An Introduction to Standard I: Professionalism | CFA Level I Ethics
Let’s dive into Standard I: Professionalism, which consists of four sub-sections:
1A. Knowledge of the Law
Members and Candidates must:
- Understand and comply with all applicable laws, rules, and regulations governing their professional activities, including the CFA Institute Code of Ethics and Standards of Professional Conduct.
- Comply with the strictest law or regulation in case of conflicts.
- Avoid knowingly participating in, assisting, or ignoring any violations.
To adhere to this standard, you should:
- Encourage your employer to establish procedures to keep employees informed of changes in relevant laws, rules, and regulations.
- Consult your supervisor, compliance personnel, or a lawyer if in doubt about any legal issues.
- Report known violations to your supervisor or compliance department, and dissociate from the activity if they cannot remedy the situation.
- Consider resigning if you cannot dissociate from a violating activity.
Application (Dissociating from a Violation):
Chris Thompson works for an investment advisory firm that focuses on sustainable investments. Chris discovers that one of the funds the firm promotes as being environmentally friendly has significant holdings in companies known for their negative environmental impact. The promotional materials for the fund do not disclose this information, potentially misleading clients about the fund’s sustainability practices. Chris is asked to present this fund to potential clients as part of his responsibilities.
Comment: Misrepresenting the true nature of a fund is a violation of the Code and Standards. Although Chris did not create the promotional materials himself, he would be assisting in violating Standard I(A) if he were to promote the fund without disclosing its holdings in environmentally harmful companies. Chris should address the issue with the person responsible for the fund or bring the matter to the attention of his supervisor or the compliance department at his firm. If the firm refuses to correct the promotional materials, Chris should dissociate himself from the activity by refusing to present the fund to potential clients and informing the firm of his reasons. If the firm insists on promoting the fund without full disclosure, Chris may need to consider seeking other employment.
Application (Following the Highest Requirements):
Emma Johnson works as a portfolio manager for a global investment management firm based in the United Kingdom. She is responsible for managing portfolios of clients located in various countries with different securities laws and regulations. One of her clients is from a country with strict insider trading laws, even more stringent than the UK and the Code and Standards. Emma comes across material non-public information about a company in her client’s portfolio. She believes that trading on this information would be legal according to UK law and the Code and Standards, but not according to the client’s home country’s regulations.
Comment: Emma is in violation of Standard I(A) if she decides to trade on the material non-public information for her client. As a portfolio manager dealing with international clients, she must be aware of and adhere to the securities laws and regulations of her clients’ home countries. In this case, she should follow the stricter requirements of the client’s home country rather than the requirements of the UK law or the Code and Standards. By not trading on the material non-public information, she would be complying with the highest ethical requirements and upholding her professional integrity.
1B. Independence and Objectivity
Members and Candidates must:
- Exercise reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities.
- Refrain from offering, soliciting, or accepting any gift, benefit, compensation, or consideration that could reasonably be expected to compromise their own or another’s independence and objectivity.
Maintaining independence and objectivity is crucial because biased work or recommendations can disadvantage clients. Some contexts where independence and objectivity are important include:
- Sell-side and buy-side: Sell-side analysts should resist pressures to issue biased ratings or research, while buy-side managers should avoid offering gifts or special compensation that could affect the objectivity of others.
- Issuer-paid research: Compensation should be fixed-rate and not dependent on the outcome of the report. Avoid accepting client accommodation and travel reimbursements unless commercial options are unavailable.
- Asset management: Do not solicit or accept gifts or compensation that can affect your objectivity when selecting investment managers or funds for clients.
- Gifts: Token gifts are usually acceptable, but firms should define a monetary value threshold for acceptable gifts and require employees to declare them. Gifts from clients in a client-advisor relationship are generally acceptable but should also be declared to the employer.
Firms should establish clear policies on independence and objectivity, appoint a compliance officer, and have procedures for reporting violations.
Application (Research Independence and Company Pressure):
David Martinez is an analyst covering the technology sector for a prominent investment research firm. He has been closely monitoring a popular tech company that has recently faced several negative news stories. Despite the negative press, Martinez’s analysis concludes that the company’s fundamentals are still strong, and he maintains a positive outlook on the stock. However, the company’s management contacts Martinez and requests that he publish a more cautious report, fearing that his current positive stance may lead to unrealistic expectations among investors.
Comment: Martinez must remain independent and objective in his analysis of the tech company, even when facing external pressure from the company itself. He should not alter his research report based on the company’s request, but should instead base his conclusions on his own analysis of the company’s fundamentals and prospects. If Martinez believes that his research is accurate and justified, he should maintain his positive outlook on the stock, regardless of the company’s request.
