Course Content
ETHICS AND TRUST IN THE INVESTMENT PROFESSION
This chapter is covered in Reading 1 of the Study Session 1, of the study material prescribed by the institute. After reading this chapter a student should be able to: a explain ethics; b describe the role of a code of ethics in defining a profession; c describe professions and how they establish trust; d describe the need for high ethical standards in investment management; e explain professionalism in investment management; f identify challenges to ethical behavior; g distinguish between ethical and legal standards; h describe a framework for ethical decision making.
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LOS A: Explain Ethics
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LOS B: Ethics and Professionalism
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LOS C: How Professions Establish Trust
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LOS D and E: Professionalism in Investment Management
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LOS F: Challenges to Ethical Conduct
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LOS G: Ethical and Legal Standards
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LOS H: Framework for Ethical Decision Making
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CODE OF ETHICS AND STANDARDS OF PROFESSIONAL CONDUCT
This chapter is covered in Reading 2 of the Study Session 1, of the study material prescribed by the institute. After reading this chapter a student should be able to: a. describe the structure of the CFA Institute Professional Conduct Program and the process for the enforcement of the Code and Standards; b. state the six components of the Code of Ethics and the seven Standards of Professional Conduct; c. explain the ethical responsibilities required by the Code and Standards, including the sub-sections of each Standard.
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LOS A: Professional Conduct Program
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LOS B: Code of Ethics
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LOS C: Code and Standards
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GUIDANCE FOR STANDARDS I–VII
This chapter is covered in Reading 3 of the Study Session 1, of the study material prescribed by the institute. After reading this chapter a student should be able to: a. demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity; b. distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards; c. recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
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Professionalism – First standard of Professional Conduct
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Integrity of Capital Markets – Second Standard of Professional Conduct
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Duties to Clients – Third Standard of Professional Conduct
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Duties to Employer – Fourth Standard of Professional Conduct
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Investment Analysis, Recommendations, & Actions
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Conflict of Interest
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Responsibility as a CFA Institute Member or CFA Candidate
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INTRODUCTION TO THE GLOBAL INVESTMENT PERFORMANCE STANDARDS (GIPS)
This chapter is covered in Reading 4 of the Study Session 1, of the study material prescribed by the institute. After reading this chapter a student should be able to: a. a explain why the GIPS standards were created, what parties the GIPS standards apply to, and who is served by the standards; b. explain the construction and purpose of composites in performance reporting; c. explain the requirements for verification.
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Why Were GIPS Standards Created?
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Who Can Claim Compliance?
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Who Benefits from Compliance?
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Composites
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Verification
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GLOBAL INVESTMENT PERFORMANCE STANDARDS (GIPS)
This chapter is covered in Reading 5 of the Study Session 1, of the study material prescribed by the institute. After reading this chapter a student should be able to: a. describe the key features of the GIPS standards and the fundamentals of compliance; b. describe the scope of the GIPS standards with respect to an investment firm’s definition and historical performance record; c. explain how the GIPS standards are implemented in countries with existing standards for performance reporting and describe the appropriate response when the GIPS standards and local regulations conflict; d. describe the nine major sections of the GIPS standards.
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Objectives of GIPS
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Overview of GIPS Standards
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Compliance with GIPS
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Recommendations
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Scope of GIPS Standards
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Implementation
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Major Section of GIPS Standards
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Ethical and Professional Standards
About Lesson

A.   Material Nonpublic Information

The members and candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.

A.1. Guidance

a.  Information is said to be material if its disclosure would likely have an impact on the price of the security.
Also, if the reasonable investors would want to know the information before making the investment decision, it will be regarded as material, as it is likely to have an impact on the investor’s decision.

b.  Some of the examples of material information are the announcement of earnings, mergers, and acquisition, change in assets, customer or supplier changes, changes in auditor’s opinion, changes in key staff members or management, bankruptcy, legal proceedings against the company, innovations, and discoveries, etc.

c.  Thus, to test whether the information is material or not one needs to consider the source and likely effect of such information.

     i.  If the source of the information is less reliable, it is less likely to be material.

    ii.  If the effect of the information on the price of the investment is more ambiguous, it is less likely to be material. If the effect of information on the price is unclear, it should not be considered material.

d.  The information continues to remain non-public until it has been made available to the public. If the information has been selectively made available by the corporation to a small group of investors or analysts and not to the public in general, it will still be considered nonpublic.
It is acceptable to possess such information, but acting based on such information is considered unethical.

