Cfa L1 Session01

Study Session 1 Ethical and ProIessional Standards
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Study Session 1
Code of Ethics

A. The Code of Ethics.
A. 1he candidate should be able to state the four components of the Code of Ethics.

Members oI AIMR shall:
Act with integrity, competence, dignity, and ethics when dealing with the public,
clients, prospects, employers, employees, and Iellow members.
Practice and encourage others to practice in a proIessional and ethical manner:
serve your clients well.
Maintain and improve the competence oI themselves and Iellow members.
Use reasonable care (as iI it were your own business) and exercise independent
(make your own judgment, regardless oI what others say) proIessional judgment:

"Members" include AIMR members, CFA charterholders, and CFA candidates.
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B. Standard I: Fundamental Responsibilities

A. Maintain knowledge of and comply with all applicable laws, rules, and
regulations (including AIMR's Code of Ethics and Standards of Professional
Conduct).

A. Know and comply with all applicable laws, rules, regulations
In general, members in all countries should comply at all time with the Code and
Standards. Since laws in diIIerent countries may establish diIIerent standards, the rule
oI thumb is to choose the stricter regulations:
II the law is tougher than the Code and Standards, adhere to the laws.
II there are no laws, or iI the Code and Standards are tougher, adhere to the Code
and Standards.
II a member lives or works in a Ioreign country, or works Ior Ioreign Iirms outside
oI his/her own country, he/she should comply with the strictest oI his/her country's
law, the Ioreign country's law, and the Code and Standards.

Members should acquire and maintain knowledge on laws and regulations by:
maintaining current Iiles on statutes.
keeping inIormed oI latest statutes.
reviewing written compliance procedures regularly.

Example: You are working in Ioreign oIIice oI your U.S.-based Iirm. Analysts in this
Ioreign country routinely solicit inside inIormation and use it as the basis Ior trading
decisions. You are told that this is not illegal in this country. In this case, the Code and
Standards are stricter. They prohibit use oI material, non-public inIormation. You
should reIrain Irom trading on the basis oI the Ioreign inIormation.

B. Don't participate or assist in violations

Don't knowingly break or help others break laws. II a member:

Ieels that a standard/law has been violated (i.e. receiving inIormation
contradictory to a registration statement), he/she should seek advice oI the Iirm's
counsel. II the member believes that the counsel iI both competent and unbiased
and he/she Iollows the counsel's advice, there is no violation.

knows that a standard/law has been violated (i.e. discovering that a client has
knowingly misstated inIormation on a prospectus), he/she should report the
incident to the appropriate supervisory person in the Iirm. II the situation is not
remedied, the analyst should disassociate Irom the situation. He/she may also seek
legal advice to see iI other actions should be taken.

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Example: An associate is engaging in illegal trading practices. He tells you to reIrain
Irom disclosing this because it will make the Iirm look bad and it is highly proIitable.
You should choose one oI the three actions above. II you seek legal counsel and are
told that the activity is actually not illegal, you have covered your obligation. This
assumes that you believe the legal counsel to be competent. II you report this to your
supervisor and are told to ignore it, you should take steps to disassociate yourselI
Irom the practice.

B. Aot knowingly participate in or assist any violation of such laws, rules, or
regulations.

Check A Ior an explanation.

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C. Standard II: Relationships with and Responsibilities to the
Profession

A. Use of Professional Designation.

Summary
Members should reIerence membership in a digniIied and judicious manner: iI
necessary, with an accurate explanation oI the requirements Ior obtaining the
membership.

CFA charterholders may use the marks "Chartered Financial Analyst" or "CFA" in
a proper, digniIied, and judicious manner: again, iI necessary, with an accurate
explanation oI the requirements Ior obtaining the right to use the designation.

CFA candidates may reIerence their participation in the CFA Program, but the
reIerence must clearly state that an individual is a CFA candidate and cannot
imply that the candidate has achieved any type oI partial designation.

Requirements to be granted the right to use the CFA or Chartered Financial Analyst
designation:
passed all three levels oI the CFA program.
received the charters.
makes an ongoing commitment to abide by the requirements oI AIMR's
ProIessional Conduct Program (including Iiling an annual proIessional conduct
statement).
due-paying (every year) charterholders in good standing.

Failure to meet any one oI these requirements will lead to the suspension oI the right
to use the CFA designation.

About the CFA mark:
It is registered in several countries (along with Chartered Financial Analyst).
It does not serve as an acronym, cannot be used as an noun, and should never be
used in the plural or the possessive.
Only CFA or Chartered Financial Analyst should appear aIter the charterholder's
name.

CFA Candidates:
To be a candidate, a person's application should have been accepted, and he /she
should be enrolled to sit Ior a speciIied exam (Ior which he / she has not received
exam results or Iailed to sit Ior the exam).
There is no designation Ior someone who has passed Level I, II or III oI the CFA
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examinations.
Candidates may indicate that they have completed Level I, II or III oI the CFA
program. However, candidates cannot imply that they have achieved partial
designation even iI they have passed all three levels oI the exam

Applications:
Advertisements: cannot mention that an individual has passed all three exams on
the Iirst try, or an individual has accomplished what Iew others have done, or the
designation implies superior perIormance capabilities.
Placing "CFA Level II Candidate" aIter candidate's name imply that it's a partial
designation, which is a violation oI II A.
The designation CFA - cannot be listed in a type set larger than that used Ior the
charterholder's name.
e.g. Richard is a CFA (or Chartered Financial Analyst) -- WRONG!
Richard is a CFA charterholder. He earned the right to use the Chartered Financial
Analyst designation. -- CORRECT!

B. Professional Misconduct.

Summary
Members shall not engage in any proIessional conduct involving dishonesty, Iraud,
deceit, or misrepresentation or commit any act that reIlects adversely on their
(personal) honesty, trustworthiness, or proIessional competence.
Members and candidates shall not compromise the integrity oI the CFA
designation, or the integrity or validity oI the CFA examinations.

Violations include:
Felony convictions or crime - more than 1 year in prison.
Misdemeanors - whether or not the oIIence relates to your proIessional activities
or they do not result in criminal convictions: lying, cheating, stealing, minor drug
related oIIenses, etc).
Poor personal behaviors: excessive lunch time, intoxication at work, etc.
Unprosecuted misdemeanors involving dishonesty, Iraud or misrepresentation:
altering receipts, taking kickbacks, etc.
ReIlecting negatively on proIessional competence.

Compliance:
Make clear that any personal behavior that reIlects poorly on the individual
involved, the institution as a whole, or the investment industry will not be
tolerated.
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Adopt a code oI ethics to which every employee must subscribe.
Conduct background checks on potential employees to ensure that they are oI
good character and not ineligible to work in the investment industry because oI
past inIractions oI the law.

Example: An investment advisor executes excessive trading volume to generate Iees
Ior himselI. He tells clients that the high level oI trading in their discretionary
accounts is needed to maintain proper diversiIication. II this statement is
misrepresentative, the advisor is clearly engaging in proIessional misconduct.

Example: A portIolio manager has three martinis at lunch and returns to the oIIice to
resume his regular activities. II the manager's judgment is impaired and he is
engaging in investment decision-making activities, he is in violation oI this Standard.

C. Prohibition against Plagiarism.

Summary
Members shall not copy or use other's material in substantially the same Iorm as
the original without acknowledgement. Members may use, without
acknowledgment, Iactual inIormation published by recognized Iinancial and
statistical reporting services.

Note:
The member should always attribute quotations, projections, data, model/product
idea, methodologies to their sources/authors.
The standard applies to written materials, oral communications, visits with clients,
use oI audio/video media, and electronic data transIer.
The member can use recognized sources (S&P, Moody's) oI Iactual inIormation
(inIormation that is already in the public realm) without acknowledgement.
The situation also depends on whom the member is representing: the member is
not required to attribute ideas, methodologies etc., developed by people within
your Iirm, when speaking with clients and prospects.
The member is should keep copies oI materials that were used in preparing
research reports.

In ethical terms, a Iinancial analyst indulging in plagiarism does not conduct himselI
with integrity. By plagiarizing, the analyst is not only stealing the ideas oI others, but
is also exposing himselI to violations oI Standards IV by making recommendations
that may not have a reasonable basis and may not avoid material misrepresentations.

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Compliance Procedures:
Maintain copies oI materials relied on in preparing research reports.
Attribute quotations other than recognized Iinancial and statistical reporting
services.
Attribute summaries oI material prepared by others.

Some examples oI violations iI a member:
uses excerpts Irom reports done by others without acknowledgement.
cites quotes attributable to "leading analysts" and "investment expert" without
speciIic reIerence.
uses charts and graphs without stating sources.
presents a Iirm's own research in an expert witness situation without attribute the
research to its speciIic source.
presents a Iirm's own research to clients/prospects/general public: NOT a violation
as the member does not need to attribute the source speciIically in this case.

Example 1: An analyst is working late to complete an evaluation oI a biotechnology
Iirm. She Iinds another analyst's report which provides detail supporting her general
opinion oI the Iirm. She includes these details and slightly edits the conclusion oI the
report to include in her own. The analyst has violated this Standard by not recognizing
the source oI her analysis. II she provides attribution to the original analyst, she
should be OK.

Example 2: An analyst includes inIormation regarding historical interest rates
collected Irom a Federal Reserve website. He uses this inIormation as part oI a report
without attribution. II the source is considered well recognized and the inIormation is
purely Iactual, then this is not a problem.
.
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D.Standard III: Relationships with and Responsibilities to the
Employer

A. Obligation to Inform Employer of Code and Standards.

Summary
Members shall inIorm their employer in writing, through their direct supervisor,
that they are obligated to comply with the Code and Standards and they are
subject to disciplinary sanctions Ior violations thereoI.
Deliver a copy oI the Code and Standards to their employer iI the employer does
not have a copy.

DeIinition oI Employee: someone in the service oI another who has the power to
control and direct the employee in the details oI how work is to be done. An employee
is not a contractor, whom you cannot control the details oI how the contractor does
the job. Employment relationship does not require written or implied contract, or
actual receipt oI monetary compensation.

Note:
NotiIication must be 'in writing (any Iorm oI communication that can be
documented, even email).
'Employer reIers to 'immediate supervisor.
II the employer has publiclv acknowledged, in writing, the adoption oI the AIMR
standards, the employee does NOT need to deliver a copy, but still need to inIorm
the employer.

Example: You have recently completed your CFA Level III examination and are now
a CFA charterholder. You work Ior an investment management Iirm as a junior equity
analyst. You are about to inIorm your manager oI your new obligations when a
colleague, also a CFA charterholder, says not to bother. Your supervisor already
knows. You still need to inIorm your supervisor in writing. You should not assume
that your manager is aware oI his obligation to comply with the Code and Standards.
II it is unlikely that the supervisor is Iamiliar with the Code and Standards, you must
provide him with a copy.

B. Duty to Employer.

Summary
Members shall not undertake any independent practice that could result in
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compensation or other beneIit in competition with their employer unless they
obtain written consent Irom both their employer and their clients.
"Practice" means any service that the employer currently makes available Ior a
Iee.

You are required to:
Provide a written statement to your employer iI you plan to engage in independent
practice, describing the types oI services, the expected duration, and the
compensation.
Provide a written statement to your prospective client about the identity oI your
employer, what the employer would charge Ior similar services, and the Iact that
you are working independently oI your employer.

You can:
make preparations (but not undertaking competitive business) to begin a
competitive business as a departing employee, provided that the preparations do
not breach the employee's duty oI loyalty.
be exempt Irom the standard iI you are an independent contractor.

