensation Arrangements: Standard IV(B)

Members must not accept gifts, benefits, or compensation that competes with, or could reasonably create a conflict with, their employer’s interest, unless they get written consent from all parties.

Check yourself

Estevez, CFA, a senior analyst at boutique research firm BIR, helps choose which micro- and small-cap companies BIR will cover under its issuer-paid research. Some companies offer her a personal bonus if they are selected for coverage. What does she need to do?

Her actions are acceptable only if her employer approves the payments in writing. Standard IV(B) Additional Compensation Arrangements requires written consent for any benefit that could create a conflict with the employer’s interest, and a bonus tied to selection clearly could bias her choices. BIR would also have to disclose to report users that the company paid her and paid for coverage. Issuer-paid research is not automatically unethical, but it demands strict safeguards, and merely avoiding material nonpublic information does not remove the need for disclosure and consent.

Responsibilities of Supervisors: Standard IV(C)

Members who have people under their supervision or authority must take reasonable steps to see that those individuals follow the law and the Code and Standards, which in practice means building and running effective compliance systems.

Example 17 · Worked

Sasha Denikin, CFA, took over Galak Investment Partners from his father, Franz Denikin, CFA, becoming a director; Franz still tells clients he manages all their accounts and keeps absolute control of the firm. When the long-time chief compliance officer (CCO) retires, Sasha is promoted to CCO despite having no compliance experience, with the retiring CCO to mentor him as a consultant. In practice Sasha has no authority to supervise his father, no permission to contact clients or review client communications (Franz insists all client contact runs through him), and no power to enforce policy against Franz. He raises compliance concerns repeatedly, gets nowhere, and eventually resigns in frustration.

1. Do Sasha’s actions violate the Code and Standards?

Solution. Yes. Standard IV(C) Responsibilities of Supervisors expects a supervisor to work at heading off and catching violations by making sure effective compliance systems are in place. If a member cannot carry out supervisory duties because the system is inadequate, the proper step is to decline the role in writing until the firm fixes it. Sasha knew he was unqualified and that the firm’s structure gave him no real authority over his father, yet he accepted the CCO title anyway. As CCO he was responsible for compliance across the firm, including his father’s conduct. Franz’s status as founder does not exempt him from oversight. Resigning eventually does not cure the breach, because Sasha stayed on for a significant period failing to meet his supervisory duties instead of refusing the role until he was trained and empowered.

Check yourself

Duhih, CFA, manages RCG’s Memphis branch, supervising several staff including Lewes, CFA, who works entirely from home with no office access and only occasional check-ins. Unknown to Duhih, Lewes also works for a rival firm and runs a secret commission-splitting scheme through an RCG colleague. Are Duhih’s supervisory actions acceptable?

No. Duhih breaches Standard IV(C). Letting Lewes work with almost no oversight suggests supervision that is minimal and ineffective. A headquarters audit could help but would not substitute for real onsite supervision. And if RCG lacked adequate detection procedures, that is no excuse; Duhih was obliged to flag the shortfall, help fix it, or decline supervisory responsibility until he understood the firm’s policies and expectations.

Standard V covers the analytical craft: doing diligent work with a reasonable basis, communicating clearly with clients about process and limits, and keeping the records that support your advice.

Diligence and Reasonable Basis: Standard V(A)

Members must be diligent, independent, and thorough, and must have a reasonable, well-researched basis for any analysis, recommendation, or action, including when they lean on someone else’s research.

Example 18 · Worked

Corix Bioscience is a startup in cannabidiol (CBD) products. Its CEO brings in Harrel, an independent analyst who is also a CFA Program candidate, to prepare and circulate a research report. The CEO feeds Harrel three claims: that Corix has agreements with indigenous tribes to farm and sell on tribal lands, that it holds a regulator’s certificate of compliance to transport, process, and export industrial hemp, and that last year’s harvest was large and high quality. Harrel prints all of it and issues a positive report. None of it is true: there are no tribal agreements, the certificate is forged, and Corix never grew meaningful quantities. Chong, a CFA charterholder at Nature’s Harvest Investment Management (NHIM), folds Harrel’s conclusions into his own report with a “buy” rating, distributes it to NHIM portfolio managers, and clients suffer heavy losses when Corix is exposed as a sham.

