R02.5 Guidance For Standards III (C), III (D), and III (E) - Answers

Question #1 of 40 Question ID: 1228336
While it would be customary to report both ve-year and ten-year performance data, Seminole
Equity Partners has been in existence for only eight years. Because of this, Kurt Dambach does
not report ten-year data but reports for both ve years and since the inception of the fund.
This he notes in a footnote at the bottom of the information sheet. This action is:
A) in accordance with the Code and Standards since he has indicated the basis in a
footnote.
B) a violation of the Standard concerning prohibition against misrepresentation.
C) a violation of the Standard concerning performance presentation.
Explanation
Members who communicate performance information must ensure that the information is
fair, accurate, and complete. Seminole Equity's presentation meets this standard.
(Study Session 1, Module 2.5, LOS 2-III.(D))
While servicing his clients' accounts, an analyst who is a CFA charterholder, determines that
one client is probably involved in illegal activities. According to Standard III(E), Preservation of
Con dentiality, the analyst may NOT do which of the following?
A) Contact CFA Institute about the determination.
B) Both contact CFA Institute and governmental authorities.
C) There are no exceptions in this list.
Explanation
Standard III(E) allows an analyst to reveal information about a client to CFA Institute since
CFA Institute will keep the information con dential. If the analyst is reasonably certain a law
has been violated, an analyst may have an obligation to report the activities to the
appropriate authorities. Therefore, none of the listed actions are exceptions from the
analyst's options.
(Study Session 1, Module 2.5, LOS 2-III.(E))

Standard III(E), Preservation of Con dentiality, applies to the information that an analyst
learns from:
A) current clients and former clients only.
B) current clients, former clients, and prospects.
C) current clients and prospects only.
Explanation
According to Standard III(E), Preservation of Con dentiality, an analyst must preserve the
con dentiality of information communicated by clients, former clients, and prospects.
The following information pertains to the Galaxy Trust, a trust established by Stephen P.
House and managed by Gamma Investment LLC:
At the time the trust was established House provided $5 million in cash to fund the
trust, but Gamma was aware that 93% of his personal assets were in the form of Oracle
stock.
Gamma has been asked to view his funds and the trust as a single entity for planning
purposes, since House's will stipulates that all of his estate will pass to the trust upon
his death.
The investment policy statement, developed in September 1996, stipulates that the
trust should maintain a short position in Oracle stock and use the proceeds to diversify
the trust more adequately.

House was able to sell all of his Oracle shares back to the corporation in January 1999
for cash.
The policy statement redrawn in September 1999 continues to stipulate that the trust
hold a short position in Oracle stock.

House has given the portfolio manager in charge of the trust an all expenses paid
vacation package anywhere in the world each year at Christmas. The portfolio manager
has reported this fact in writing to his immediate supervisor at Gamma.
Which of the following is most correct? The investment manager is:
A) not in violation of the Code and Standards for not properly updating the
investment policy statement in light of the change in the circumstances and is not
B) in violation of the Code and Standards by not properly updating the investment
policy statement in light of the change in the circumstances but is not in violation
ih d h f h if f
C) in violation of the Code and Standards by not properly updating the investment
policy statement in light of the change in the circumstances and is in violation with
d h f h f f
Explanation
The investment manager is in violation of the Standard requiring him to make a reasonable
inquiry into the client's nancial situation and update the investment policy statement since
such a dramatic change in the client's circumstances would undoubtedly alter the
investment policy statement and would probably eliminate the need to hold a short position
in Oracle. The investment manager is not in violation of the Standard concerning additional
compensation, since the gift has been reported to his supervisor and has come from a
client. If there was a failure to report such a gift, if the rm had a rule in place against the
acceptance of gifts from clients, or if the gift had come from a non-client, there would be a
violation of the standard.
(Study Session 1, Module 2, LOS 2.a)
Patricia Young is an individual investment advisor who uses a computer model to place each
of her clients into an appropriate portfolio. The model analyzes a range of simulated portfolios
and computes for each the probabilities of achieving various levels of return. Young then
selects the portfolio that provides the highest probability of achieving the clients' minimum
required return. By using this process, Young is:
A) violating Standard III(C) - Suitability.
B) not violating the Standards.
C) violating Standard I(C) - Misrepresentation.
Explanation
Standard III(C) Suitability requires that Young select investments that are consistent with
clients' risk and return objectives. However risk tolerance is not adequately addressed by
Young's process.

Bob Hat eld, CFA, has his own money management rm with two clients. The accounts of the
two clients are equal in value. One of the clients gets married and the assets of the new
spouse and the client are combined. With the larger portfolio of the now married client,
Hat eld determines that they can assume a higher level of risk and begins a change in the
policy concerning that portfolio. Which of the following would violate Standard III(C),
Suitability?
A) Assess the time horizon of the newly married client and his spouse.
B) Implement a similar policy for the other client who did not just get married.
C) Assess the return objectives of the newly married client and his spouse.
Explanation
According to Standard III(C), Suitability, the analyst must assess the time horizon, return
objectives, tax considerations, and liquidity needs of a client before changing an investment
policy. The analyst must notify the client of the new policy. Implementing the policy for the
other client may be a violation of the Standard unless that client's needs are totally
reassessed and determined to be identical to the needs of the newly married client.
(Study Session 1, Module 2.5, LOS 2-III.(C))
A broker was sanctioned for unsuitable recommendations and excessive trading involving
three accounts under his care. These clients were unsophisticated, inexperienced individual
investors with limited means.
Question #7 - 8 of 40 Question ID: 1228319
In this situation, all of the following would be components of an e ective compliance process
EXCEPT:
A) educating clients in the basics of investment characteristics.
B) using margin accounts.
C) diversifying portfolios where appropriate.
Explanation
Using margin accounts would be inappropriate in this situation because it would increase
the risk of loss and require clients to pay interest on the margin loan, adding to the cost to
maintain the account. Trading on margin is inappropriate for unsophisticated, inexperienced
individual investors with limited means.