Violations:
You get a new job. BeIore leaving your current job, you solicit your employer's
clients (Ior both current and potential client, BUT soliciting rejected client is NOT
a violation).
Misuse oI conIidential inIormation or misappropriation oI trade secrets: take home
client lists, investment statements, marketing presentations and buy lists.
Provide consulting services on your own time: you must get written consent Irom
both the employer and the client.
Copy your employer's computer models and other property.
Solicitation oI the employer's clients prior to termination oI employment.
Encourage your colleagues to leave your employer to join your new company.

Example: You agree to serve as an investment advisor to a non-proIit institution run
by a Iriend. Your Iirm provides similar services but you elect to do this on your own
Ior a very modest Iee. Even iI no Iee was involved, you are obliged to obtain written
consent Irom your employer and your Iriend's organization.

Example: An independent investment advisor is hired by a brokerage Iirm. However
she wants to keep the existing clients Ior herselI. In this case she must get the
employer's written consent and disclose the new employment to the old clients.

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C. Disclosure of Conflicts to Employer.

Summary
Disclose to their employer all matters, including beneIicial ownership oI securities
or other investments, that reasonably could be expected to interIere with their duty
to their employer or ability to make unbiased and objective recommendations.
Comply with any prohibitions on activities imposed by their employer iI a conIlict
oI interest exists.

Report any beneIicial interest (ownership oI securities), corporate directorships,
trusteeships and any special relationships to your employer.
Discuss any action involving conIlict oI interest with your Iirm's compliance
oIIicer.

Many Iirms restrict employees' investment activities to avoid conIlicts oI interest. You
are NOT required to desist Irom personal trading and board memberships, iI your
employer allows them.

Compliance Procedures:
Report to employers any beneIicial interest and special relationships (e.g.
corporate directorships) that may be considered conIlict oI interest.
Discuss with compliance oIIicer or supervisor beIore taking any actions that could
lead to such conIlict.

Example: You come Irom a wealthy Iamily that made much oI its Iortune in the
automotive industry. You and your Iamily still have a considerable position in several
stocks in the industry. You are employed as an industry analyst in the automotive
sector. You are obliged to disclose your beneIicial ownership to your employer.

Example: Mark makes personal trades without compliance with the Iirm's prohibition
as the Iirm has no intention oI trading these stocks, and Mark does not cover that
particular industry within the Iirm. Mark violates the standards Ior ignoring the Iirm's
trading prohibitions. He should realize that the Iirm's policy is designed to prevent
material conIlict oI interest and appearance oI conIlict.

Example: John acts as a trustee Ior another company. However he's not disclosed his
involvement to his employer. He violates the standards as III(C) prohibits a member's
conIlicts oI interest that might be detrimental to the employer's business: being a
trustee can be time-consuming, and thus detrimental to the Iirm.

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D. Disclosure of Additional Compensation Arrangements.

Summary
Members shall disclose to their employer in writing all monetary compensation or
other beneIits that they receive Ior their services that are in addition to
compensation or beneIits conIerred by a member's employer.

Outside compensation/beneIits may aIIect loyalties and objectivity, and create
potential conIlicts oI interest. They include direct compensations Irom clients, and
indirect compensations or other beneIits Irom third parties.

Procedures for Compliance

Members should make an immediate written report to their employer speciIying any
compensation they receive or propose to receive Ior services in addition to
compensation or beneIits received Irom their primary employer. This written report
should state the terms oI any oral or written agreement under which a member will
receive additional compensation; terms include the Iollowing:
nature oI the compensation
amount oI compensation
duration oI the agreement

Note: accepting giIts is allowed, but you must inIorm your employer in writing beIore
accepting.

Applications:
In an attempt to increase portIolio perIormance a Iirm's client oIIers the portIolio
manager an incentive, such as a Iree vacation... a conIlict oI interest exists. The
portIolio manager must inIorm the Iirm beIore accepting the arrangement.

Example: One oI your Iirm's clients manages a ski resort in Colorado. She has told
you that as long as you are managing her assets, you are entitled to complimentary liIt
tickets at the resort. To be in compliance with this Standard, you must report this in
writing to your employer. The employer will want to ensure that this client receives
no special consideration as a result oI the arrangement.

E. Responsibilities of Supervisors.

Summary
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Members with supervisory responsibility shall exercise reasonable supervision
over those subject to their supervision to prevent any violation oI applicable
statutes, regulations, or provisions oI the Code and Standards. In so doing,
members are entitled to rely on reasonable procedures to detect and prevent such
violations.


A supervisor complies with Standard III (E) by identiIying situations in which legal
violations or violation oI the Code and Standards are likely to occur and establishing
and enIorcing compliance procedures to prevent such violations. Adequate
compliance procedures should provide Ior the Iollowing:
Be draIted so that the procedures are easy to understand.
Designate a compliance oIIicer and clearly deIine the oIIicer's authority and
responsibility.
Outline the scope oI the procedures.
Outline permissible conduct.
Delineate procedure Ior reporting violations and sanctions.

Once a compliance program is in place, a supervisor should take the Iollowing
actions:
Disseminate the contents oI the program to appropriate personnel.
Periodically update procedures to ensure that the measures are adequate under the
law.
Continually educate personnel regarding the compliance procedures.
Issue periodic reminders oI the procedures to appropriate personnel.
Incorporate a proIessional conduct evaluation as part oI the employee's
perIormance review.
Review the actions oI employees to ensure compliance and identiIy violators.
Take the necessary steps to enIorce the procedures once a violation has occurred.

Once a violation is discovered, a supervisor should take the Iollowing actions:
Respond promptly.
Conduct a thorough investigation oI the activities to determine the scope oI the
wrongdoing.
Increase supervision or place appropriate limitations on the wrongdoer pending
the outcome oI the investigation.

II a supervisory member was unable to detect violations, he may not violate III(E) iI
he takes steps to institute an eIIective compliance program, AND he adopts
reasonable procedures to prevent and identiIy violations.

Applications:
The presence oI a compliance policy manual and compliance dept, do not remove
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your supervisory responsibilities.

Example: A supervisor in an investment management Iirm concludes that since all
Iive equity analysts working Ior her are CFA charterholders, she can trust them to
reIrain Irom violations oI laws, regulations, and the Code and Standards. While she
can trust them to reIrain Irom such violations, this does not constitute reasonable
supervision.

Example: You are oIIered promotion to supervise all investment managers involved in
discretionary trading. You are told that there have been instances oI improper trading
in some accounts and that at least one manager is likely perIorming additional
investment services Ior several oI his clients. However, the operation is highly
proIitable so senior management has no immediate concern regarding these issues.
You are responsible Ior prevention oI violations oI the Code and Standards. II there
are known violations and little or no control over the investment process, you should
decline the supervisory position until reasonable procedures can be established.

Example: A supervisor returns Irom a two week vacation to Iind that one oI his
brokers has been making personal trades in advance oI the release oI analysts' reports
to clients. II there are established reporting processes to monitor employee trading and
a reasonable eIIort is made to evaluate the appropriateness oI trades, then the
supervisor has not violated the Standard. However, iI there is no reasonable
monitoring process, the supervisor has violated the Standard.

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E. Standard IV: Relationships with and Responsibilities to Clients
and Prospects

A. Reasonable Basis and Representations.

Summary
Exercise diligence and thoroughness in making investment recommendations or in
taking investment actions.
Have a reasonable and adequate basis, supported by appropriate research and
investigation, Ior such recommendations or actions.
Make reasonable and diligent eIIorts to avoid any material misrepresentation in
any research report or investment recommendation.
Maintain appropriate records to support the reasonableness oI such
recommendations or actions.

Example: You are very excited about a small, high-tech Iirm that is developing a new
method oI making internet connections more eIIicient. You advise your clients to buy
this security and tell them that a Iull report will be available shortly. Your
recommendation is neither diligent nor thorough. You have not provided reasonable
basis Ior the recommendation. It is impossible to distinguish between Iact and opinion
without Iurther inIormation.


Members can comply with Standard IV (A.1) by addressing the Iollowing areas:

Analyze basic characteristics. BeIore recommending a speciIic investment or
investment discipline to a broad client group, a member should investigate the
investment's basic characteristics. Furthermore, written records should indicate the
characteristics (Ior example, quality ratings, terms such as "businessman's risk" or
"speculative issue") and the basis Ior the recommendations (quantitative,
Iundamental, technical, etc.). A research report can serve as a record oI the
Iindings that support conclusions about a particular issue or group oI securities.
With respect to a quantitative investment discipline, the process should be
illustrated in thorough detail, and any applicable back-testing date should be made
available Ior inspection or review.

Analyze portIolio needs. A member has the obligation to analyze clients'
investment needs as well as the basic characteristics oI investments. The analysis
oI a client's needs and circumstances is a continuing responsibility. The basic
characteristics oI the entire portIolio will largely determine whether client Iactors
are being served. Thus, the Iocus should be on the characteristics oI the total
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portIolio rather than an issue-by-issue review.

At the outset oI the relationship, the portIolio manager and client should develop a
statement oI investment objectives, and they should review this statement
periodically (annually and when a major change in client circumstances occurs).
These objectives should be set Iorth in writing. Each recommendation or
transaction should be made in view oI the client objectives and the basic
characteristics oI the investment to be bought or sold.

Maintain Iiles. A member should maintain Iiles to support investment
recommendations. In addition to Iurnishing excellent reIerence materials Ior
Iuture work, research Iiles play a key role in justiIying investment decisions under
later scrutiny. Files can serve as the ultimate prooI that recommendations and
actions, good or bad, were made based on the same methodology that drove the
analyst's decisions.

II recommendations are based on a report Irom an outside source, the member
should keep a copy oI the report. II the member undertakes original research, the
member should include details oI where the necessary data were obtained and
include enough inIormation about the analytical method to allow the process to be
reconstructed. In the case oI Iundamental research, the member should keep
company-published data, industry data, and records oI all management contracts.
Records and Iiles may be kept on paper or in electronic Iorm. II kept in electronic
Iorm, members should maintain adequate backup.

Applications:

A quantitative analyst recommends an out-oI-Iavor stock based on analysis oI
its 3-year records: the recommendation is not based on through quantitative
work. A longer time period should be covered.

Because oI restrictions Irom the Iirm's executives, an analyst cannot obtain the
inIormation necessary to perIorm analysis: the analyst must let the client know
when he/she is "conIlicted" or "restricted".

Because oI lacking suIIicient research resources, an analyst decides to estimate
the IPO prices based on the relative size oI each company, and justiIy the
pricing later when she has time: her analysis is not based on thorough research
with reasonable basis. She should take on the work only when she could
adequately handle.

An investment banker presses the securities issuer to project the maximum
production level. He then uses these numbers as the base-case production
levels during sales pitches: he misrepresents the chances oI achieving that
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production level. He should have given a range oI production scenarios during
the pitch.

A client requests to change his investment strategy Irom investing in
North-American blue chips to emphasizing countries with high economic
growth rates. The portIolio manager should explain the potential risks and
returns to the client, and ask her to consider them beIore changing the
investment strategy.

An analyst recommends purchasing what the market in general has christened
as "hot" stocks without Iurther research: conventional wisdom oI the markets
does not Iorm a reasonable and adequate basis.

B. Research Reports.

Summary
Use reasonable fudgment regarding the inclusion or exclusion oI relevant Iactors
in research reports.
Distinguish between facts and opinions in research reports.
Indicate the basic characteristics of the investment involved when preparing Ior
public distribution a research report that is not directly related to a speciIic
portIolio or client.