1. Which individuals violated the Code and Standards?

Solution. Both Harrel and Chong violated Standard V(A) Diligence and Reasonable Basis. Harrel simply repeated the CEO’s assertions without any independent check, so he lacked a reasonable basis. Chong then relied on Harrel’s report to justify a “buy” without doing his own verification. Professionals who use third-party research must make reasonable efforts to confirm it is sound; nothing shows Chong checked the facts, critically reviewed the work, or had a track record with Harrel that justified reliance. He also failed to register that Harrel had produced issuer-paid research, the kind that warrants extra scrutiny, and that Harrel, as an independent with no supervising structure, offered no assurance of diligence. NHIM should have had due-diligence procedures for Chong to follow before publishing.

Communication with Clients: Standard V(B)

Members must disclose the nature and costs of their services and the basic process and principles behind their investment approach, promptly flag material changes to that process, disclose significant risks and limits, highlight the factors that matter, and separate fact from opinion.

Check yourself

Dukis, CFA, oversees credit ratings for commercial mortgage-backed securities (CMBSs), where the debt service coverage ratio (DSCR) is a key input. After the global financial crisis, the agency quietly changes how it calculates DSCR for certain securities, and subsequent ratings, published without disclosing the change, come out higher than the old method would have produced. Any violation?

Yes. Dukis breaches Standard V(B) Communication with Clients by not disclosing a change that materially affects the rating process. Investors rely on consistent, transparent methodology to compare ratings and judge how much weight to give them. That the new method may better reflect risk does not excuse the silence, and because the methodology change raised the ratings, DSCR was clearly a key factor whose change had to be disclosed.

Record Retention: Standard V(C)

Members must build and keep the records that support their analyses, recommendations, actions, and client communications.

Check yourself

Duermott, CFA, runs a small firm whose clients are longtime friends. He knows their circumstances intimately, meets them often in and out of the office, and adjusts portfolios as their lives change. Clients complete a profile at account opening, but Duermott updates those profiles only “whenever he finds the time.” Is that acceptable given his close contact?

No. Standard V(C) Record Retention requires appropriate, current records. Updating profiles only when he happens to find time is neither prompt nor regular. Personal familiarity does not substitute for documentation; without current know-your-client records he cannot demonstrate that he identified client needs and reflected them in his advice. When circumstances, goals, risk tolerance, or income needs change, records should be updated promptly and reviewed regularly.

Standard VI is about conflicts: disclose or avoid them, keep client trades ahead of your own, and be transparent about referral compensation.

Avoid or Disclose Conflicts: Standard VI(A)

Members must steer clear of, or else fully and fairly disclose, anything that might reasonably be expected to compromise their independence and objectivity or get in the way of their duties. Any disclosure must be prominent, written in plain language, and genuinely informative.

Check yourself

Reebh, CFA, founder of Lux Asset Management, allocates client money to third-party subadvisers, which his clients know about and approve. The subadvisers pay Lux based on the value of client assets Reebh places with them. He has disclosed the use of subadvisers but not the payments. Is that enough?

No. Standard VI(A) Avoid or Disclose Conflicts requires disclosure of the payment arrangement itself, because being paid on assets placed gives Reebh an incentive to pick subadvisers who pay him rather than those best for clients. He can avoid the conflict by dropping the payment structure; if he keeps it, he must disclose it. Disclosing only that subadvisers are used does not cover the financial arrangement, and this is not a simple referral, since he hires the subadvisers directly on clients’ behalf.

Priority of Transactions: Standard VI(B)

Client and employer transactions must take priority over transactions in which the member is a beneficial owner. Front-running (trading ahead of clients) is the classic breach.