In this situation, which of the following would NOT be a component of an e ective compliance
process?
A) Examine risk tolerance carefully because risk tolerance is an important element in

determining an appropriate investment policy statement.
B) Educate clients on how to select investments because this can help clients
accomplish their investment policy statement goals.
C) Use concentrated portfolios consisting of only a few assets because this approach
reduces trading costs.
Explanation
In this case, the broker increased the risk of loss for the clients beyond that consistent with
the client objectives by concentrating much of their equity in particular securities. A
component of an e ective compliance process would be to develop diversi ed portfolios to
reduce portfolio risk.
An analyst thinks that a major change in the tax law will bene t holders of utility company
stocks. She immediately begins calling all her clients and telling them of the upside potential
of investing in such assets now. Based upon this information, this is most likely:
A) a violation of Standard V(A), Diligence and Reasonable Basis.
B) congruent with Standard V(A), Diligence and Reasonable Basis.
C) a violation of Standard III(C), Suitability.
Explanation
According to Standard III(C), the analyst needs to determine the suitability of an investment
for each client. It is doubtful that all her clients are identical in their needs. According to the
information, the analyst mentions the upside potential but does not mention the downside
risk. Although the information says that she thinks that the change in the tax law will bene t
holders of utility company stocks and says nothing of how she arrived at this conclusion, we
do not know if she has or has not made her decision on a reasonable basis.

While having a conversation with a prospective client, John Henry states that his performance
across all of his past clients over the past ve years was over 20%, which was 200 basis points
higher than his benchmark. He tells the client that while the benchmark may rise or fall over
time, his excess performance will remain consistent. Henry violated the Standards of
Professional Conduct because:
A) he cannot discuss performance without clearly stating that the composite does
not conform to GIPS.
B) he cannot discuss prospective future performance in any manner.
C) the statement of excess performance is misleading with respect to its certainty.
Explanation
Guaranteeing performance on investments that are inherently volatile is misleading to