A report can be given in many Iorms: written report, in-person communication,
telephone conversation, media broadcast, and transmission by computer (e.g. on the
Internet).

Opinions should be distinguished clearly Irom Iacts:
Past should be separated Irom Iuture. Past represents Iacts, while Iorecast on
Iuture represents opinions.
In the case oI quantitative analysis, Iacts should be separated Irom statistical
conjecture.


The selection oI relevant Iactors is an analytical skill, and determination oI
whether a member is in compliance depends heavily on case-by-case review. To
assist the aIter-the-Iact review oI a report, the member must maintain records
indicating the nature oI the research and should, iI asked, be able to supply
additional inIormation to the client (or any user oI the report) covering Iactors not
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included.

Members must take reasonable steps to assure themselves oI the reliability,
accuracy, and appropriateness oI the data included in each report. II the data has
been processed in any way (e.g., into Iinancial ratios), a member should ascertain
that such processing has been done in a manner consistent with the member's
analytical purposes.

Acknowledgment oI the source(s) should be made when appropriate.

Regulatory agencies, selI-regulating organizations, and exchanges have speciIic
requirements relating to research reports that members should review and satisIy.
Most Iirms have developed written compliance procedures incorporating these
requirements and other matters deemed desirable. Members are strongly urged to
encourage their Iirms to develop such procedures iI they do not have them in place.

Applications:

To simpliIy his report, an analyst leaves out details oI the valuation models: he
violates IV(A2) because clients need to Iully understand the analyst's process and
logic in order to implement the recommendation.

An analyst issues a "buy" recommendation on a stock, mainly based on his
optimistic assessment oI the company's operation. He violates IV(A2) by Iailing
to distinguish between opinions Irom Iacts: his optimistic assessment about the
company is just his own opinion.

An analyst issues a report promoting the Iirm's new investment strategy. The
report stresses the likelihood oI high returns. However, it does not describe the
strategy in detail. He violates IV(A2) because his report Iails to describe properly
the basic characteristics oI the investment strategy.

Members should consider including the Iollowing inIormation in research reports:
Expected annual rate oI return, taking into account cash Ilows and expected price
changes during the holding period;
Annual amount oI income expected (current and Iuture);
Current rate oI income return or yield to maturity;
Degree oI uncertainty associated with the cash Ilows;
Degree oI marketability/liquidity;
Business, Iinancial, political, sovereign, and market risks.

The Iollowing checklist provides basic investigative steps and inIormation appropriate
Ior a Iundamental company analysis. This checklist is provided Ior illustrative
purposes only and is not intended to be all-inclusive.
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Macroeconomic Iactor - Domestic/international Iiscal and/or monetary policies,
exchange rates, and business conditions.
Industry Consideration - Historical/projected growth, nature oI competition,
regulatory environments, capital requirements, methods oI distribution, etc.
Position in the industry - Strengths/weaknesses, based on input Irom management,
competitors and trade sources.
Income statement and statement oI cash Ilows - Review Ior two business cycles
and analyze reasons Ior changes in volume/price changes, operating margins,
eIIective tax rates, capital requirements, and working capital.
Balance sheet - Analyze reasons Ior historical/prospective changes in Iinancial
condition and capital structure.
Accounting policies - Determine compliance, policies and examine the auditor's
opinion.
Management - Evaluate reputations, experience and stability. Also, evaluate the
records and policies toward corporate governance, acquisitions and divestitures,
personnel (including labor relations) and governmental relations.
Facilities/programs - Review plant networks, competitive eIIectiveness, capacity,
Iuture plans, and capital spending.

Also consider the Iollowing:
Dividend record and policy;
Research/new products;
Marketing/distribution; Nature oI security; Security price record.
Future outlook - Examine principal determinants oI company operating and
Iinancial perIormance, major risks, and goals and reasonableness oI same.

C. Independence and Objectivity.

Summary
Members shall use reasonable care and judgment to achieve and maintain
independence and objectivity in making investment recommendations or taking
investment action.

External sources may try to inIluence the investment process by oIIering investment
managers a variety oI perks. Excessive giIts, or lavish investor relation Iunctions
could prejudice their opinions about a sponsor. Modest giIts and entertainment are
acceptable.

Example 1: You are an analyst Ior the banking industry. The head oI investor relations
Ior one oI the larger Iirms in this industry oIIers to take you to dinner at a posh
CFACENTER.COM 19
restaurant and discuss the upcoming quarterly earnings Iigures. He provides you with
a new, state oI the art, titanium golI club as his limo drops you oII at the end oI the
evening. He calls you the next day to ask iI your report on his Iirm is progressing and
indicates that there is a job waiting Ior you at the bank iI you decide to leave your
current position. First, the bank oIIicer may have violated his Iiduciary duty to his
shareholders iI he provided you with material, non-public inIormation. Regardless,
you have been wined and dined, received a giIt and a job oIIer Irom a senior oIIicer oI
a Iirm you evaluate. Even iI these inducements do not compromise your independence
and objectivity, they may provide that perception. This violates the Standard.

Example 2: An analyst Iollows the stock oI company XYZ. He is invited by XYZ Ior
a visit to the company. XYZ pays all travel expenses Ior him. In general, when
allowing companies to pay Ior expenses, analysts should ensure that such
arrangements do not impinge on their independence and objectivity. In this case, as
long as the trip is strictly Ior business without lavish hospitality, payment is
acceptable.

Example 3: An analyst is asked by the Iirm's executives to issue Iavorable
recommendations to secure the client's business. The analyst should conduct the
review and make the recommendation based on his own independent and objective
view.


Members should Iollow certain practices and should encourage their Iirms to establish
certain procedures to avoid violations oI Standard IV (A.3).

Protect integrity oI opinions. Members and their Iirms should establish policies
stating that every research report on issuers by a corporate client reIlects the
unbiased opinion oI the analyst. Firms should also design compensation systems
that protect the integrity oI the investment decision process by maintaining the
independence and objectivity oI analysts.

Disclose all corporate relationships. Members should disclose relationships in
which any analyst, oIIicer, partner, or employee oI the securities Iirm is a director
oI a company and disclose whether the Iirm underwrites the securities oI that
company and/or makes a market in them.

Disclose personal holdings/beneIicial ownerships. Members should disclose
interests in all members' aIIiliated entities or accounts and those accounts over
which the member has control (e.g., spouse or other relative's account).

Create a restricted list. II the senior managers at a member's Iirm are unwilling to
permit dissemination oI adverse opinions about a corporate client, the Iirm should
CFACENTER.COM 20
remove the controversial company Irom the research universe and put it on a
restricted list so that the Iirm disseminates only Iactual inIormation about the
company.

Restrict special cost arrangements. When attending meetings at an issuer's
headquarters, a member should pay Ior commercial transportation and hotel
charges. No corporate issuer should reimburse a member Ior air transportation.

Members should encourage issuers to limit the use oI corporate aircraIt to
situations in which commercial transportation is not available or in which eIIicient
movement could not otherwise be arranged. Members should take particular care
that when Irequent meetings are held between an individual issuer and an
individual member, that the issuer is not always the host oI the member.

Limit giIts. Members should limit the acceptance oI gratuities and/or giIts to token
items. $100 is the maximum acceptable value Ior a giIt or gratuity. Standard IV
(A.3) does not preclude customary, ordinary, business-related entertainment so
long as its purpose is not to inIluence or reward members.

Restrict investments. Members should restrict (or encourage their investment
Iirms to restrict) employee purchases oI equity or equity-related IPOs. Strict limits
should be imposed on investment personnel acquiring securities in private
placements.

Review procedures. Members should implement (or encourage their Iirms to
implement) eIIective supervisory and review procedures to ensure that analysts
and portIolio managers comply with policy relating to their personal investment
activities.

In short, you are required to:
Protect the integrity oI opinions, i.e. ensure that research reports are unbiased.
Disclose all corporate relationships, including directorships, underwriting
arrangement or market making.
Disclose personal holdings/beneIicial ownerships.
Limit giIts to under USD100 in value.
Restrict special cost arrangements, i.e. pay Ior your travel costs rather than letting
corporate issuers picking up the tab.
Restrict investments by employees at your Iirm in IPOs and private placements.

You are NOT required to:
Decline giIts given by clients, even those over USD100, so long as you inIorm
your employer.

CFACENTER.COM 21
D. Fiduciary Duties.

A fiduciary duty is a position oI trust.
A fiduciary is someone with the duty oI acting Ior the beneIit oI another party.
You owe loyalty to clients and prospects.
Clients' interests come beIore yours.
A heightened level oI Iiduciary duty arises iI the Iiduciary has "custody" or
eIIective control oI the client's assets.
Governing documents (e.g. trust documents and investment management
agreements) are primary determinants oI a Iiduciary's powers and duties.

Extra care should be taken to determine the identity oI the "client" to whom the
Iiduciary duty is owed.
When managing personal assets oI an individual, the investment manager
owes loyalty to that individual (i.e. the client).
When managing the portIolios oI a pension plan or trust, the investment
manager owes loyalty to beneIiciaries oI the plan or trust (i.e. the "client"), not
the person who hires the manager.

Prudent Man Rule: exercise judgment as a prudent man would iI managing their
own aIIairs.

For pension plans, ERISA sets diIIerent standards. It Iocuses on the portIolio rather
than individual investments:
act solely Ior participants and beneIiciaries.
act with diligence oI a prudent person.
diversiIy to reduce risk oI loss.

Soft dollars: OIten a manager may direct clients' trades through a particular broker.
The broker may provide research services that provide a broader beneIit to the
manager. The manager has used "soIt dollars" to purchase beneIicial services. Since
the manager would expect to purchase research services anyway, the soIt dollar
arrangement is not necessarily inappropriate. The manager must seek the best price
and execution. The manager must disclose any soIt dollar arrangements.

Example 1: A client anxiously tells you that he needs to liquidate a bond portIolio
immediately because he needs Iunds to pay Ior an operation Ior a relative. The bonds
are highly liquid, but you and a colleague purchase the securities Ior about 75 oI
their market value. This is a clear violation oI your Iiduciary duty to the client. You
have violated your position oI trust. Furthermore, you have engaged in a deceitIul
action which dishonors the CFA designation.

CFACENTER.COM 22

F. Portfolio Investment Recommendations and Actions.

Summary

Make a reasonable inquiry into a client's Iinancial situation, investment experience,
and investment objectives prior to making any investment recommendations and
shall update this inIormation as necessary, but no less Irequently than annually, to
allow the members to adjust their investment recommendations to reIlect changed
circumstances.

Consider the appropriateness and suitability oI investment recommendations or
actions Ior each portIolio or client. In determining appropriateness and suitability,
members shall consider applicable relevant Iactors, including the needs and
circumstances oI the portIolio or client, the basic characteristics oI the investment
involved, and the basic characteristics oI the total portIolio. Members shall not
make a recommendation unless they can reasonably determine that the
recommendation is suitable to the client's Iinancial situation, investment
experience and investment objectives.

Distinguish between Iacts and opinions in the presentation oI investment
recommendations.

Disclose to clients and prospects the basic Iormat and general principles oI the
investment processes by which securities are selected and portIolios are
constructed and shall promptly disclose to clients and prospects any changes that
might signiIicantly aIIect those processes.

Know the type and nature oI your clients.
Know the return objectives and risk tolerance oI your clients.
Know the liquidity needs, expected cash Ilows, investable Iunds, time horizon, tax
considerations, regulatory and legal circumstances and other constraints oI your
clients.

Change an existing client portIolio as soon as it comes under your discretion -- it
is best to take a bit oI time, plan and implement actions in an organized way.

