STUDY SESSION 1
The topical coverage corresponds with the following CFA Institute assigned reading:
1 & 2. Code of Ethics and Standards of Professional Conduct and Guidance for
Standards I–VII
The candidate should be
...
STUDY SESSION 1
The topical coverage corresponds with the following CFA Institute assigned reading:
1 & 2. Code of Ethics and Standards of Professional Conduct and Guidance for
Standards I–VII
The candidate should be able to:
a. describe the six components of the Code of Ethics and the seven Standards of
Professional Conduct. (page 1)
b. explain the ethical responsibilities required of CFA Institute members and candidates in
the CFA Program by the Code and Standards. (page 2)
a. demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards
of Professional Conduct by applying the Code and Standards to specific situations.
(page 6)
b. recommend practices and procedures designed to prevent violations of the Code of
Ethics and Standards of Professional Conduct. (page 6)
The topical coverage corresponds with the following CFA Institute assigned reading:
3. Application of the Code and Standards
The candidate should be able to:
a. evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics
and Standards of Professional Conduct. (page 90)
b. explain how the practices, policies, and conduct do or do not violate the CFA Institute
Code of Ethics and Standards of Professional Conduct. (page 90)STUDY SESSION 2
The topical coverage corresponds with the following CFA Institute assigned reading:
4. Introduction to Linear Regression
The candidate should be able to:
a. distinguish between the dependent and independent variables in a linear regression.
(page 105)
b. explain the assumptions underlying linear regression and interpret regression
coefficients. (page 107)
c. calculate and interpret the standard error of estimate, the coefficient of determination,
and a confidence interval for a regression coefficient. (page 111)
d. formulate a null and alternative hypothesis about a population value of a regression
coefficient and determine the appropriate test statistic and whether the null hypothesis is
rejected at a given level of significance. (page 114)
e. calculate the predicted value for the dependent variable, given an estimated regression
model and a value for the independent variable. (page 116)
f. calculate and interpret a confidence interval for the predicted value of the dependent
variable. (page 117)
g. describe the use of analysis of variance (ANOVA) in regression analysis, interpret
ANOVA results, and calculate and interpret the F-statistic. (page 118)
h. describe limitations of regression analysis. (page 123)
The topical coverage corresponds with the following CFA Institute assigned reading:
5. Multiple Regression
The candidate should be able to:
a. formulate a multiple regression equation to describe the relation between a dependent
variable and several independent variables and determine the statistical significance of
each independent variable. (page 134)
b. interpret estimated regression coefficients and their p-values. (page 135)
c. formulate a null and an alternative hypothesis about the population value of a regression
coefficient, calculate the value of the test statistic, and determine whether to reject the
null hypothesis at a given level of significance. (page 136)
d. interpret the results of hypothesis tests of regression coefficients. (page 136)
e. calculate and interpret 1) a confidence interval for the population value of a regression
coefficient and 2) a predicted value for the dependent variable, given an estimated
regression model and assumed values for the independent variables. (page 140)
f. explain the assumptions of a multiple regression model. (page 155)
g. calculate and interpret the F-statistic, and describe how it is used in regression analysis.
(page 142)
h. distinguish between and interpret the R2 and adjusted R2 in multiple regression.
(page 149)
i. evaluate how well a regression model explains the dependent variable by analyzing the
output of the regression equation and an ANOVA table. (page 144)
j. formulate a multiple regression equation by using dummy variables to represent
qualitative factors and interpret the coefficients and regression results. (page 151)
k. explain the types of heteroskedasticity and how heteroskedasticity and serial correlation
affect statistical inference. (page 156)
l. describe multicollinearity and explain its causes and effects in regression analysis.