Application (Research Independence and Gift Influence):
Sophia Kim is a pharmaceutical analyst who is responsible for covering several companies within the industry. One of the companies she covers recently invited her to an all-expenses-paid conference at a luxury resort as a token of appreciation for her coverage. The conference, while featuring some industry presentations, is primarily a leisure event. Sophia is aware that she will be releasing a research report on the company shortly after the conference, and she is concerned that accepting the invitation might compromise her objectivity.
Comment: To maintain research independence and avoid potential conflicts of interest, Sophia should not accept the invitation to the luxury conference. Attending an event like this, especially when it is primarily a leisure event and paid for by the company she covers, could create the perception of bias or influence over her research. Instead, Sophia should continue to base her research and recommendations on the objective analysis of the pharmaceutical company’s fundamentals and prospects, without the potential influence of gifts or other incentives.
1C. Misrepresentation
Members and Candidates must avoid making misrepresentations in regards to their investment analysis, recommendations, actions, or any other professional undertakings.
Here are some key points:
- Claiming ignorance isn’t an excuse if you should’ve known about a misrepresentation in your profession.
- Misrepresentation isn’t just about false data, but also omitting important information.
- Electronic communications, including social media, must adhere to the same standards as formal publications.
- Guaranteeing specific returns on risky investments is a violation.
- Plagiarism is a major violation – always credit your sources.
Firms should publish summaries of employee qualifications and periodically review documents for misrepresentation. They should also retain the rights to work produced by employees.
Example 10 (Selective Disclosure of Performance):
Samantha Johnson is the portfolio manager for a boutique investment firm that offers a range of funds to clients. Over the past year, two of the firm’s funds significantly outperformed their benchmarks, while the other three funds underperformed. In a presentation to prospective clients, Johnson highlights only the two outperforming funds and omits any mention of the underperforming funds.
Comment: By selectively disclosing the performance of only the outperforming funds, Johnson is misrepresenting her firm’s overall performance and potentially misleading prospective clients. To comply with Standard I(C), Johnson should provide a balanced and accurate representation of the firm’s performance, including both the positive and negative results. Selectively showcasing only successful funds could create unrealistic expectations among potential clients about the firm’s overall performance and capabilities.
Example 11 (Misleading Comparison with Benchmarks):
Oliver Smith is an investment manager at a wealth management firm. He recently developed a new investment strategy focused on sustainable investing. To attract clients to the new strategy, Smith compares the performance of the sustainable investment portfolio to a well-known benchmark index that consists of traditional investments rather than a more appropriate sustainable investment index. As a result, the sustainable investment portfolio appears to significantly outperform the benchmark index.
Comment: By comparing the performance of the sustainable investment portfolio to an inappropriate benchmark, Smith is misrepresenting the true performance of the investment strategy and potentially misleading clients. To comply with Standard I(C), Smith should use a more appropriate benchmark that accurately reflects the nature and objectives of the sustainable investment portfolio. This would provide a fair and accurate comparison, helping clients to make informed decisions based on the actual performance and risk characteristics of the investment strategy.
Standard 1D: Misconduct
It is prohibited for Members and Candidates to carry out any professional activities that entail dishonesty, fraud, deception, or any behavior that casts a negative light on their professional image, integrity, or skills.
- This standard acts as a catch-all for behaviors that may not be illegal but are unprofessional.
- Firms should publish a code of ethics and provide employees with a list of potential violations and punishments.
- Even the absence of appropriate conduct can be a violation.
- Appropriate disciplinary measures are in place to address misuse of the Code and Standards.
Application (Misuse of Company Resources):
David Thompson is a portfolio manager at a well-respected investment management firm. He regularly uses his work computer and email account to manage his personal investment portfolio, communicate with brokers about personal transactions, and conduct research on investment opportunities unrelated to his clients’ portfolios. This personal use of company resources takes up a significant amount of his work time, which could otherwise be spent on managing his clients’ investments.
Comment: Thompson’s misuse of company resources for personal benefit violates Standard I(D) because it adversely reflects on his professionalism and competence. His behavior demonstrates a lack of dedication to his clients’ interests and could raise concerns about his commitment to fulfilling his professional responsibilities. To comply with Standard I(D), Thompson should limit his personal investment activities to his personal time and resources, ensuring that his professional responsibilities to clients remain his top priority.
That’s a wrap on Standard I! Make sure to check out the case studies in the CFA curriculum text for a better understanding of the scenarios you might encounter in the exam. See you at Standard II!
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