Client IdentiIication
IdentiIy the type and nature oI clients, and the existence oI separate beneIiciaries.

Investor Objectives
CFACENTER.COM 23
Consider the client's return objectives (income, growth in principal, maintenance
oI purchase power)
Risk tolerance (suitability, and stability oI values).

Investor Constraints include the Iollowing:
liquidity needs,
expected cash Ilows (patterns oI additions and/or withdrawals),
investable Iunds (assets and liabilities or other commitments),
time horizon,
tax considerations,
regulatory and legal circumstances,
investor preIerences, circumstances, and unique needs, and proxy voting
responsibilities and guidance.

The investor's objectives and constraints should be maintained and reviewed
periodically to reIlect any changes in the client's circumstances. Annual review is
reasonable unless business or other reasons dictate more or less Irequent review.

Example 1: AIter a Iive minute interview, you advise a client how to invest a
substantial proportion oI her wealth. You have violated the "Know your customer"
rule. You do not have adequate basis to make a detailed recommendation.

Example 2: An analyst tells a client about the upside potential, without discussing the
downside risks. He violates IV (B2) because he should discuss the downside risks as
well.

Example 3: When recommending an investment to a client, an analyst mainly Iocuses
on the characteristics oI the speciIic investment. He violates IV (B2) because the
primary Iocus Ior determining the suitability oI an investment should be on the
characteristics oI the entire portIolio.

C. Fair Dealing.

Summary
Members shall deal Iairly and objectively with all clients and prospects when
disseminating investment recommendations;
disseminating material changes in prior investment recommendations;
taking investment action.

"Fairly" implies that members must not discriminate against or Iavor any clients.
CFACENTER.COM 24
Fairness shall be maintained in quality and timing oI services, and allocation oI
investment opportunities. The term "Iairly" is used, not "equally," as this would be
physically impossible to reach all customers at the same exact instant, and not all
recommendations or investment actions are suitable Ior all clients.

You are required to adhere to the standard in:

Dissemination of recommendations -- Establish procedures Ior simultaneous
dissemination oI recommendations, i.e. all clients must be inIormed at
approximately the same time. Good business practice dictates that initial
recommendations be made available to all customers who indicate an interest.
Although a member need not communicate a recommendation to all customers,
the selection process by which customers receive inIormation should be based on
suitability and known interest, not on any preIerred or Iavored status. A common
practice to assure Iair dealing is to communicate recommendations within the Iirm
and to customers simultaneously.

Order Placement -- Develop trade allocation procedures to ensure Iairness to
clients (both in priority oI execution and allocation oI price obtained on block
trades), timeliness oI execution, accuracy oI trade records and client positions.
Clients in discretionary accounts should be treated the same as those who are not
in discretionary accounts. Members must draIt and adhere to equitable and
appropriate allocation procedures.

Members and their Iirms are required to take the Iollowing steps to ensure that
adequate trade allocation practices are Iollowed:
Obtain advance indications oI client interest Ior new issues.
Allocate new issues by client rather than by portIolio manager.
Adopt a pro rata or similar objective method or Iormula Ior allocating trades.
Treat clients Iairly in terms oI both trade execution order and price.
Execute orders in an eIIicient and timely manner.
Keep accurate records oI trades and client accounts.
Periodically review all accounts to ensure that all clients are being treated
Iairly.

II the issue is oversubscribed, members should Iorgo any sales to themselves or
their immediate Iamilies. Members must disclose to clients/prospects the
allocation procedures, and how they can aIIect the clients/prospects. Members
shall not withhold "hot issue" securities Ior their own beneIits or use such
securities as rewards or incentives Ior others. Members shall not trade ahead oI the
dissemination oI research reports /recommendations to clients.

Give the same level oI services to all clients, e.g. you can give more inIormation
CFACENTER.COM 25
and research to discretionary clients than to transaction-only clients.

Members have an obligation to ensure, within the limits oI their employment, that
their Iirms establish compliance procedures requiring all employees who disseminate
investment recommendations or take investment actions to treat customers and clients
Iairly. The Iormality and complexity oI such compliance procedures depend on the
nature and size oI the organization and the type oI securities involved.

Members should consider the Iollowing points when establishing Iair-dealing
compliance procedures:
Limit the number oI people involved.
Shorten the time Irame between decision and dissemination.
Publish personnel guidelines Ior pre-disseminations.
Disseminate inIormation simultaneously to all parties.
Establish control over trading activity.
Establish procedures Ior determining material change.
Maintain a list oI clients and their holdings.
Develop trade allocation procedures.

Example 1: AIter attending an analyst's brieIing, you decide to reevaluate your
research report on Horton Industries. You conclude that the company is no longer a
"buy" but is now a "strong buy". The report is scheduled Ior release to your clients
next week but you call several large clients to inIorm them oI this change. You have
not treated all clients Iairly.

Example 2: An analyst tells a client that he will soon issue a recommendation. He
thereIore violates the standard because he should send the inIormation to all clients
beIore discussing it with any speciIic client(s).

Example 3: Just 30 minutes beIore the close oI the market, Huntington Biomedical
releases a report indicating that EPS Ior the upcoming quarter will be materially lower
than previously expected and sales growth Ior the Iirm will also be below
expectations Ior the next Iour quarters. You only have 3 clients with signiIicant
positions in Huntington. You contact each oI those clients and two oI them direct you
to liquidate their holdings in the Iirm immediately. The third client elects to hold her
position. Even iI you have other clients with small positions in this Iirm, you have
treated all clients Iairly. You have shown preIerence to clients with greater concern
about the news release.

Example 4: An analyst's employer low-balls earning projection Ior company XYZ.
The analyst is conIident that the earnings should be higher, but goes along with the
Iirm when issuing his own recommendation. Then he passes his real estimate to his
large clients. He thereIore violates the standard by not sharing his recommendation
with all clients and not treating all clients Iairly.
CFACENTER.COM 26
H. Priority of 1ransactions.

Summary

The standard is designed to prevent any potential conIlict oI interest or even the
appearance oI a conIlict oI interest with respect to the analyst's personal transactions.
The standard applies to transactions in which the Iinancial analyst is deemed to be a
beneIicial owner.

Transactions Ior clients and employers shall have priority over transactions in
securities or other investments oI which a member is the beneIicial owner so that such
personal transactions do not operate adversely to their clients' or employer's interests.
II members make a recommendation regarding the purchase or sale oI a security or
other investment, they shall give their clients and employer adequate opportunity to
act on their recommendations beIore acting on their own behalI. For purposes oI the
Code and Standards, a member is a "beneIicial owner" iI the member has
a direct or indirect pecuniary interest in the securities.
the power to vote or direct the voting oI the shares oI the securities or investments
the power to dispose or direct the disposition oI the security or investment.

The standard applies to all access persons. A member may undertake personal
transactions only aIter his clients and employer have had an adequate opportunity to
act on the recommendation. Personal transactions include those made Ior the
member's own accounts, Iamily accounts, and accounts in which the member has a a
direct or indirect pecuniary interest. Note that Iamily accounts that are also client
accounts should be treated like any other Iirm accounts. Neither special treatment nor
disadvantage should be given to such accounts


Members should encourage their Iirms to prepare and distribute a code oI ethics and
compliance procedures, applicable to principals and employees, emphasizing their
obligation to place the interests oI clients above personal and employer interests. The
Iorm and content oI such compliance procedures depend on the size and nature oI
each organization and the laws to which it is subject. In general, however, the code
and procedures should do the Iollowing.
DeIine personal transactions. A minimum deIinition is included in Standard IV
(B.4), in certain circumstances, including a stricter standard might be appropriate.
DeIine investment. The deIinition oI "investment" Ior the purposes oI Standards is
any medium by which placement oI Iunds generally occurs with the expectation oI
preserving the value and earning a positive return and may include such assets as
real estate, natural sources' tangible property, etc.
Limit the number oI access persons, i.e., persons who have knowledge oI pending
or actual investment recommendations or actions.
CFACENTER.COM 27
DeIine prohibited transactions. Participation by investment personnel in equity or
equity-based IPOs should be restricted.
Prevent managers or employees involved in the investment decision-making
process Irom initiating trades in a security Ior which their Iirms have a pending
buy or sell order within a 24-hour period beIore the order is executed or canceled.
As a general rule, members and their Iirms should prohibit investment personnel
Irom proIiting in the purchase and sale or sale and repurchase oI the same or
equivalent securities within 60 calendar days. Members' Iirms should encourage
the placement oI Iirm and manager accounts at risk along with the investments oI
clients.
Establish reporting and prior-clearance requirements. Including the date and
nature oI the transaction, the price, and the name oI the broker, dealer, or bank
through which it was eIIected. Monthly reporting or more Irequent requirements
might be desirable. Require that access (covered) persons direct their brokers to
supply duplicate copies oI conIirmations oI all personal securities transactions and
copies oI periodic statements.
Procedures requiring prior approval Ior all personal investment transactions by
employees will prevent any employee Irom unknowingly allowing a personal
transaction to take precedence over those Ior clients or the employer.
Consider special situations. A review committee made up oI senior Iirm oIIicials
and/or independent parties should review these situations.
Ensure that procedures will be enIorced. Persons assigned to approve transactions
should have a third party approve their personal investment transactions.
Contain disciplinary procedures. An internal investigation should be promptly
conducted into any questionable trade. Managers should disgorge all proIits and
assume any losses Irom the trade.

Example 1: You receive a news release that a small Iirm in the industry you Iollow
has obtained a major contract with a multinational Iirm. The contract will double sales
Ior the small Iirm. You note that the small Iirm's stock price has already increased
Irom $12 to $13. You immediately submit an order to buy 1000 shares. AIter your
order is conIirmed, you send an email advisory to all clients summarizing the news
and suggesting that this is a buying opportunity. This is a clear violation oI the
standard. Clients had no opportunity to act on this inIormation prior to your personal
trading.

Example 2: An analyst tells her Iather about a tender oIIer. She does not trade Ior her
client until her Iather has made the trade. She violates the standard by placing her
Iather's interest above her clients'.

Example 3: An analyst maintains an account in his wiIe's maiden name at another
Iirm. By using that account, he oIten buys hot issues while his clients cannot
participate. He violates the standard by trading Ior his wiIe beIore his clients can
acquire the shares. He also should disclose the trading Ior his wiIe's account to his
CFACENTER.COM 28
employer.

Example 4: David is a portIolio manager. He manages the retirement account
established with the Iirm by his parents. David does not trade Ior this account until all
other accounts are traded. He violates the standard by discriminating his parent's
account. As Iee-paying clients to the Iirm, his parent should be treated the same as any
other clients.

I. Preservation of Confidentiality.

Summary
Members shall preserve the conIidentiality oI inIormation communicated by
clients, prospects, or employers concerning matters within the scope oI the
client-member, prospect-member, or employer-member relationship unless a
member receives inIormation concerning illegal activities on the part oI the client,
prospect, or employer.

The analyst must preserve conIidentiality when the Iollowing two criteria are met:
the analyst must be in a relationship oI trust with the client who has engaged him,
the inIormation received must result Irom or be relevant to that portion oI the
client's business that is the subject oI the conIidential relationship.


The simplest, most conservative, and most eIIective way to comply with Standard IV
(B.5) is to avoid disclosing any inIormation received Irom a client except to
authorized Iellow employees who are also working Ior the client. In some instances,
however, a member may want to disclose inIormation received Irom clients that is
outside the scope oI the conIidential relationship and does not involve illegal activities.
BeIore making such a disclosure, a member should ask the Iollowing questions:
In what context was the inIormation disclosed?
II disclosed in a discussion oI work being perIormed Ior the client, is the
inIormation relevant to the work?
Is the inIormation background material that, iI disclosed, will enable the member
to improve service to the client?