clients.
Chandra Patel, CFA, manages private client portfolios for QED Investment Advisers. Part of
QED's rm-wide policy is to adhere to CFA Institute Standards of Professional Conduct in the
management of all client portfolios, and to this end, the rm requires that client objectives,
investment experience, and nancial limitations be clearly established at the outset of the
relationship. This information is updated at regular intervals not to exceed eighteen months.
The information is maintained in a written investment policy statement for each client.
Anarudh Singh has been one of Patel's clients ever since she began managing money ten
years ago. Shortly after his regular situational update, Singh calls to inform Patel that his uncle
is ill, and it is not known how long the uncle will survive. Singh expects to inherit "a sizeable
sum of money," mainly in the form of municipal bonds. His existing portfolio allocation
guidelines are for 75% to be invested in bonds. Singh believes that the expected inheritance
will allow him to assume a more aggressive investment pro le and asks Patel to begin moving
toward a 75% allocation to equities. He is speci cally interested in opening sizable positions in
several technology rms, some of which have only recently become publicly traded
companies. Patel agrees to begin making the changes to the portfolio and the next day begins
selling bonds from the portfolio and purchasing stocks in the technology sector as well as in
other sectors. After placing the trade orders, Patel sends Singh an email to request that he
come to her o ce sometime during the next week to update his investment policy statement.
Singh replies to Patel, saying that he can meet with her next Friday.
A few days before the meeting, however, Singh's uncle dies and the portfolio of municipal
bonds is transferred to Singh's account with QED. Patel sees this as an opportunity to
purchase more technology stocks for the portfolio and suggests taking such action during her
meeting with Singh, who agrees. Patel reviews her les on technology companies and locates a
report on NetWin. The analyst's recommendation is that this stock is a "core holding" in the
technology sector. Patel decides to purchase the stock for Singh's account, as well as several
other wealthy client accounts with high risk tolerance levels, but due to time constraints she
does not review the holdings in each account. Patel does examine the aggregate holdings of
the accounts to determine the approximate weight that NetWin should represent in each
portfolio.
Since Patel has very recently passed the Level III examination leading to the award of the CFA
designation, QED sends a promotional email to all of the rm's clients. The email states "QED
is proud to announce that Chandra Patel is now a CFA (Chartered Financial Analyst). This
distinction, which is the culmination of many years of work and study, is further evidence of
the superior performance you've come to expect at QED." Patel also places phone calls to
inform of her accomplishments several brokers that she uses to place trades for her accounts,
stating that she "passed all three CFA examinations on the rst attempt." One of the people
Patel contacts is Max Spellman, a long-time friend and broker with TradeRight Brokers Inc.
Patel uses the opportunity to discuss her exclusive trading agreement with TradeRight for
Singh's account.
When ordering trades for Singh's account, Patel's agreement with TradeRight for brokerage
services requires her to rst o er the trade to TradeRight and then to another broker if
TradeRight declines to take the trade. TradeRight never refuses the trades from any manager's
clients. Patel established the relationship with TradeRight because Singh, knowing the rm's
fee schedule relative to other brokers, asked her to do so. However, because TradeRight is
very expensive and o ers only moderate quality of execution, Patel is considering directing
trades on Singh's account to BullBroker, which charges lower commissions and generally
completes trades sooner than TradeRight.
Do QED's policies comply with CFA Institute Standards of Professional Conduct with respect to
the information contained within the client investment policy statements and the frequency
with which the information is updated?
Information Frequency
A) No Yes
B) No No
C) Yes No
Explanation
According to Standard III(C) Suitability, members and candidates must consider investment
experience, objectives (risk and return), and constraints before investing funds on the
client's behalf or recommending investments to the client. The rm has complied with the
information content. The investment policy statement must be updated at least annually, or
after signi cant changes in client circumstances, however, according to the guidance
statement accompanying Standard III(C). Thus the rm has not complied with Standard III(C)
in this regard.
In light of Singh's comments during his telephone call to Patel prior to his uncle's death, which
of the following actions that Patel can take comply with CFA Institute Standards of Professional
Conduct?
A) Patel must not place any trades in the account until she meets with Singh to
develop a new portfolio strategy based on the updated information.
B) Patel must adhere to the existing portfolio strategy until she meets with Singh to
develop a new portfolio strategy based upon updated nancial information but
l d hi h i ih h i i
C) Patel may change the current portfolio strategy and begin trading based upon
Singh’s expectations because he advised her to do so.
Explanation
According to Standard III(C) Suitability, Patel must observe the written investment objectives
now in e ect as determined in cooperation with the client and may trade only on that basis.
Because the anticipated change in Singh's nancial condition was subject to an event of
indeterminable timing, she should continue to honor the existing written investment
objectives until a change (1) is warranted by an actual increase in the client's total nancial
assets and (2) has been agreed upon with her client.
According to CFA Institute Standards of Professional Conduct, may Patel reallocate Singh's
portfolio toward technology stocks after his Uncle dies but before the meeting with Singh?
A) Yes, because the total value of the municipal bonds received into the account will
be too large relative to the other assets in the portfolio.
B) No, because Patel and Singh must meet and revise the investment policy
statement and portfolio strategy before reallocating.
C) No, because Patel must wait until the next annual meeting to reallocate.
Explanation
According to Standard III(C) Suitability, investment recommendations and actions must be

consistent with a client's written objectives and constraints (usually in the form of an
investment policy statement (IPS)). Because Singh's written IPS would not allow the large
allocation to technology stocks prior to receiving the inheritance, the IPS must be updated
by Singh and Patel prior to taking any actions that deviate from the original IPS. Patel will
violate Standard III(C) by reallocating the portfolio before meeting with Singh.
Did Patel violate any CFA Institute Standards of Professional Conduct when she purchased the
NetWin stock for Singh's portfolio or for the other clients' portfolios?
Singh's Other
portfolio portfolios
A) Yes Yes
B) No Yes
C) No No
Explanation
According to Standard III(C) Suitability, Patel must analyze the appropriateness and
suitability of NetWin.com stock on a case-by-case basis before buying it. This will necessarily
consider the basic characteristics of the security and how these will a ect overall portfolio
characteristics relative to the existing investment strategy for each portfolio. Patel has not
analyzed the e ect that the stock will have on any of the individual portfolios in question
and has thus violated the Standard. Patel cannot look at aggregate measures to determine
the appropriate weight that the security should represent in the individual portfolios
because the portfolios are being managed individually, not in aggregate.

Which of the following is least accurate regarding the promotional announcement of Patel
passing the Level III exam?
A) The announcement violates the Code of Ethics because it implies that obtaining a
CFA charter leads to superior performance.
B) The promotional announcement uses the letters “CFA” as a noun which is

prohibited by CFA Institute.
C) The fact that a promotional announcement was made violates the restrictions on
misrepresenting the meaning of the CFA designation.
Explanation
An announcement that a member of a rm has received the right to use the CFA®
designation is not a violation of the Code or Standards. However, Standard VII(B) requires
that any reference to the Charter must not misrepresent or exaggerate the meaning or
implications of the CFA designation. A Charterholder cannot claim that holding a Charter
leads to superior performance results. Using the letters "CFA" as a noun, as in "he is a CFA"
is prohibited by CFA Institute. Finally, passing all three exams does not give one the right to
use the designation. All criteria must be met (e.g., experience requirements) before Patel
can use the designation.
With respect to the choice of broker, did Patel violate any CFA Institute Standards of
Professional Conduct?
A) Yes, since Patel failed to properly notify Singh that using TradeRight would lead to
higher commissions and opportunity costs.
B) Yes, since Patel is obligated to seek the best possible price and execution for all
clients.
C) No.
Explanation
Since Singh directed Patel to use TradeRight, this should be considered client-directed
brokerage. While Patel should inform Singh of the implications of that choice, Patel has no
option but to follow the client's direction according to Standard III(A) Loyalty, Prudence, and
Care. Singh was fully aware of the fees charged by TradeRight relative to other brokerage
rms and elected to use TradeRight anyway. Investment managers are obligated to seek the
best price and execution in the absence of client direction.

Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents
special requirements. To construct an investment policy statement for Peters, Hull inquires
about Peters' investment experience, risk and return objectives, and nancial constraints.
Peters states that he has a great deal of investment experience in the capital markets and
does not wish to answer questions about his tolerance for risk or his other holdings. Under
Standard III(C), Suitability, Hull:
A) is permitted to manage Peters’ account without any knowledge of his risk

preferences.
B) may accept Peters’ account but may only manage his portfolio to a benchmark or
index.
C) must decline to enter into an advisory relationship with Peters.
Explanation
Hull would not violate Standard III(C), Suitability, by managing Peters' account without
knowledge of his risk preferences. She made a reasonable inquiry into Peters' investment
experience, risk and return objectives, and nancial constraints, as the Standard requires. If
a client chooses not to provide some of this information, the member or candidate can only
be responsible for assessing the suitability of investments based on the information the
client does provide.
Greg Stiles, CFA, CAIA, is liquidating a large portion of a client's portfolio because the client is
planning to buy a vacation home. Stiles informs one of his colleagues at the rm that the client
is looking for a vacation home, because the colleague's wife is a licensed real estate broker.
With respect to Standard III(E) Preservation of Con dentiality, this action:
A) violates the Standard unless the client has given explicit permission to disclose his
plans.
B) does not violate the standards because he did not share the information outside
the rm.
C) Does not violate the standards because he did not disclose any details about the
client’s portfolio or other nancial resources.
Explanation
According to Standard III(E) Preservation of Con dentiality, Stiles must keep client
information con dential and limit the information to others in his rm that are involved in
the work being performed for the client. The con dentiality standard applies to any
information that a member has learned in the performance of his duties for the client.
Greg Stiles, CFA, keeps a list of his clients' birthdays and has personally sent them a birthday
card each year at the appropriate time. With respect to this action, which of the following may
be a violation of Standard III(E), Preservation of Con dentiality?
A) Sending a gift along with the card.
B) Hiring a company outside the rm to perform the task.
C) The mere act of sending a birthday card each year.
Explanation
According to Standard III(E), an analyst should limit the number of persons who have access
to clients' personal information. Allowing a company outside the rm to send birthday cards
could be a violation. Sending a birthday card is not a violation, nor is sending a gift of
reasonable value.
A money management rm has created a new junk-bond fund. When the rm advertised the
new fund at its issuance, they used care to accurately compute the returns from the past 10
years for all assets in the fund. The rm used the current portfolio weights to determine an
average annual historical return equal to 18% and claim an 18% annual historical return in
their advertising literature. With respect to Standard III(D), Performance Presentation, this is:
A) in compliance.
B) a violation because the advertisement implies the rm generated this return.
C) a violation because the Standard prohibits computing historical returns on risky

assets like junk bonds.
Explanation
Reporting the historical returns of all assets now in the fund introduces a survivorship bias.
Also, the advertisement is misleading because the fund just came into existence and has no
historical record. Thus, the rm has misled the public as to their performance history.
Ned Brenan manages two dozen pension accounts, one of which earned over 25% during the
past two years. Brenan tells prospective clients that based on past experience they can expect
a 25% return on their funds. Which of the following statements is CORRECT?
A) Brenan has violated Standard of Professional Conduct III(D), Performance

Presentation, but Brenan has not violated Standard I(C), Misrepresentation.
B) Brenan has violated both Standard of Professional Conduct III(D), Performance

Presentation, and Standard I(C), Misrepresentation.
C) Brenan has not violated Standard of Professional Conduct III(D), Performance