Example 19 · Worked

Yang, CFA, works as a research analyst for Dacco, which is a registered broker/dealer and adviser. While there, he sets up Prestige Trade Investments and acts as adviser to its clients, designing its strategy and directing all its trades. Over several days, in his personal Dacco account, he buys 50,000 Zhongpin shares and 1,978 Zhongpin call options. Shortly afterward he uses $29.8 million of Prestige client funds to buy more than 3 million Zhongpin shares.

1. Do Yang’s actions violate the Code and Standards?

Solution. Yes. Yang is front-running his Prestige clients, violating Standard VI(B) Priority of Transactions, which puts client trades ahead of the member’s own. He buys Zhongpin stock and calls personally before pushing $29.8 million of client money into the same stock, a purchase big enough to move the price in his favour. It does not matter that his personal positions point the same way as his clients’ interests; the problem is the timing, buying for himself first. Nor does it matter whether clients were ultimately harmed by his earlier trades; even the appearance that he could profit at their expense erodes trust in him and in the market.

Example 20 · Worked

Perrkins, CFA, is chief investment officer of GT Financial (GTF), whose compliance officer is his wife. GTF has several dozen retail clients and $70 million under management, all discretionary. Perrkins trades through an omnibus account, buying and selling blocks for many clients at once, and parcels out the fills to individual accounts once the market has closed. Across a single six-month stretch he funnels 75% of the winning trades to nine accounts he or his wife own or control, while dumping 82% of the losing trades onto the accounts of GTF’s three largest clients.

Perrkins’s post-close trade allocation over six months

ETH 10 Application of the Code and Standards: Level I
Trade outcome	Share sent to	Recipient
Profitable trades	75%	Nine accounts Perrkins or wife control
Unprofitable trades	82%	Three largest GTF clients

1. Are Perrkins’s allocation practices acceptable if he discloses them?

Solution. No. By waiting until after the close to allocate, Perrkins can watch each security’s intraday move and hand the winners to accounts he benefits from, violating Standard VI(B) Priority of Transactions. He then buries the losers in clients large enough to absorb them without noticing, which also breaches Standard III(B) Fair Dealing. Disclosing the scheme does not make fraud acceptable, and he cannot favour himself now on a promise to make clients whole later; ethical duties are not a running tally to be settled over time. Members must comply at all times.

Check yourself

Kapadia, CFA, trades equities for a large mutual fund and can time the orders during the day. Before executing, he tips off close friends and relatives about which securities the fund will trade, and they trade ahead of him. He never trades in his own account. Acceptable, since he does not personally profit or share individual client data?

No. Kapadia facilitates front-running by his friends and relatives, breaching Standard VI(B) Priority of Transactions. He benefits personally by enriching people close to him, even without trading himself, and it does not matter whether the fund is financially harmed. Although he does not reveal individual investors’ data, he does leak confidential information about the fund’s own imminent trades.

Referral Fees: Standard VI(C)

Members must disclose, to employers, clients, and prospects as appropriate, any compensation or benefit given or received for recommending products or services.

Check yourself

Kiang, CFA, encourages happy clients to refer friends and family. Each year he throws an elaborate party for clients who referred others, hands out nominal gift cards, and sometimes cuts advisory fees for those whose referrals proved especially lucrative. He makes no separate disclosure about this. Any violation?

Yes. Standard VI(C) Referral Fees requires disclosure of benefits paid for recommending services. The party, gift cards, and fee discounts given specifically for referrals are referral fees that must be disclosed to prospects, and a new client’s later discovery of a discount is not adequate disclosure. It would be fine to reward all clients regardless of referrals, but tying benefits to referrals without disclosure breaches the standard even if he treats clients evenhandedly.

Standard VII protects the CFA Institute and its programs: do nothing to compromise exam integrity, and never misrepresent what membership, the designation, or candidacy actually mean.

Conduct as Participants in CFA Institute Programs: Standard VII(A)

Members and candidates must do nothing that damages the reputation of CFA Institute or of the CFA designation, and nothing that weakens the integrity, validity, or security of the organization’s programs.