However, iI the inIormation concerns illegal activities by the client, the analyst may
be required to consult with his supervisor, and with legal counsel, decide whether to
report the activities to the appropriate governmental organization.
CFACENTER.COM 29

avoid discussing any inIormation received Iorm a client, except to Iellow
employees working with the same client.
ask yourselI iI the disclosure is necessary and beneIicial to the client in cases
where you have disclose inIormation.
Iorward conIidential inIormation to the PCP (AIMR's ProIessional Conduct
Program) iI PCP requests so, even iI the client and you have a settlement
agreement with conIidentiality clauses.

Example 1: You work in the trust department oI a large bank. A client tells you that
she must sell a signiIicant portion oI her personal stock portIolio in order to generate
cash to meet the payroll oI her small business. Shortly aIter the meeting, a colleague
in the commercial lending department oI the bank mentions seeing you with the client.
She has applied Ior a large business loan. He asks you iI you have any inIormation
that could help the bank with the loan decision. You cannot disclose the content oI
your meeting with the client. II the colleague wants additional inIormation, he should
contact your client directly.

Example 2: The employer oI a client asks to meet with you. The employer suspects
your client oI embezzling Iunds Irom his place oI work. You are aware that the client
has made several substantial additions into his discretionary account during the past
two months. It may be appropriate to provide inIormation iI it pertains to illegal
activities. However, you are expected to preserve client conIidentiality unless there is
a clear indication oI these activities. Contact your supervisor or legal counsel beIore
providing inIormation about your client.

Example 3: A Iinancial advisor learns that a client plans to make a charity donation.
He tells a charity to solicit donation Irom the client. The Iinancial advisor violates the
standard Ior revealing conIidential client inIormation.

Example 4: An analyst claims that he cannot disclose client trading inIormation to the
AIMR PCP committee. He thereIore violates the standard Ior not providing
conIidential client inIormation to the PCP.

1. Prohibition against Misrepresentation.

Summary
Members shall not make any statements, orally or in writing, that misrepresent
the services that they or their Iirms are capable oI perIorming.
CFACENTER.COM 30
their qualiIications or the qualiIications oI their Iirm.
the member's academic or proIessional credentials.

Members shall not make or imply, orally or in writing, any assurances or guarantees
regarding any investment except to communicate accurate inIormation regarding the
terms oI the investment instrument and the issuer's obligations under the instrument. It
prohibits statements or assumptions that an investment is "guaranteed," or that
superior returns can be expected based on the analyst's past success.

The standard applies to oral representations, advertising, electronic communications
(including web pages, e-mails), and written materials (whether publicly disseminated
or not).


Members can prevent unintentional misrepresentations oI the qualiIications oI
services the member or the member's Iirm is capable oI perIorming iI each
member understands the limit oI the Iirm's or individual's capabilities and the need
to be accurate and complete in presentations.
Firms can provide guidance Ior employees who make written or oral presentations
to clients or potential clients by providing a written list oI the Iirm's available
services and a description oI the Iirm's qualiIications, and compensations that are
both accurate and suitable Ior client or customer presentations. Firms can also
help prevent misrepresentation by speciIically designating which employees are
authorized to speak on behalI oI the Iirm. Whether or not the Iirm provides
guidance, members should make certain that they understand the services the Iirm
can perIorm and its qualiIications.
In addition, each member should prepare a resume oI the member's own
qualiIications and a list oI the services the member is capable oI perIorming to use
in accurate presentations to clients. Members should use a written resume and job
description oI Iirm services when making a presentation to a client or prospective
client to help the member Iocus on the Iirm's and the member's own strengths and
limitations. Firms can aid member compliance by also periodically reviewing
employee correspondence and documents that contain representations oI
individual or Iirm qualiIications.

Example 1: Your prospective client is unsure whether to contract with you Ior services.
You mention that investment decisions are made by a team oI 5 proIessionals, each a
CFA charterholder. This is an above average level oI expertise Ior a Iirm oI this size
and should lead to superior investment perIormance. Even iI decisions are made by
individuals with CFA charters, you can not inIer that this will lead to superior
perIormance. II you could substantiate the superior level oI expertise among managers
in your Iirm, then that part oI your statement is OK.

CFACENTER.COM 31
Example 2: An analyst calls himselI a "portIolio management specialist". In Iact he is
just a trainee. The analyst violates the standard Ior misrepresenting his qualiIications.

Example 3: A Iirm advertises that investors can increase their returns by investing in
money market Iunds rather than municipal Iunds. They don't mention that the
statement is not true Ior investors in the highest tax bracket. The Iirm thereIore
violates the standard because the advertisement predicts perIormance Ior all investors,
without distinguishing the impact on investors in high tax brackets.

K. Disclosure of Conflicts to Clients and Prospects.

Summary

Members shall disclose to their clients and prospects all matters, including beneIicial
ownership oI securities or other investments, that reasonably could be expected to
impair the members' ability to make unbiased and objective recommendations.

A member must disclose to clients/prospects the Iollowing conIlicts:
Material ownership in the member's Iirm's investment account.
Market-making activities.
Corporate Iinance relationships.
Directorships.

Members should disclose, with approval Irom their employer, special compensation
arrangements with the employer that might conIlict with clients' interest, such as
bonuses based on short-term perIormance, commissions, perIormance Iees, incentive
Iees, and reIerral Iees.


Many Iirms require employees and their Iamilies to report all transactions by
employees and their Iamilies Ior purposes oI detecting conIlicts oI interest and trading
on material nonpublic inIormation. Whether such Iirm requirements exist or not,
members should report to employers, clients, and prospects any material beneIicial
interest they may have in securities and any corporate directorships or other special
relationships they may have with the companies they are recommending. Members
should make the disclosures beIore they make any recommendations or take any
action regarding such investments.

Two approaches to avoid potential conIlicts oI interest:
CFACENTER.COM 32
Avoidance - personal investment through "blind trust" or "mutual Iund", in which
you got not inIluence on their investment decisions.
Disclosures

Example 1: Failure to disclose a perIormance-based bonus plan. A manager gets a
bonus Irom her employer based on the perIormance oI the pension accounts she
manages. One oI her clients asks her why his pension plan seems to be weighted in
Iavor oI high beta stocks. She says nothing about the bonus plan.

Example 2: You manage the pension Iund Ior the Tremont Corporation. Huntington
Biomedical is one oI the largest holdings in the Iund. You also serve on the board oI
directors Ior Huntington. You must disclose this relationship. While it is not unethical
to have a responsibility to the Iund's beneIiciaries and to the shareholders oI
Huntington, you must make sure that the Iund's board is aware oI your other
appointment.

Consider the same scenario, but instead oI being on Huntington's board, you own a
signiIicant block oI Huntington stock. You must disclose this beneIicial ownership. As
long as you do not violate other Standards regarding Priority oI Transactions or Fair
Dealing, disclosure oI your holdings will be suIIicient to meet the Standard.

Example 3: An analyst recommends a stock. However, he Iails to disclose that he is
on the company's board, or he has inherited a sizable amount oI the stock, or his wiIe
own 20 oI the company. The standard is violated Ior the analyst's Iailing to disclose
his beneIiciary interest in the recommended company.

Example 4: Company XYZ is considering hiring John to manager its pension Iund.
XYZ asks John to vote the XYZ stock proxies held in other accounts he manages in
Iavor oI XYZ's management. John will violate the standard iI he accepts XYZ's oIIer.
He should vote the proxies in the best interest oI his clients.

Example 5: A portIolio manager gets a bonus Irom his employer based on the
perIormance oI his clients' accounts. He does not disclose the bonus plan to his clients.
The standard is violated because he Iails to disclose the bonus plan to the clients.

L. Disclosure of Referral Fees.

Summary
Members shall disclose to clients and prospects any consideration or beneIit
received by the member or delivered to others Ior the recommendation oI any
CFACENTER.COM 33
services to the client or prospect.

Such disclosure should help the client evaluate any possible partiality shown in
any recommendations oI services as well as evaluate the Iull cost oI services.

Disclose the existence and terms oI any reIerral Iee agreements to all clients or
prospects, who have been reIerred under such agreements.

Describe the nature oI the consideration and its estimated dollar value in this
disclosure. Consideration includes all Iee, whether paid or not: in cash, in soIt
dollars or in kind.

Consult a supervisor and legal counsel concerning any prospective arrangement
regarding reIerral Iees.

Example 1: You provide investment counseling on a Iee-Ior-services basis. You
encourage all oI your clients to place trades through a particular broker, Richard Jones.
You have known Mr. Jones Ior many years and Ieel that he is an excellent broker with
Iees and services that are competitive Ior the type oI clients you typically work with.
Mr. Jones also provides you with a "Iinder's Iee" Ior each client you reIer to him.
Even iI the services recommended are reasonable and appropriate, you must still
disclose the reIerral Iee.

Example 2: ABC Firm has an agreement with XYZ Firm that ABC will recommend
prospective pension clients to XYZ, and in return, XYZ will give ABC Iree research.
ABC does not disclose the arrangement to prospective clients. ABC violates the
standard Ior not disclosing the arrangement to prospective clients.
CFACENTER.COM 34
F. Standard V: Relationships with and Responsibilities to the Public

A. Prohibition against Use of Material Aonpublic Information

Summary
Members are prohibited Irom seeking out or using any inside inIormation in analyzing
investments, making investment recommendations or making investment decisions iI
Such trading would breach a duty; or
The inIormation is misappropriated; or
The inIormation relates to a tender oIIer; or
Members receive material inIormation in conIidence.

Additionally, iI members receive inside inIormation in conIidence, they shall make
reasonable eIIorts to achieve public dissemination oI material nonpublic inIormation
disclosed in breach oI duty.

InIormation is material iI its disclosure may aIIect the price oI a security, or
reasonable investors would want to know the inIormation beIore investing.
InIormation is nonpublic iI it has not been disseminated to the marketplace in general,
or investors have had an opportunity to react to the inIormation. (Note that disclosing
the inIormation to a selected group oI analysts does not make it public.) ThereIore,
this standard prohibits use oI material nonpublic inIormation, not:
Nonmaterial public inIormation;
Nonmaterial nonpublic inIormation;
Material public inIormation.

Topics which should be considered material in an insider trading context include:
a Iorthcoming dividend declaration or mission;
corporate reorganizations or takeovers;
the acquisition or loss oI a major contract;
a major purchase or sale oI company assets;
an event oI deIault;
knowledge oI Iorthcoming press coverage oI a company's aIIairs, whether positive
or negative; and
substantial increases or decreases in earnings projections.

A member shall not trade on the basis oI inIormation disclosed by a person (tipper)
conveying the inIormation in violation oI a conIidence or in breach oI a duty. The test
Ior determining iI a tipper is breaching a Iiduciary duty is whether the tipper
personally beneIits Irom the disclosure. Note that Iiduciary duty cannot be imposed
unilaterally by telling someone to "keep the inIormation conIidential". There are three
types oI personal beneIits:
Pecuniary beneIit or a reputational beneIit that will translate into Iuture
CFACENTER.COM 35
earnings Ior the tipper.
An equal exchange relationship between the insider and the recipient oI the
inIormation.
A giIt oI conIidence inIormation to, say, a relative.

II a member determines that the inIormation is material and has been disclosed in
breach oI duty, the member should make reasonable eIIorts to achieve public
dissemination oI the inIormation. This eIIort usually means encouraging the issuing
company to make the inIormation public.