(page 163)m. describe how model misspecification affects the results of a regression analysis and
describe how to avoid common forms of misspecification. (page 165)
n. describe models with qualitative dependent variables. (page 169)
o. evaluate and interpret a multiple regression model and its results. (page 170)
The topical coverage corresponds with the following CFA Institute assigned reading:
6. Time-Series Analysis
The candidate should be able to:
a. calculate and evaluate the predicted trend value for a time series, modeled as either a
linear trend or a log-linear trend, given the estimated trend coefficients. (page 181)
b. describe factors that determine whether a linear or a log-linear trend should be used
with a particular time series and evaluate limitations of trend models. (page 186)
c. explain the requirement for a time series to be covariance stationary and describe the
significance of a series that is not stationary. (page 189)
d. describe the structure of an autoregressive (AR) model of order p and calculate one- and
two-period-ahead forecasts given the estimated coefficients. (page 190)
e. explain how autocorrelations of the residuals can be used to test whether the
autoregressive model fits the time series. (page 191)
f. explain mean reversion and calculate a mean-reverting level. (page 192)
g. contrast in-sample and out-of-sample forecasts and compare the forecasting accuracy of
different time-series models based on the root mean squared error criterion. (page 193)
h. explain the instability of coefficients of time-series models. (page 194)
i. describe characteristics of random walk processes and contrast them to covariance
stationary processes. (page 195)
j. describe implications of unit roots for time-series analysis, explain when unit roots are
likely to occur and how to test for them, and demonstrate how a time series with a unit
root can be transformed so it can be analyzed with an AR model. (page 196)
k. describe the steps of the unit root test for nonstationarity and explain the relation of the
test to autoregressive time-series models. (page 196)
l. explain how to test and correct for seasonality in a time-series model and calculate and
interpret a forecasted value using an AR model with a seasonal lag. (page 201)
m. explain autoregressive conditional heteroskedasticity (ARCH) and describe how
ARCH models can be applied to predict the variance of a time series. (page 205)
n. explain how time-series variables should be analyzed for nonstationarity and/or
cointegration before use in a linear regression. (page 207)
o. determine an appropriate time-series model to analyze a given investment problem and
justify that choice. (page 208)STUDY SESSION 3
The topical coverage corresponds with the following CFA Institute assigned reading:
7. Machine Learning
The candidate should be able to:
a. distinguish between supervised machine learning, unsupervised machine learning, and
deep learning. (page 218)
b. describe overfitting and identify methods of addressing it. (page 220)
c. describe supervised machine learning algorithms—including penalized regression,
support vector machine, k-nearest neighbor, classification and regression tree, ensemble
learning, and random forest—and determine the problems for which they are best
suited. (page 222)
d. describe unsupervised machine learning algorithms—including principal components
analysis, k-means clustering, and hierarchical clustering—and determine the problems
for which they are best suited. (page 226)
e. describe neural networks, deep learning nets, and reinforcement learning. (page 227)
The topical coverage corresponds with the following CFA Institute assigned reading:
8. Big Data Projects
The candidate should be able to:
a. state and explain steps in a data analysis project. (page 234)
b. describe objectives, steps, and examples of preparing and wrangling data. (page 235)
c. describe objectives, methods, and examples of data exploration. (page 238)
d. describe objectives, steps, and techniques in model training. (page 242)
e. describe preparing, wrangling, and exploring text-based data for financial forecasting.
(page 236)
f. describe methods for extracting, selecting and engineering features from textual data.
(page 240)
g. evaluate the fit of a machine learning algorithm. (page 244)
The topical coverage corresponds with the following CFA Institute assigned reading:
9. Probabilistic Approaches: Scenario Analysis, Decision Trees, and
Simulations
The candidate should be able to:
a. describe steps in running a simulation. (page 253)
b. explain three ways to define the probability distributions for a simulation’s variables.