Presentation, but Brenan has violated Standard I(C), Misrepresentation.
Explanation
Brenan violated Standard of Professional Conduct III(D) by using only one portfolio's results
to create a false impression of all the portfolios, and Brenan violated Standard of
Professional Conduct I(C) by creating the impression that a certain return was assured (he
should have used the words "might" or "could" instead of "can").
Greg Stiles, CFA, may withhold from CFA Institute information about a client acquired in the
regular performance of his duties:
A) for neither of the reasons listed.
B) only if Stiles has a special con dentiality agreement with the client.
C) only if Stiles is a relative of the client.
Explanation
According to Standard III(E), Preservation of Con dentiality, Stiles may not withhold
information under any of the listed reasons. The reason is that CFA Institute will keep the
information con dential.
A money manager is meeting with a prospect. She gives the client a list of stocks and says,
"These are the winners I picked this past year for my clients. Their double-digit returns
indicate the type of returns I can earn for you." The list includes stocks the manager had
picked for her clients, and each stock has listed with it an accurately measured return that
exceeds 10%. Is this a violation of Standard III(D), Performance Presentation?
A) Yes, unless the positions listed constitute a complete presentation (i.e., there were
no stocks omitted that did not perform in the double digits).
B) Yes, because the manager cannot reveal historical returns of recent stock picks.
C) No, because the manager had the historical information in writing.
Explanation
Standard III(D) requires fair representations concerning past and potential future
performance. Unless the list of the "winners" includes all the positions that the rm held,
the manager is misrepresenting past performance. The following statement is questionable:
"Their double-digit returns indicate the type of returns I can earn for you," but the action of
submitting a partial list is clearly a violation. The manager should have information on past
performance in writing.
The O'Douls (husband and wife) have decided to work with Jane Mack, CFA, to have her
recommend an investment portfolio for them. The O'Douls are novice investors and Mack has
determined their asset allocation model falls into the conservative category. After researching
various investment options for the O'Douls, Mack has made a recommendation that they
divide their account on a 25%/75% basis between shares of a computer peripherals
manufacturing company her brokerage rm is underwriting and investment grade corporate
bonds. The O'Douls are not aware that Mack's rm is underwriting an o ering of the company
in question. Which CFA Institute Standard(s) has Mack violated given her actions?
A) Standard V(A), Diligence and Reasonable Basis, and I(D), Misconduct.
B) Standard III(B), Fair Dealing, and III(A), Loyalty, Prudence, and Care.
C) Standard VI(A), Disclosure of Con icts, and III(C), Suitability.
Explanation
Mack is obliged to disclose the con ict of interest regarding her company's IPO and to
consider both the appropriateness and the suitability of the investment for her client. She
has apparently failed in both respects.
Lance Tuipulotu, CFA, manages investments for 400 individuals and families and often nds
his resources stretched. When his largest investors petition him to include a 5% to 7%
allocation of non-investment-grade bonds in their portfolios, he decides he needs additional
help to meet the request. He considers various independent advisors to use as submanagers,
but determines that the most quali ed advisors would be too expensive. Reasoning that a
lower-cost provider would enable him to pass the savings along to his clients, he chooses that
provider to invest the new bond allocation. Tuipulotu has violated:
A) Standard III(C) Suitability by failing to consider the appropriateness of the non-

investment-grade bonds.
B) Standard V(A) Diligence and Reasonable Basis by letting fee structure determine
the selection of the submanager.
C) Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis.
Explanation
Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis were
violated. Tuipulotu must perform a full IPS review to determine the appropriateness of the
new portfolio allocations. Submanagers should not be selected by cost structure alone, as
the quality and appropriateness of the submanager is Tuipulotu's responsibility.

While servicing his clients' accounts, an analyst who is a CFA charterholder, determines that
one client is probably involved in illegal activities. According to Standard III(E), Preservation of
Con dentiality, the analyst may NOT do which of the following?
A) There are no exceptions in this list.
B) Contact CFA Institute about the determination.
C) Contact the appropriate governmental authorities about the determination.
Explanation
Standard III(E) allows an analyst to reveal information about a client to CFA Institute since
CFA Institute will keep the information con dential. If the analyst is reasonably certain a law
has been violated, an analyst may have an obligation to report the activities to the
appropriate authorities. Therefore, neither of the listed actions are exceptions from the
analyst's options.
Stephen Rangen, a broker, has three accounts consisting of unsophisticated, inexperienced
individual investors with limited means. One of these accounts is an elderly couple. The clients
want to invest in safe, income-producing investments. They rely heavily on Rangen's advice
and expect him to initiate most transactions in their respective accounts. In managing their
accounts, Rangen pursues the following strategies: (1) buys U.S. treasury strips and non-
dividend paying over-the-counter (OTC) stocks recommended by his rm's research
department, (2) uses margin accounts, and (3) concentrates the equity portion of their
portfolio in one or two stocks. Rangen's approach leads to extremely high turnover rates in all
three accounts.
Which of the following statements about Rangen's conduct is most accurate? Rangen's
conduct:
A) meets the requirements of the Code and Standards because his rm's research
department recommended the U.S. Treasury strips and non-dividend paying
k
B) does not meet the requirements of the Code and Standards because his
investment strategy is inconsistent with his clients' objectives.
C) meets the requirements of the Code and Standards because his clients are aware
of the risks that he is taking in managing their accounts.
Explanation
Rangen's actions are inconsistent with Standard III(C) Suitability because his investment
actions are neither appropriate nor suitable for each client. Even if his clients were aware of
the risks, the portfolios that he constructed are inconsistent with their nancial needs.
Although Rangen relies upon recommendations from his rm's research department, he
cannot shift blame to his employer because he must follow recommendations that are in the
best interests of his clients.
Kim Lee manages a variety of accounts at Superior Investments. Some are permitted to invest
in tax-exempt issues only; others may not invest in a stock unless it pays dividends. Lee is
researching a biotech rm specializing in the analysis of "mad cow" disease. While touring
company facilities and meeting with management, she learns that they believe they may have
found a way to reverse the disease. Moreover, one manager conjectured, "Suppose that we
reversed the disease in someone who didn't even have it? We might then be able to boost that
individual's IQ into the stratosphere!" Lee returns to her o ce and buys shares for all
accounts under her supervision. This action is:
A) appropriate given the obvious potential of the therapy.
B) a violation of the Standard concerning appropriateness and suitability of

investment actions.
C) a violation of the Standard concerning duciary duties.
Explanation
Given the variety of accounts under her supervision, it is not likely the shares of a
speculative biotech rm would be suitable for all accounts. Placing such shares in all
accounts indicates that she has failed to consider the appropriateness and suitability of the
investment for each account, and this places her in violation of Standard III(C).
A candidate or member is least likely violating the Standard regarding the con dentiality of
client information if he shares con dential client information, when not required by law, with:
A) the client’s attorney.
B) the CFA Institute Professional Conduct Program.