A member shall not take investment action or pass on material nonpublic inIormation
that the member knows has been misappropriated or illegally obtained. A member
shall never trade or cause others to trade in a security while the member possesses
material nonpublic inIormation related to a tender offer regarding that security. Note
that mere possession oI material nonpublic inIormation on a tender oIIer trigger
trading restrictions.

Example 1: An insider tells you that his Iirm will announce a signiIicant drop in EPS
Ior the upcoming year. The announcement will be released in three days. You can't
trade. You can't recommend that your investors sell their positions. You can (and
should) encourage the Iirm to disclose the inIormation immediately.

Example 2: You are at an analysts' brieIing Ior Horton Industries attended by 20
analysts. During the presentation, Horton's president indicates that the Iirm is
considering closing its Alberta operations because oI diIIiculty in controlling costs at
that location. He asks the audience not to act on this inIormation yet because a Iinal
decision will not be made Ior at least another week. The analyst's brieIing likely
qualiIies as a public disclosure. II you Iind these comments to have reasonable basis,
you can inIorm your clients oI the new inIormation and trade on their behalI.

Example 3: Barnes, the president oI XYZ decides to accept a proposed tender oIIer.
He tells this decision to his sister, who tells her daughter, who tells her husband Staple,
who tells his broker, who buys stocks Ior himselI. The broker is prohibited Irom
trading the XYZ stock because the inIormation involves tender oIIer. However, the
broker has no reason to believe a duty was breached in the transmission oI the
inIormation.

Example 4: A passenger in an elevator overhears a conversation between two
executives oI a publicly traded company. The passenger trades the stock based on that
inIormation. The passenger does not violate the standard because the executives do
not breach any duty and the inIormation is not misappropriated.

Example 5: Walsh overhears that someone sneaked into the CEO's oIIice and
discovered inIormation about a pending tender oIIer. Walsh trades the stock
CFACENTER.COM 36
subsequently. Walsh violates the standard because the inIormation is misappropriated
and it concerns tender oIIer.

Example 6: An analyst Iails to protect privacy when discussing nonpublic inIormation
in a conIerence call. Another employee overhears the inIormation, and subsequently
trades Ior his clients' accounts. The analyst violates the standard Ior lack oI adequate
procedures. The Iirm should have established inIormation barriers, also called Fire
Walls, between departments.

Example 7: A magazine has a weekly investment column. A magazine employee
trades on inIormation in the column beIore it is published. The employee violates the
standard because the inIormation is misappropriated.


Members and their Iirms should adopt written compliance procedures designed to
prevent trading while in the possession oI material nonpublic inIormation. Members
who receive material nonpublic inIormation Irom an issuer should generally consult
their supervisor or legal counsel beIore trading (or causing others to trade) while in
possession oI that inIormation.

The most common and widespread approach to prevent insider trading by employees
is an inIormation barrier known as a "Fire Wall" (or "Chinese Wall"). The purpose oI
a Fire Wall is to prevent communication oI material nonpublic inIormation and other
sensitive inIormation Irom one department oI a Iirm to other departments. The
minimum elements oI such a precaution include the Iollowing:
Substantial control (preIerably by the compliance department) oI relevant
interdepartmental communications;
Review oI employee trading through eIIective maintenance oI some combination
oI "watch," "restricted," and "rumor" lists;
Heightened review or restriction oI proprietary trading while the Iirm is in
possession oI material nonpublic inIormation.

Additional procedures, used typically in conjunction with an inIormation barrier
include:
Restricting or prohibiting personal and proprietary employee trading;
CareIul monitoring oI Iirm and personal employee trading;
Placing securities on a restricted list when the Iirm has or may have material
nonpublic inIormation (unless the placing oI a security on a restricted list would
itselI tend to reveal outside the Iirm that the Iirm is engaged in a nonpublic
engagement relating to the security);
Using a stock watch list known only to a limited number oI people when the Iirm
has or may have material nonpublic inIormation to monitor transactions in
speciIied securities;
CFACENTER.COM 37
ConIining the dissemination oI material nonpublic inIormation to persons who
have a need to know the inIormation in order to carry out their responsibilities;
Designating a supervisor or compliance oIIicer who will have the speciIic
authority and responsibility to decide whether inIormation is suIIiciently public or
is suIIiciently lacking in materiality that it may be used as a basis Ior investment
recommendations or decisions.
Firms should circulate written policies and guidelines to all employees. The
policies and guidelines should be coupled with a program oI seminars and
reIresher courses Ior the employees.

Other basic components oI typical compliance guidelines are the Iollowing:
Require Communication. Anyone who receives inIormation that is known or
reasonably believed to be material nonpublic inIormation should communicate
that inIormation to designated supervisor or compliance oIIicer. The recipient oI
said inIormation should be required to reIrain Irom trading on the inIormation or
Irom discussing the inIormation inside or outside the Iirm until a supervisor
decides the inIormation either is not material or has been made public.
Establish training and compliance procedures.
Review Accounts. A pattern oI trading on inside inIormation can be more easily
detected iI employees and Iirm members are required to make periodic reports oI
their transactions on their own behalI or on behalI oI members oI their Iamilies.
Keep all research.

Rule 10b-5 oI the Securities Exchange Act oI 1934 makes it unlawIul Ior certain
persons to trade, or recommend trading in, securities on the basis oI material
nonpublic (inside) inIormation.

Traditional Theory -- A securities trader commits Iraud by violating Section 10(b)
and Rule 10b-5 only iI he Iails to disclose material inIormation prior to the
consummation oI a transaction when he is under duty to do so. The duty to disclose
arises Irom a Iiduciary duty.

Fiduciary Trust Theory -- A relationship oI trust and conIidence, not mere
possession, is a prerequisite Ior imposing a duty to disclose or abstain Irom trading..
The test oI whether a Iiduciary duty has been breached is whether the insider beneIits
directly or indirectly Irom the disclosure. (Similar to traditional theory.)

Misappropriation Theory -- A person violates Rule 10b-5 when he misappropriates
material nonpublic inIormation in breach oI a Iiduciary duty, and uses that
inIormation in a securities transaction or communicates it to others who then use it. It
is not necessary, as in the traditional theory, that a buyer or seller oI securities be
shareholders oI the corporation to whom the insider's duty is owed.

Mosaic Theory -- Insider trading violations should not result when a perceptive
CFACENTER.COM 38
analyst reaches a conclusion about a corporate action or event through an analysis oI
public inIormation and items oI nonmaterial nonpublic inIormation (that is, a
"mosaic" oI inIormation). Under mosaic theory, Iinancial analysts are Iree to act
without risking liability. That is, a Iinancial analyst may use nonpublic inIormation as
the basis Ior investment recommendations and decisions even iI that conclusion
would have been material inside inIormation had they been communicated directly to
the analyst by a company.

B. Performance Presentation

Statement of Standard

Members shall not make any statements, orally or in writing, that misrepresent
the investment perIormance that they or their Iirm has accomplished or can
reasonably be expected to achieve.

II members communicate individual or Iirm perIormance inIormation directly
or indirectly to clients or prospective clients, or in a manner intended to be
received by clients or prospective clients, members shall make every
reasonable eIIort to assure that such perIormance inIormation is Iair, accurate
and complete presentation oI such perIormance.


Misrepresentations about the investment perIormance oI the Iirm can be avoided iI the
member maintains data about the Iirm's investments perIormance in written Iorm and
understands the classes oI investments or accounts to which those data apply and the
risks and limitations inherent in using such data. In analyzing inIormation about the
Iirm's investment perIormance, the member should ask the Iollowing questions:
How many years' past perIormance does this inIormation reIlect?
Does it reIlect perIormance Ior the prior year only, aIter several years oI poor
perIormance, or an average oI several years' perIormance?
Has the perIormance been measured in accordance with AIMR standards?
Does investment perIormance vary widely among diIIerent classes oI Iunds or
accounts? II so, the member must describe investment perIormance by classes
rather than by an overall average Iigure and accurately explain what the
perIormance Iigures represent.
CFACENTER.COM 39

Example: Your bond Iund has generated a below average perIormance Ior 4 oI the
past 5 years. You use this as the basis Ior expectations oI an above average
perIormance Ior the upcoming year. II your average, or expected perIormance, is
properly determined, you should have a 50 probability oI meeting or exceeding that
average. Thus, it is inappropriate to declare that because perIormance was below
average last year it is likely to be above average next year.

CFACENTER.COM 40
G. Topical Studies

A. Fiduciary Duty

Fiduciary duty reIers to the obligations oI loyalty and care in regard to responsibility
oI managing someone else's assets. This duty is a critical legal construct and the
obligations oI the Iiduciary will diIIer depending on the type oI client relationship.

Trust Management: This is the primary source Ior legal thinking regarding Iiduciary
duty. It outlined the Prudent Man Rule and later, the Prudent Investor Rule.

The original text oI the Prudent Man Rule was contained in a decision by the
Massachusetts Supreme Court:
"...to observe how men of prudence, discretion and intelligence manage their own
affairs, not in regard to speculation, but in regard to the permanent disposition of
their funds, considering the probable income, as well as the probable safetv of the
capital to be invested."

How has this been interpreted? Preserve capital and avoid risk.
How does the Iiduciary apply it? Invest the client's assets in very saIe Iinancial
securities (Treasury bills, certiIicates oI deposit, savings bonds). Unless the agreement
between Iiduciary and client speciIies, riskier asset classes (stocks, long-term bonds,
derivatives) would be considered imprudent. Since this interpretation oI prudence is
highly restrictive and requires all individual investments to pass the saIety test, a new
doctrine, the Prudent Investor Rule, has evolved.

Prudent Investor Rule: Modern portIolio theory stresses that relevant risk is
portIolio risk. This means that individual securities may be risky when held alone, but
may help to reduce risk when held as part oI a properly diversiIied portIolio.
loyalty, impartiality and prudence still matter
overall portIolio risk should be reasonable; risk and return should be suitable to
the trust. Focus on the tradeoII.
provide reasonable diversiIication. Fiduciary has latitude regarding individual
assets iI they are proper elements to the portIolio.
act with prudence when delegating authority to others
be cost conscious

Pension Plans: The Employment Retirement Income Security Act, or ERISA, deIines
Iiduciary duties Ior managers oI private pension Iunds.
Who is a Iiduciary? (1) Someone who exercises control over the management or
disposition oI the Iund's assets; (2) gives investment advice Ior a Iee or other
compensation regarding any aspect oI the plan; (3) has discretionary responsibility
regarding plan administration.
CFACENTER.COM 41
Regarding Iiduciary duty: It cannot be delegated. But the plan manager can
delegate investment management to a qualiIied individual as long as it is clear that
the plan manager retains Iiduciary duty.
Fiduciary responsibilities:
sole interest in plan participants and beneIiciaries
exclusive purpose oI providing beneIits to participants and beneIiciaries
Prudent Expert Rule: care, prudence, and diligence ... that a prudent person
acting in like capacity and Iamiliar with such matters would use... Manager
must be as prudent as the average expert.
diversiIy to avoid large losses unless imprudent given the circumstances.
maintain consistency with governing documents and ERISA
Prudent Procedures:
written investment policy Ior plan
diversiIy
make investment decisions with the skill and care oI a prudent expert
monitor investment perIormance
control investment expenses
avoid prohibited transactions (selI-dealing, conIlict oI interest, kickbacks)
The Iiduciary may receive beneIits (iI a beneIiciary) according to plan terms and
reasonable compensation Ior services rendered. The Iiduciary can be an employee
or agent oI an outside party.
Note, in a deIined contribution plan, the beneIiciary has control over their share oI
Iund assets. The plan administrator is relieved oI some Iiduciary duties regarding
issues such as diversiIication and risk oI loss but may retain others such as
responsibilities as an investment advisor.