(page 253)
c. describe how to treat correlation across variables in a simulation. (page 253)
d. describe advantages of using simulations in decision making. (page 255)
e. describe some common constraints introduced into simulations. (page 256)
f. describe issues in using simulations in risk assessment. (page 257)
g. compare scenario analysis, decision trees, and simulations. (page 258)STUDY SESSION 4
The topical coverage corresponds with the following CFA Institute assigned reading:
10. Currency Exchange Rates: Understanding Equilibrium Value
The candidate should be able to:
a. calculate and interpret the bid–offer spread on a spot or forward currency quotation and
describe the factors that affect the bid–offer spread. (page 269)
b. identify a triangular arbitrage opportunity and calculate its profit, given the bid–offer
quotations for three currencies. (page 271)
c. distinguish between spot and forward rates and calculate the forward premium/discount
for a given currency. (page 274)
d. calculate the mark-to-market value of a forward contract. (page 276)
e. explain international parity conditions (covered and uncovered interest rate parity,
forward rate parity, purchasing power parity, and the international Fisher effect).
(page 277)
f. describe relations among the international parity conditions. (page 283)
g. evaluate the use of the current spot rate, the forward rate, purchasing power parity, and
uncovered interest parity to forecast future spot exchange rates. (page 284)
h. explain approaches to assessing the long-run fair value of an exchange rate. (page 284)
i. describe the carry trade and its relation to uncovered interest rate parity and calculate the
profit from a carry trade. (page 286)
j. explain how flows in the balance of payment accounts affect currency exchange rates.
(page 288)
k. explain the potential effects of monetary and fiscal policy on exchange rates. (page 289)
l. describe objectives of central bank or government intervention and capital controls and
describe the effectiveness of intervention and capital controls. (page 292)
m. describe warning signs of a currency crisis. (page 293)
The topical coverage corresponds with the following CFA Institute assigned reading:
11. Economic Growth and the Investment Decision
The candidate should be able to:
a. compare factors favoring and limiting economic growth in developed and developing
economies. (page 307)
b. describe the relation between the long-run rate of stock market appreciation and the
sustainable growth rate of the economy. (page 309)
c. explain why potential GDP and its growth rate matter for equity and fixed income
investors. (page 309)
d. distinguish between capital deepening investment and technological progress and
explain how each affects economic growth and labor productivity. (page 310)
e. forecast potential GDP based on growth accounting relations. (page 312)
f. explain how natural resources affect economic growth and evaluate the argument that
limited availability of natural resources constrains economic growth. (page 313)
g. explain how demographics, immigration, and labor force participation affect the rate
and sustainability of economic growth. (page 314)
h. explain how investment in physical capital, human capital, and technological
development affects economic growth. (page 315)
i. compare classical growth theory, neoclassical growth theory, and endogenous growth
theory. (page 318)
j. explain and evaluate convergence hypotheses. (page 321)k. describe the economic rationale for governments to provide incentives to private
investment in technology and knowledge. (page 321)
l. describe the expected impact of removing trade barriers on capital investment and
profits, employment and wages, and growth in the economies involved. (page 322)
The topical coverage corresponds with the following CFA Institute assigned reading:
12. Economics of Regulation
The candidate should be able to:
a. describe the economic rationale for regulatory intervention. (page 331)
b. explain the purposes of regulating commerce and financial markets. (page 332)
c. describe anticompetitive behaviors targeted by antitrust laws globally and evaluate the
antitrust risk associated with a given business strategy. (page 333)
d. describe classifications of regulations and regulators. (page 333)
e. describe uses of self-regulation in financial markets. (page 334)
f. describe regulatory interdependencies and their effects. (page 335)
g. describe tools of regulatory intervention in markets. (page 335)
h. describe benefits and costs of regulation. (page 336)
i. describe the considerations when evaluating the effects of regulation on an industry.
(page 337)WELCOME TO THE 2020 LEVEL II
SCHWESERNOTES™
Thank you for trusting Kaplan Schweser to help you reach your goals. We are pleased that
you have chosen us to assist you in preparing for the Level II CFA Exam. In this introduction,
I want to explain the resources included with these SchweserNotes, suggest how you can best
use Schweser materials to prepare for the exam, and direct you toward other educational
resources you will find helpful as you study for the exam.
Besides the SchweserNotes themselves, there are many educational resources available at
Schweser.com. Log in using the individual username and password that you received when
you purchased your SchweserNotes.