C) the co-owner of the client’s account.
Explanation
Standard III(E) Preservation of Con dentiality states that sharing information with the PCP
when requested as part of an investigation is not a violation unless it is prohibited by law.
Disclosure to those outside the rm in other cases is a violation unless the client has given
speci c permission or disclosure is required by law.
According to Standard III(C) Suitability, which of the following is least likely to be considered a
relevant factor in determining the appropriateness and suitability of investment

recommendations or actions for each portfolio or client?
A) Basic characteristics of the total portfolio.
B) Best interests of the investment professional.
C) Needs and circumstances of the portfolio or client.
Explanation
Determining appropriateness and suitability focuses on the portfolio or client, not on the
investment professional. Investment professionals should take particular care to ensure that
their goals in selling products or executing security transactions do not con ict with the best
interests of the client.
Brenda Clark is an investment advisor. Two years ago Clark decided to stop calculating a
return composite because of the time required to make those calculations. A prospective
client asks Clark what she thinks her performance would have been over the past two years.
Clark:
A) cannot answer the question because it would be misleading.
B) can answer the question orally but cannot state the numbers in writing.
C) cannot answer the question, nor can she discuss potential future market returns
with the prospective client.
Explanation
Any discussion of past performance would imply that Clark had made some calculations,
which would be misleading. However, Clark need not calculate historical performance to be
an advisor. She can also talk about her view on the future of capital markets.
Dan Je ries is a portfolio manager who is being sued by one of his clients for inappropriate
investment advice. The Professional Conduct Program of CFA Institute is investigating Je ries
for the same o ense. Je ries settles the lawsuit with the client while the Professional Conduct
Program investigation is ongoing. When the Professional Conduct Program sta questions
Je ries about the problematic investment advice, Je ries claims he cannot talk about it
because doing so would violate the con dentiality of his client. Je ries has:
A) not violated the Standards by executing the settlement agreement or by refusing

to talk about the case with the Professional Conduct Program.
B) violated the Standards by refusing to talk about the case with the Professional
Conduct Program, but not by executing the settlement agreement.
C) violated the Standards by executing the settlement agreement, but not by refusing
to talk about the case with the Professional Conduct Program.
Explanation
Because the Professional Conduct Program will maintain client con dentiality, Standard III(E)
Preservation of Con dentiality does not permit members to refuse to cooperate with a PCP
investigation because of con dentiality concerns. The Standards do not require members to
delay dealing with related legal matters while a PCP investigation is in progress.
Sally Watson works as an equity portfolio manager for Brunswick Investment Advisers (BIA).
Wally Jackson, President and Chief Investment O cer of the rm, is a CFA charterholder who
supervises Watson and other investment professionals within the rm. Watson is a candidate
in the CFA Program, and she has recently passed the Level II exam. BIA's clients include trusts,
foundations, endowments, corporations, and high net worth individuals, including accounts
for family and friends of its employees. Jackson and Watson manage client portfolios with a
growth strategy and concentrate on holdings in the healthcare, technology, and
communications sectors. About 10 percent of BIA accounts are actively managed.

Because BIA uses Accommodate Broker Dealer for executing transactions, Accommodate
provides research to BIA regarding holdings in accounts that are actively managed. The fees
Accommodate charges BIA are competitive, and BIA applies the same basic fee structure to all
its clients. BIA's clients do not know about BIA's arrangement to get research information from
Accommodate.
The clients do know that Accommodate routinely allocates shares in IPOs that it underwrites
to BIA. Jackson is eagerly awaiting the IPO of a new technology company that he intends to
allocate across all current portfolios, including the proprietary account and accounts of friends
and family. Based upon his research, Jackson feels this IPO has good potential and has been
working to get an unusually large number of shares of the IPO.
BIA has recently been awarded two new client accounts, totaling $100 million, which are in the
process of completing transitions from other managers. Although an investment objective and
guidelines have not been formalized for the accounts, Jackson allocates shares of the IPO
across all client accounts on a pro rata basis, including an allocation for these new client
accounts.
Watson serves on the board of directors for New Medical Developments, a biotech rm in
which she maintains signi cant stock and options. BIA owns 4.5 percent of New Medical's
stock on behalf of its clients and in its proprietary account. At a special meeting of New
Medical's board, Watson learns that Remedy Inc. is preparing a con dential tender o er for all
of New Medical's shares outstanding. After the meeting, Watson sends an electronic mail
message to Jackson detailing the o er.
Jackson immediately places New Medical Developments on BIA's restricted list so

representatives of BIA cannot recommend the stock. As rumors circulate in the investment
community about the tender o er, some of Jackson's clients call and ask him to look into the
possibility of purchasing stock in New Medical Developments. Jackson is fearful of his situation
and puts o such requests. As a result, one client, Craig Mills, les a complaint with CFA
Institute that Jackson is not responding to his requests. Knowing the precarious situation he is
in, Jackson decides to wait until the tender o er has been announced to address Mills'
complaint.
CFA Institute becomes suspicious of Mills, because he seems to have a history of trading
stocks for which material information soon becomes public. As part of an investigation into
possible insider trading activities, CFA Institute asks Jackson to furnish CFA Institute with Mills'
trading history.
Watson must notify BIA of all the following EXCEPT:

A) her ownership of the stock in New Medical Developments.
B) her plans for taking the next CFA exam.
C) any independent consulting work she performs for third parties.
Explanation
Watson does not have to inform BIA about her plans to take a CFA exam. She should be
careful, of course, not to misinform BIA of her plans, i.e., say she will when she knows she
cannot. All of the other noti cations are required. Standard VI(A) requires her to inform BIA
about potential con icts of interest. Standard IV(A) requires her to inform BIA about any
consulting work she performs.
With respect to the arrangement that BIA has with Accommodate, based on the information
provided:
A) no violation has occurred since BIA charges the same fee structure to all of its
clients.
B) no violation has occurred as long as BIA informs CFA Institute that the rm
receives research information from the brokerage rm.
C) a violation has occurred because BIA charges the same fee structure to all of its
clients.
Explanation
Watson has violated the Soft Dollar Standard. For directing the trades through a given
brokerage rm, BIA is getting research that only bene ts about 10 percent of the clients. The
remaining clients are paying the same fees, but they are not getting the same bene t. If BIA
were to inform all of its clients of the arrangement, it might not be a violation, but the
vignette says that information has not been disclosed.
With respect to how Jackson allocated the shares in the IPO of the technology company, has
Jackson acted in accordance with the Code and Standards?
A) No, Jackson has violated Standard VI(B) Priority of Transactions.

B) Yes, Jackson allocated the shares of the o ering fairly on a pro rata basis to all
client accounts.
C) No, Jackson has violated Standard III(C) Suitability.
Explanation
Jackson violated Standard III(C) – Suitability by allocating shares of the public o ering to the
two new client accounts without establishing an investment objective or guidelines for the
accounts. Standard III(C) requires a reasonable inquiry into the client's nancial situation,
investment experience, and investment objectives prior to taking any investment actions.
Such information must also be updated regularly. The Standard also requires that the
appropriateness and suitability of investment recommendations or actions be considered
for each client, including 1) client needs and circumstances; 2) basic characteristics of the
investment involved; and 3) basic characteristics of the total portfolio. Although the shares
were allocated pro rata across all client portfolios, no investment action should have been
initiated for the new clients without appropriate consultation regarding investment
objectives and guidelines.
Given Brunswick's current ownership in New Medical, the Code and Standards require Jackson
to:
A) trade the shares in client accounts before any accounts for himself, family or
friends.
B) not take any investment action but communicate the information to other
members of the proxy committee in preparation for consideration.
C) not initiate any investment action prior to the information being publicly
disseminated.
Explanation
Under the Code and Standards, Jackson should not initiate any investment action on the
information provided by Watson in order to prevent a violation of Standard II(A) – Material
Nonpublic Information. The information provided by Watson involved a proposed
con dential tender o er for New Medical's outstanding shares and, therefore, was material,
nonpublic information. Information is "material" if its disclosure would have an impact on
the stock value or if a reasonable investor would want to know the information prior to
making an investment decision. Material is "nonpublic" until it has been generally
disseminated to the marketplace and investors have had an opportunity to react to the
information. Neither Jackson, nor Watson should take any investment action regarding New
Medical. Upon receipt of the information, Jackson should inform his compliance o cer of
the information, but otherwise keep the information con dential. However, not responding
to unsolicited requests from clients to purchase New Medical is a possible violation because
it appears that he is not acting in the best interest of the clients.
Given Watson's actions, which of the following statements is most accurate?
A) Standard III(A) – Loyalty, Prudence, and Care was violated.
B) Standard III(E) – Preservation of Con dentiality was violated.
C) None of the Code and Standards were violated.
Explanation
Watson communicated the tender o er information to her supervisor which is not a

violation of any standards because shares of the target rm, New Medical, are held in some
of BIA's client's portfolios and in the rm's proprietary account thus trading in New Medical
should be put on a restricted list. The information provided by Watson involved a proposed
tender o er for New Medical's outstanding shares and, therefore, was material, nonpublic
information. Information is "material" if its disclosure would have an impact on the stock
value or if a reasonable investor would want to know the information prior to making an
investment decision. Material is "nonpublic" until it has been generally disseminated to the
marketplace and investors have had an opportunity to react to the information. Neither
Jackson, nor Watson should take any investment action regarding New Medical and it should
be added to Brunswick's restricted list to prevent a violation. Since Watson serves on the
board of New Medical she has a duty to the rm but the communication of the tender o er
(for New Medical) by Watson to Jackson is not a violation of Standard III(A) Loyalty,
Prudence, and Care because neither New Medical nor the o ering rm, Remedy, are clients
of BIA the rm Watson works for. Standard III(E) – Preservation of Con dentiality does
not appear to have been violated by Watson's actions. She does not appear to communicate
any con dential information provided by clients, prospects, or her employer concerning the
scope of any client-member, prospect-member or employer-member relationship.