Public Pension Plans: Management and laws governing these plans vary, but most
Iollow ERISA mandates. Remember, iI the Code and Standards set a higher standard
oI conduct than state laws, members must adhere to it.

Money Management: There are prohibitions and expectations Ior investment
managers. The U.S. Investment Advisers Act oI 1940 states that advisors cannot
deIraud, deceive, or manipulate clients. II trading on behalI oI a client, an advisor
must Iirst disclose the transaction and receive consent. Advisors are expected to
adhere speciIically to section IV (Relationships with and Responsibilities to Clients
and Prospects) oI the Standards.

Brokers and Dealers: They are held to a higher standard. They cannot "churn" or
engage in excessive trading in a client's account, accept Iunds they know to be
insolvent, manipulate the market, or engage in Iraud.

The "Shingle Theory": When you advertise yourselI as an investment proIessional
(hanging a "shingle"), you are subject to strict standards. There is an expectation oI
Iair dealing. Since broker/dealers can exploit clients' trust and ignorance, they are held
CFACENTER.COM 42
to a higher standard oI care.

Analysts: Duty oI independent judgment, adequate disclosure, and Iair dealing with
clients. Analysts should strive to maintain independence and objectivity.

Charitable Organizations: Fiduciaries are expected to Iollow spending and
investment policies established by their organizations. The major legal doctrine is the
UniIorm Management oI Institutional Funds Act, or UMIFA. UMIFA stresses
portIolio concerns (diversiIy, risk oI individual securities are not directly relevant iI
useIul to the portIolio). Managers must Iollow the standard oI ordinary business care.
This simply states that the directors oI a charitable organization exercise ordinary and
reasonable care in duties and act with honesty and good Iaith.

Social Investing and Relationship Investing: ERISA states that economic and
investment merit come Iirst. Social Iactors may be considered, but only in a secondary
manner. Social goals can not compromise broader Iiduciary duties. Likewise, a
Iiduciary can get involved more closely in management oI a company it holds in its
asset base. This type oI relationship investing is not prohibited, but again must retain a
Iocus on the primary Iiduciary duties. One special issue in relationship investing
regards conIlict oI interest. II a Iund holds a large voting block oI stock and the Iund
manager also retains a directorship with the corporation, Iiduciary duty is to the
shareholders.

B. Insider 1rading

What is Inside Information? Inside InIormation is "material and non-public"
inIormation about a company. Material? It is inIormation that is "reasonably certain
to have substantial impact on the market price." Non-public? It is inIormation that
has not been generally disclosed to the investing public.

Liability for Insider Trading: There are two primary theories, the traditional theory
and the misappropriation theory. They diIIer in the roles and relationships played by
the "tipper" (the insider who provides the inIormation) and the "tipee" (the individual
receiving the inIormation).

Traditional Theory: We start with the basic premise that anyone holding inside
inIormation is prohibited Irom trading on it or passing it along. Insiders are typically
managers and oIIicers oI a company, but the deIinition is typically extended to include
lawyers, accountants, Iinancial advisors, analysts, and even Iinancial printers who
have temporary access to inside inIormation. Here are three articulations oI this basic
CFACENTER.COM 43
statement: (1) a tipee can not be held responsible Ior withholding nonpublic
inIormation unless he/she has a Iiduciary responsibility to do so; (2) a tipee can be
held responsible iI he/she knows or should know that the tipper has breached
Iiduciary duty; (3) SEC rule 14e-3 speciIically prohibits communication oI or trading
on material nonpublic inIormation relating to tender oIIers.

Misappropriation Theory: You can not use deception to appropriate material
nonpublic inIormation and then trade on it. Misappropriation typically applies to
"temporary insiders." For example, iI an advising lawyer, Iinancial printer, or
journalist learns oI a pending tender oIIer and then trades or passes on this
inIormation, then the inIormation has been misappropriated. This deIinition oI insider
trading has also been applied to situations where doctors or dentists have received
inside inIormation Irom patients and acted upon it.

Other issues in insider trading:
A deIense: The Mosaic Theory: II an analyst can collect nonpublic and
nonmaterial inIormation Irom a variety oI sources and put them together to arrive
at a signiIicant conclusion, then the analyst is Iree to act on this conclusion.

Selective Disclosure: What iI a corporation discloses signiIicant inIormation to
only some interested parties? Corporations should design policies that allow broad
and equitable dissemination.

Compliance with Code and Standards: Firms handling sensitive inIormation should
construct "Iire walls" to prevent insider trading violations. This should include
documented procedures to control inIormation Ilow between departments, monitoring
employee trading, particularly when the Iirm is in possession oI material nonpublic
inIormation.

What should an analyst do iI he/she learns inside inIormation? II the analyst has no
conIidential relationship with the "tipper", and the inIormation is not material, it may
be used. However, the analyst should conIer with supervisors beIore doing so. II the
inIormation is material, the analyst should reIrain Irom trading and make reasonable
eIIorts to encourage the company to make a public disclosure.

C. Personal Investing

This section discusses investment practices oI members oI AIMR. Since members are
oIten investment proIessionals or otherwise in a position oI having superior
inIormation, there are critical responsibilities regarding duty to clients and employers.
CFACENTER.COM 44
Since investment proIessionals are in a position oI trust and responsibility, they have a
Iiduciary duty to their clients. When there is a conIlict oI interest, clients' interests
come Iirst.

It is not unethical Ior investment proIessionals to trade and proIit Irom personal
investing iI (1) the client is not disadvantaged, (2) there is no personal beneIit Irom
trades undertaken Ior clients, and (3) regulatory requirements are satisIied.

Recommendations oI AIMR's Personal Investing Task Force: Generally, investment
Iirms should establish procedures to eliminate conIlicts oI interest. II a supervisor
Iinds the current procedures inadequate, senior managers should be notiIied. The
supervisor should reIuse Iurther responsibility in this area until procedures are made
adequate.

Investment personnel or supervisors should:
ReIrain Irom participation in equity IPOs
Limit participation in private placements
Establish blackout/restriction periods Ior trading on speciIic securities
Discourage short-term trading (less than 60-day holding period)
Do not accept giIts oI material value Irom business contacts
Allow service as directors with prior approval and disclosure
Establish reporting procedures Ior personal investments
Disgorge proIits on prohibited trades
Disclose the Iirm's personal investing policies

D. Corporate Covernance

The primary issue in this section regards the proper use oI shareholder voting rights
delegated to a Iiduciary. The bottom line is that Iiduciary duty dictates how shares
should be voted. Fiduciaries are obligated to vote proxies in an inIormed and
responsible manner Ior the beneIit oI the beneIiciaries.

A corporation has a board oI directors that oversees management. In theory, the board
oI directors acts in the interest oI shareholders. Shareholders can vote on speciIic
corporate actions including the election oI directors. II shareholders are dissatisIied
with management oI a company, they can sell their shares. However, this option may
be limited iI the investor must retain the investment Ior diversiIication or other
specialized reasons.

Proxies: Fiduciaries oIten control voting interests oI clients or beneIiciaries through
CFACENTER.COM 45
proxies. It is important to establish and administer a proper proxy voting policy to
IulIill Iiduciary duties.

Obstacles to eIIective proxy voting:
Lack oI a clear policy
Not distinguishing routine proxies Irom important ones
Do proxies matter iI Iund is passive? (i.e., an index Iund)
Communicating inIormation in a timely manner
Delegation oI vote does not transIer duty

Elements oI a Proxy Voting Policy:
First, establish a policy-making body. This body will develop guidelines oI how to
review proxy issues, veriIy that voting action is in accord with objectives oI
investors or beneIiciaries, determine how to query Iirm management prior to the
vote, and how to report actions to investors, beneIiciaries, and plan sponsors. This
body must also identiIy major proxy issues.
Second, the policy should clariIy who has the authority to vote proxies, provide
Ior adequate record keeping, assure timely receipt oI materials, identiIy and
minimize conIlicts oI interest, and provide training Ior staII.

E. AIMR's Soft Dollar Standards

SoIt dollar practices reIer to the use oI client brokerage to purchase services that are
valuable to the investment decision-making process. The classic example? An advisor
uses a particular broker Ior client transactions. The broker provides the advisor with
research services. The advisor has purchased research with soIt dollars. Note that
these Standards are voluntary.

Fundamental Principles oI AIMR's Standards:
1. As a Iiduciary, the manager must disclose all relevant beneIits obtained Irom
client brokerage
2. Proprietary research (Irom broker) and third-party research (Irom an independent
source) are treated the same. Each has a cost.
3. Research purchased through brokerage should beneIit the investment
decision-making process, not the management oI the investment Iirm
4. II unclear, pay Ior services with manager's Iunds, not client brokerage

The Standards:
1. General issues. Brokerage is the property oI the client. The manager must seek
best execution, minimum transaction costs, use oI client brokerage to beneIit
CFACENTER.COM 46
clients. Client interests come Iirst. Allocation oI brokerage can not be based on
client reIerrals Irom the broker.

2. Relationship with clients. The manager is required to disclose soIt dollar
arrangements involving client accounts to clients. It is recommended that the
manager assure that clients receive beneIits oI research purchased with client
brokerage.

3. Selection oI Brokers. The manager must obtain Best Execution. This means that
the client's total cost is most Iavorable under the circumstances. The manager is
required to consider the capabilities oI the broker to provide Best Execution. It is
recommended that the manager consider a broker's responsiveness, commission
rate or spread, and range oI services when evaluating capabilities.

4. Evaluation oI Research. The manager is required to:
determine whether Research provided meets Standard IV.A., beneIits the
Client, and disclose to the Client (and get Client's consent) iI the research
provides beneIit Ior other clients.
not pay Ior research that does not meet these standards
determine the portion oI Mixed-Use Research paid Ior with client
brokerage. It should be a reasonable, justiIiable, and documentable
allocation. Only the portion applied to the investment decision-making
process should be allocated. Reevaluate allocation at least annually.

5. Client-Directed Brokerage. Brokerage is the property oI the client. The manager
is required not to use other client's brokerage to pay Ior brokerage that is
client-directed. It is recommended that the manager continue to seek to obtain
Best Execution.

6. Disclosure. A manager is required to (1) disclose soIt dollar policies to clients and
potential clients; (2) disclose research received through third-party arrangements
to clients; (3) provide an annual statement explaining how soIt dollar
arrangements comply with Standards; (4) disclose in writing that additional detail
can be requested.

7. Record Keeping. Managers are required to maintain records to (1) meet legal
requirements, (2) concerning all relevant aspects oI soIt dollar arrangements, (3)
documenting compliance with Standards, and (4) documenting all client
disclosures and authorizations.

CFACENTER.COM 47
H. Global Investment Performance Standards

a. explain why the CIPS standards were created.

The overall purpose oI GIPS is to provide guidelines Ior Iair and Iull disclosure oI
investment perIormance. This will allow current and potential clients to properly
interpret investment results over time and between Iirms. GIPS represents a minimum
set oI reporting standards.

There are Iour goals oI GIPS:
Bolster investor conIidence by ensuring the completeness and Iairness oI
investment management perIormance inIormation on a global basis.

Serve as a minimum standard to which all investment managers in the world
should adhere.

Enable global investment management Iirms to present perIormance results
that are comparable with Iirms in other countries.