Check yourself

Taveras, CFA, teaches a society exam-prep course. At a post-exam celebration, students discuss how hard the exam felt and which curriculum areas surprised them, and Taveras asks about the toughest questions. Which use of this is allowed: telling future students the exam was harder than expected so they should prepare thoroughly, or passing along the specific questions and tested areas?

He may tell future students, in general terms, that past candidates found it tougher than expected and to prepare thoroughly. Standard VII(A) Conduct as Participants in CFA Institute Programs lets candidates discuss their experience in general terms but forbids sharing specific questions or the particular areas tested. So Taveras must not solicit or pass along exam specifics, but encouraging thorough study is fine.

The line on exam discussion

General impressions (“it was hard,” “study everything”) are permissible; specifics (actual questions, which topics appeared) are not. The security of future exams depends on that boundary, so when in doubt, keep it general.

Reference to CFA Institute and the CFA Designation: Standard VII(B)

When they refer to CFA Institute, to membership, to the designation, or to candidacy, members and candidates must not overstate or distort what any of those actually signify.

Example 21 · Worked

Ahmed, newly awarded the CFA designation, has joined a medium-sized hedge fund in a senior analyst role. His boss, Bennett, the founder, earned her charter a decade ago and features it on her business card and marketing. She confides that she has not paid CFA Institute dues for four years and no longer takes part in continuing education, insisting the charter is a permanent credential, no different from a university degree, that can never be taken away. Later, in a meeting with a prospective investor who says he only hires firms with CFA charterholders in senior roles, the investor asks whether everyone on the investment side holds the charter. Bennett answers “Yes,” and Ahmed, who knows her membership has lapsed, says nothing.

1. Did Ahmed, Bennett, or both violate the Code and Standards?

Solution. Both violated the Code and Standards. Under Standard VII(B) Reference to CFA Institute, the designation is not a permanent degree: keeping the right to call yourself a charterholder requires satisfying membership obligations, including paying dues. Bennett’s membership has lapsed, so continuing to present herself as a charterholder to a prospect violates VII(B). Ahmed, knowing this, stays silent while false information is given to an investor, which under Standard I(A) Knowledge of the Law makes him a participant in the misconduct even though he did not speak the words. The better path is for Ahmed to take it up with Bennett directly, urging her either to restore her membership or to walk back the claim; if she will not, he should escalate to compliance and stop taking part in such meetings.

End of lesson.

Back to MODULE 01 — Ethics (Ethical and Professional Standards)

ETH 10 Application of the Code and Standards: Level I

Overview

The Ethical Decision-Making Framework

Professionalism

Knowledge of the Law: Standard I(A)

Independence and Objectivity: Standard I(B)

Misrepresentation: Standard I(C)

Misconduct: Standard I(D)

Competence: Standard I(E)

Integrity of Capital Markets

Material Nonpublic Information: Standard II(A)

Market Manipulation: Standard II(B)

Duties to Clients

Loyalty, Prudence, and Care: Standard III(A)

Fair Dealing: Standard III(B)

Suitability: Standard III(C)

Performance Presentation: Standard III(D)

Preservation of Confidentiality: Standard III(E)

Duties to Employers

Loyalty: Standard IV(A)

Additional Compensation Arrangements: Standard IV(B)

Responsibilities of Supervisors: Standard IV(C)

Investment Analysis, Recommendations, and Actions

Diligence and Reasonable Basis: Standard V(A)

Communication with Clients: Standard V(B)

Record Retention: Standard V(C)

Conflicts of Interest

Avoid or Disclose Conflicts: Standard VI(A)

Priority of Transactions: Standard VI(B)

Referral Fees: Standard VI(C)

Professional Responsibilities as a CFA Member or Candidate

Conduct as Participants in CFA Institute Programs: Standard VII(A)

Reference to CFA Institute and the CFA Designation: Standard VII(B)