With respect to the complaint Mills led against Jackson, and the subsequent investigation of
Mills by CFA Institute, which of the following statements is least accurate?
A) Jackson violated the Code and Standards by putting New Medical Developments
on its restricted stock list.
B) Jackson violated the Code and Standards by not responding to Mills.
C) Jackson did not violate the Code and Standards if he provides Mills’ trading
information to CFA Institute.
Explanation
Rules concerning the con dentiality of client information do not apply to investigations of
CFA Institute, which will keep any information it receives con dential. Jackson does not
violate a Standard by placing a stock on a restricted list when the rm is in possession of
material nonpublic information, and this is a recommended move. However, unsolicited
requests from clients deserve a response. Jackson is putting his self-interest above his own
by trying to protect himself by not responding to client inquiries concerning New Medical.
Janine Walker is an individual investment advisor with 200 individual clients. When she rst
obtains a client, Walker solicits personal data that helps her formulate an investment
recommendation, including tax status, income, expenditure needs, and risk tolerance. The
Standards:
A) only require to update a client's data when a material change is being made to the
clients' portfolio.
B) require Walker to update the data regularly.
C) require updating a client's data only when a material change occurs to the
personal data.
Explanation
According to Standard III(C), Suitability, Members and Candidates must reassess client
information and update regularly.

Nancy Korthauer, CFA, has launched a new hedge fund called the Korthauer Tautology Fund
and is actively soliciting clients from competitor's rms. Client presentations are necessarily
brief and often take place with the prospective client's current investment advisor in the room.
The Code and Standards require that:
A) all client presentations provide a thorough review of all elements of the

investment management process. Abbreviated presentations are forbidden.
B) member or candidate provide (on request) additional detail information which

supports the abbreviated presentation.
C) a prospective client’s current investment advisor not participate in meetings.
Explanation
See Standard III(D). When presentations are brief, additional detail which supports the
abbreviated presentation information must be provided on request. Best practice dictates
that the member or candidate should make reference to the abbreviated nature of the
presentation.

R02.5 Guidance For Standards III (C), III (D), and III (E) - Answers

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R02.5 Guidance For Standards III (C), III (D), and III (E) - Answers

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Question #1 of 40 Question ID: 1228336

B) a violation of the Standard concerning prohibition against misrepresentation.

C) a violation of the Standard concerning performance presentation.

(Study Session 1, Module 2.5, LOS 2-III.(D))

Question #2 of 40 Question ID: 1228340

A) Contact CFA Institute about the determination.

B) Both contact CFA Institute and governmental authorities.

C) There are no exceptions in this list.

(Study Session 1, Module 2.5, LOS 2-III.(E))

A) current clients and former clients only.

B) current clients, former clients, and prospects.

C) current clients and prospects only.

(Study Session 1, Module 2.5, LOS 2-III.(E))

Question #4 of 40 Question ID: 1153566

House and managed by Gamma Investment LLC:

the trust more adequately.

hold a short position in Oracle stock.

has reported this fact in writing to his immediate supervisor at Gamma.

Which of the following is most correct? The investment manager is:

(Study Session 1, Module 2, LOS 2.a)

Question #5 of 40 Question ID: 1228354

A) violating Standard III(C) - Suitability.

B) not violating the Standards.

C) violating Standard I(C) - Misrepresentation.

(Study Session 1, Module 2, LOS 2.a)

Question #6 of 40 Question ID: 1228324

(Study Session 1, Module 2.5, LOS 2-III.(C))

investors with limited means.

Question #7 - 8 of 40 Question ID: 1228319

A) educating clients in the basics of investment characteristics.

B) using margin accounts.

C) diversifying portfolios where appropriate.

(Study Session 1, Module 2.5, LOS 2-III.(C))

A) Examine risk tolerance carefully because risk tolerance is an important element in

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #9 of 40 Question ID: 1228325

A) a violation of Standard V(A), Diligence and Reasonable Basis.

B) congruent with Standard V(A), Diligence and Reasonable Basis.

C) a violation of Standard III(C), Suitability.

(Study Session 1, Module 2.5, LOS 2-III.(C))

Professional Conduct because:

B) he cannot discuss prospective future performance in any manner.

C) the statement of excess performance is misleading with respect to its certainty.

Guaranteeing performance on investments that are inherently volatile is misleading to

(Study Session 1, Module 2, LOS 2.a)

completes trades sooner than TradeRight.

Question #11 - 16 of 40 Question ID: 1228329

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #12 - 16 of 40 Question ID: 1228330

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #13 - 16 of 40 Question ID: 1228331

According to Standard III(C) Suitability, investment recommendations and actions must be

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #14 - 16 of 40 Question ID: 1228332

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #15 - 16 of 40 Question ID: 1228333

passing the Level III exam?

B) The promotional announcement uses the letters “CFA” as a noun which is

(Study Session 1, Module 2.5, LOS 2-III.(C))

Question #16 - 16 of 40 Question ID: 1228334

(Study Session 1, Module 2.5, LOS 2-III.(C))

A) is permitted to manage Peters’ account without any knowledge of his risk

C) must decline to enter into an advisory relationship with Peters.