Facilitate communications between investment managers and their prospective
clients on evaluating historical perIormance results and developing Iuture
strategies.

b. explain what parties the CIPS standards apply to and who they serve.

1. Firms: the GIPS standards apply primarily to investment management Iirms. The
perIormance results oI Iirms adopting GIPS will be more readily comparable.
However, while Iirms are encouraged to adopt GIPS, the standards are voluntary.

2. AIMR Members, CFA Charterholders, and CFA Candidates:
GIPS is a way oI ensuring that no material misrepresentation oI perIormance
takes place
It satisIies Standard V.B.
Members, charterholders, and candidates should inIorm employers oI GIPS
and encourage its adoption (but it is not mandatory)

3. Prospective and Current Clients:
They are the primary beneIiciaries
Allows eIIective comparisons: they can directly compare the perIormance
CFACENTER.COM 48
results oI Iirms adopting GIPS.
Clients must still use due diligence

c. state the objectives and key characteristics of the CIPS standards.

Objectives
1. Obtain worldwide acceptance oI a standard Ior the calculation and
presentation oI investment perIormance in a Iair, comparable Iormat that
provides Iull disclosure.
2. Ensure accurate and consistent investment and perIormance data Ior reporting,
record keeping, marketing and presentation.
3. Promote Iair, global competition among investment Iirms Ior all markets
without creating barriers to entry Ior new Iirms.
4. Foster a notion oI industry selI-regulation on a global basis.

Key Elements

GIPS are ethical standards, not legal standards, Ior perIormance presentation:
the objective is to present perIormance results Iairly and with Iull disclosure.

GIPS serve as minimum worldwide standards: iI local laws are more strict
than GIPS, local laws should be applied. II local laws don't exist or are less
strict than GIPS, the GIPS should apply. In cases oI conIlicts with GIPS, the
Standards require that local laws and regulations take precedence over GIPS.
Firms should disclose the conIlicts.

Require inclusion oI all Iee-paying discretionary portIolios in composites
showing a minimum oI Iive years oI GIPS compliant history.
Composite is deIined as a group oI portIolios that are managed with
the same strategy or objective. Rather than presenting perIormance oI
each individual portIolio, the Iirm can simply disclose the composite
return oI the portIolios as a group.
Firms should present their long-term perIormance record. This
generally means a 5-year record (which, eventually, will be extended to
10 years) oI its actual perIormance history. Firms cannot alter their
perIormance history by excluding portIolios no longer under
management or no longer managed by the same manager, and by
including the perIormance oI portIolios managed by current employees
beIore they started working Ior the Iirm.

CFACENTER.COM 49
Certain procedures must be met beIore a Iirm can claim compliance with GIPS,
and that its compliance with GIPS has been veriIied.

d. state the scope of the CIPS standards with respect to definition of firm, historical
performance record, and compliance.

It is intended that GIPS compliance be available to any Iirm. A Iirm must comply with
GIPS on a firm-wide basis to claim compliance with the standards. All actual,
Iee-paying, discretionary portIolios managed by the Iirm must be included in the
perIormance measurement process.

Definition of a firm

To be in compliance, an entity must state how it deIines itselI as a Iirm. A Iirm may be
deIined as:
an entity registered with an appropriate national investment regulatory
authority. This is the broadest deIinition oI "the Iirm.
an investment Iirm, subsidiary or division held out to be a distinct business
unit Ior managing investment assets. This could be part oI a larger
organization.
all assets managed in one or more base currencies. This deIinition can only be
used until January 1, 2005.

Historical Performance Record

To be in compliance, a Iirm must:
initially present a minimum oI 5 years oI compliant annual investment
perIormance results except Ior composites which have been in existence Ior
less than 5 years in which case composite perIormance since inception must be
presented.
add an additional year oI compliant perIormance results each year until they
reach 10 years oI results.

The goal is to have 10 years oI GIPS compliant perIormance results presented. To
encourage Iirms to participate, GIPS only requires 5 years oI data to initially come
into compliance allowing the Iull 10 years oI perIormance results to be built over time.
There is nothing to prevent a Iirm Irom initially presenting a Iull 10 years oI
compliant results. To maintain compliance a compliant Iirm presenting less than 10
years oI perIormance results must increase the number oI years oI perIormance results
presented.
CFACENTER.COM 50

Claim of Compliance

In order to claim compliance, a Iirm must meet all the requirements set Iorth in GIPS.
Firms that Iully comply with GIPS may use the Iollowing compliance statement in
their perIormance presentations: |Name oI the Iirm| has prepared and presented this
report in compliance with the Global Investment PerIormance Standards (GIPS).

With regard to compliance, a Iirm is either in compliance or not in compliance. Firms
may not make any claims to being "in compliance except Ior...".

Only investment management firms can claim compliance with GIPS.
Pension and proIit sharing plan sponsors and consultants cannot claim
compliance with GIPS, unless they actually manage the portIolios. Such
entities can only endorse GIPS.
SoItware developers and vendors cannot claim compliance with GIPS since
they don't actually manage portIolios.

It should be noted that components oI GIPS that are currently "recommended" may at
a Iuture date be required. Firms should establish procedures to monitor GIPS
requirements and the Iirm's perIormance measurement and presentation to ensure
continued compliance.

e. identify the requirements of each of the five main topics of the CIPS standards:
input data, calculation methodology, composite construction, disclosures, and
presentation and reporting.

Following are the Iive basic elements involved in GIPS. Each element has required
components and recommended components. Required procedures must be Iollowed in
order to be Iully compliant with the GIPS. Many oI the recommended components are
not necessary to claim compliance but will become required at a Iuture date.
Presented below are the required components.

Input data
Input data requirements set standards Ior the collection oI the data necessary
Ior calculating perIormance results that will be comparable across Iirms.
PortIolios should be valued at least monthly (quarterly valuations were
acceptable prior to 2001) using market values oI the assets held. It is
anticipated that starting in 2010, portIolio valuations must be made at any time
external cash Ilows occur between monthly valuation dates.
CFACENTER.COM 51
Fixed income security valuations should include accrued interest while
dividend paying securities credit dividends as oI the ex-date.

Calculation Methodology
Total returns methodology is required Ior compliance. Total returns include
realized and unrealized capital gains/loses and interest (accrued during
valuation period) and dividends paid (considered paid on the ex-date).
Geometrically linked time-weighted returns must be used.
When external cash Ilows occur between portIolio valuation dates, the
time-weighted returns must be adjusted Ior the daily weighted cash Ilows. It is
anticipated that starting in 2010 valuation will be required on all external cash
Ilow dates so time-weighted returns will not need to be adjusted.
Fixed income valuation must include accrued interest.
Returns are computed net oI transactions costs.
Asset weightings in composites are based on beginning oI period asset values.
Cash and cash-equivalent returns must be included in total return calculations,
regardless oI the objective oI the portIolio.

Composite Construction
All discretionary, Iee-paying portIolios must be included in at least one
composite.
Composites should included all portIolios oI similar investment strategy or
objective.
New portIolios must be included into an appropriate composite on a timely
basis.
Composites must include terminated portIolios up through the last Iull
reporting period prior to termination.
Composites must include only assets that are under management and may not
link actual returns with simulated or model portIolio returns.
Single asset class composites carved out oI multiple asset class portIolios must
include cash as part oI the single asset class. Starting in 2005, multiple asset
class portIolios may not be carved out to Iorm a single asset class composite
unless the assets are actually managed in that Iashion with their own cash
allocation.

Disclosures
DeIinition oI the Iirm.
Total Iirm assets Ior each period.
Availability oI a list and description oI the Iirm's composites.
II settlement date valuation is used (trade date is preIerred).
Minimum asset level Ior a portIolio's inclusion in a composite (iI a minimum
is set, no portIolios below that asset size should be included in the composite.)
The currency used Ior expressing perIormance.
The usage oI leverage or derivatives with enough detail to allow Ior
CFACENTER.COM 52
assessment oI the risks involved.
Whether results are net or gross oI management Iees or other Iees paid by
clients to the Iirm.
Relevant details oI treatment oI taxes.
For composites managed against benchmarks, the percentage oI composite
assets invested in countries or regions not included in the benchmark.
Any known inconsistencies between exchange rates used Ior translating
composite returns and those used Ior translating benchmark returns.
Whether any non-Iee-paying portIolios are included in composites, and iI so,
the percentage oI composite assets that are non-Iee-paying.
Whether the presentation conIorms with local laws that diIIer Irom GIPS, and
iI so, what are the conIlicts.
Whether any perIormance Ior periods prior to 2000 do not comply with GIPS,
and iI so when and how do the presented results Iail to comply.
When a single asset class composite is carved out oI a multiple asset class
portIolio, the methodology Ior allocating the cash to the composite.

Presentation and Reporting
At least 5 years (or since inception oI composite iI less than 5 years) oI
perIormance that is GIPS compliant. To maintain compliance, an additional
year oI compliant perIormance results must be added each year until a total oI
10 years oI compliant perIormance are presented.
For each year, presentation must include:
Annual returns.
Number oI portIolios in composite.
Total assets in composite.
Percentage oI Iirm's total assets represented by the composite.
A measure oI dispersion oI component portIolio returns around the
composite return.
Standard Compliance Statement indicating Iirmwide compliance with GIPS.
Composite creation date.
Firms may link non-compliant perIormance so long as the minimum compliant
time periods (5 years initially increasing to 10 years over the next 5 years) are
met and no non-compliant time periods occur aIter January 1, 2000. Firms
must disclose the non-compliance stating how the perIormance reporting is
non-compliant.
PerIormance periods oI less than one year should not be annualized.
PerIormance results Irom a past Iirm or aIIiliation can only be linked to
perIormance results oI a new Iirm or aIIiliation iI:
the change was a change in ownership or in name only, or
the new Iirm has all the supporting records required Ior perIormance
calculation, substantially all oI the assets in the composite are
transIerred to the new Iirm, and the investment decision making
process remains substantially the same.
CFACENTER.COM 53
II a compliant Iirm and a non-compliant Iirm are combined, the resulting Iirm
has one year to bring the non-compliant assets into compliance.
When single asset class composites are carved out oI multiple asset class
composites the Iirm shall report:
the underlying composites Irom which the carve-out was drawn, and
the percentage oI each composite the carve-out represents.
The total return Ior a benchmark portIolio must be presented Ior the same time
periods as the composite returns. The benchmark must represent a similar
investment style as the composite. The presentation must disclose why no
benchmark returns are not presented iI there are no benchmark returns. II the
benchmark changes during the presentation history, the date oI and reason Ior
the change must be disclosed. II the benchmark is a combination oI other
benchmarks or a custom benchmark, the methodology Ior creating and
rebalancing the benchmark must be disclosed.

f. describe the scope and purpose of verification.

VeriIication reIers to the independent review oI a Iirm's perIormance measurement
processes and procedures. VeriIication applies to the Iirm as a whole, not to individual
composites, and tests whether the Iirm has complied with GIPS composite
construction requirements on a Iirm-wide basis, and whether the Iirm's processes and
procedures are designed to calculate and present GIPS compliant perIormance results.
Again, the Iocus oI veriIication is not on individual composites, but is on the
processes the Iirms Iollows to Iorm composites and calculate and report perIormance.

At this point in time, veriIication is not mandatory, but it is strongly recommended.
Firms may claim compliance, but independently veriIied compliance adds credibility
to those claims. The minimum period oI perIormance presentation that can be veriIied
is one year. It is recommended though that Iirms have all years Ior which they are
claiming compliance veriIied. Firms may only claim veriIied compliance Ior those
years that have actually been veriIied.

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Study Session 1 Ethical and ProIessional Standards

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