A.1.1. Mosaic Theory

a.  The analysis of publically available information and analysis of non-material nonpublic information, considered separately, is acceptable as they do not affect the investment decision.

b.  However, the analysis of public information along with an analysis of non-material non-public information may lead to the conclusion that may be material non-public. This would be considered a mosaic.

c.  The conclusions drawn out of the analysis of mosaic information may make a huge impact on the investment decision.

d.  It is acceptable to use mosaic information. However, all the way, while working on such information, the analysts should save the documents and all the research.

A.1.2. Social Media

a.  Not all the information that is available on social media is public. The members and candidates, before using any material information obtained from social media, should verify whether it is publically available from another source as well.

b.  While distributing any information with social media also, one needs to make sure whether the necessary regulatory filings have been made or not.

A.1.3. Using Industry Expert

a.  The industry experts may possess information that is non-public and may have a material impact on the investment decision.

b.  The members and candidates may pay for the expert insight, but not for the confidential information that the expert may have access to.

A.1.4. Investment Research Reports

a.  Some of the analysts have such a record that their reports have the ability to move the markets.

b.  Since these analysts are neither the company insider nor did they use the material nonpublic information; they should not publish the report for the public before sharing the same.

A.2. Recommended Procedures for Compliance

a.  Achieve Public Dissemination: If an analyst receives any information that is material and nonpublic, he should encourage the issuer of such information to make the same public before using it.

b.  Adopt Compliance Procedure: The companies should adopt the compliance procedures to avoid any misuse of material nonpublic information by the employees. To do the same, the firms should have proper procedures, documentation, and review policy for the employee and proprietary trading.

c.  Adopt Disclosure Procedures: The firms should adopt disclosure procedures to ensure that the information is disseminated equitably.

d.  Issue Press Releases: The companies should issue press releases before any important analyst meetings, conference calls, etc., where any important nonpublic information may be expected to be released for the first time.

e.  Firewall Elements: There should be firewall elements within the firms that act as an information barrier for interdepartmental communication, review of employee trading through maintenance of “watch”, “restricted”, or “rumor” list.

f.  Appropriate Interdepartmental Communication: The communication between the two departments within a firm should be appropriately formalized.

g.  Physical Separation of Departments: The different departments and their respective files should have a separate location to avoid leakage and misuse of material nonpublic information.

h.  Prevention of Personnel Overlap: To maintain the firewall, there must be no overlap of personnel between the two departments such as investment banking versus corporate finance, sales, and research, etc.

i.  Personal Trading Limitations: There should be limitations on the personal trading activities by the employees for themselves and the benefit of their family members, to avoid the misuse of material nonpublic information. There should be reporting requirements in place for such trading, and the use of a restricted list.

j.  Record Maintenance: There should be written records of all the communication amongst different departments of the firms.

k.  Proprietary Trading Procedures: There may be proprietary trading procedures such as restrictions on the trade of certain stocks. However, these restrictions will depend on the nature of trading.

l.  Communication to all Employees: There should be compliance policies and guidelines, and training procedures to impart proper communication training to the employees.

B.   Market Manipulation

a.  The members and candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.

b.  Market manipulation lowers the value of the information and lowers the investor’s confidence.

c.  Market manipulation includes:

     i.  dissemination of false or misleading information

    ii.  transactions that deceive or would be likely to mislead the market participants by distorting the price-setting mechanism of the financial instruments

d.  This standard excludes legitimate trading strategies. Here, the intent to manipulate the market is important.

B.1. Information-Based Manipulation

The information-based rumor includes spreading the false rumor to induce trading by others. This may inflate the prices of the stocks and then the same can be dumped at a very high price.

B.2. Transaction-Based Manipulation

a.  Transaction-based manipulation includes involvement in the actions that affect the prices of a security. This may include giving the impression of activity. For example, if I have to give an impression of high volumes of trades of security, I might make simultaneous purchases and sales of the stocks from different accounts.

b.  Transaction-based manipulation may also include securing a dominant position in a financial asset to exploit and manipulate the price of a related derivative (also called cornering).

 

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