SchweserNotes™
These notes consist of five volumes that include complete coverage of all 17 Study Sessions
and all 456 Learning Outcome Statements (LOS). Examples and Module Quizzes (multiplechoice questions) are provided along the way to help you master the material and check your
progress. At the end of each major topic area, you can take a Topic Assessment for that topic
area. Topic Assessment questions are created to be exam-like in format and difficulty, to help
you evaluate how well your study of each topic has prepared you for the actual exam.
Practice Questions
Studies have shown that to retain what you learn, it is essential that you quiz yourself often.
For this purpose we offer SchweserPro™ QBank, which contains thousands of Level II
practice questions and explanations. Questions are available for each LOS, topic, and Study
Session. Build your own quizzes by specifying the topics and the number of questions.
SchweserPro™ QBank is an important learning aid for achieving the depth of proficiency
needed at Level II. It should not, however, be considered a replacement for rehearsing with
“exam-type” questions as found in our Practice Exams, Volumes 1 & 2 and our Schweser
Mock Exam.
Practice Exams
Schweser offers four full 6-hour practice exams: Schweser Practice Exams Volume 1 and
Volume 2 each contain two complete 120-question tests. These are important tools for
gaining the speed and skills you will need to pass the exam. Each book provides answers with
full explanations for self-grading and evaluation. By entering your answers at Schweser.com,
you can use our Performance Tracker to find out how you are performing compared to other
Schweser Level II candidates.
Schweser Resource Library
We have created a number of online reference videos, which are available to all purchasers of
Schweser Premium Instruction and PremiumPlus packages. Schweser Resource Library
videos range from 20 to 60 minutes in length and cover such topics as: “Introduction to ItemSets,” “Hypothesis Testing,” “Foreign Exchange Basics,” “Ratio Analysis,” and “Forward
Contracts.”
How to Succeed
The Level II CFA exam is a formidable challenge (48 readings and 456 Learning Outcome
Statements), so you must devote considerable time and effort to be properly prepared. There
is no shortcut! You must learn the material, know the terminology and techniques, understand
the concepts, and be able to answer 120 questions quickly and mostly correctly. Fifteen hours
per week for 25 weeks is a good estimate of the study time required on average, but different
candidates will need more or less time, depending on their individual backgrounds and
experience.
There is no way around it; CFA Institute will test you in a way that will reveal how well you
know the Level II curriculum. You should begin early and stick to your study plan. Read the
SchweserNotes and complete the Module Quizzes for each topic review. Prepare for and
attend a live class, an online class, or a study group each week. Take quizzes often using
SchweserPro QBank and go back to review previous topics regularly. At the end of each
topic area, take the online Topic Assessment to check your progress. You should try to finish
reading the curriculum at least four weeks before the Level II exam so that you have
sufficient time for Practice Exams and Mock Exams and for further review of those topics
that you have not yet mastered.
I would like to thank Kent Westlund, CFA Content Specialist, for his contributions to the
2020 Level II SchweserNotes for the CFA Exam.
Best regards,
Dr. Bijesh Tolia, CFA, CA
VP of CFA Education and Level II Manager
Kaplan SchweserVideo covering
this content is
available online.
The following is a review of the Ethical and Professional Standards principles designed to address the learning
outcome statements set forth by CFA Institute. Cross-Reference to CFA Institute Assigned Readings #1 & #2.
READINGS 1 & 2: CFA INSTITUTE CODE
OF ETHICS AND STANDARDS OF
PROFESSIONAL CONDUCT AND
GUIDANCE FOR STANDARDS I–VII
Study Session 1
EXAM FOCUS
In addition to reading this review of the ethics material, we strongly recommend that all
candidates for the CFA® examination read the Standards of Practice Handbook 11th Edition
(2014). As a Level II CFA candidate, it is your responsibility to comply with the Code and
Standards. The complete Code and Standards are reprinted in Volume 1 of the CFA Program
Curriculum.
MODULE 1.1: INTRODUCTION TO THE CODE
AND STANDARDS
LOS 1.a: Describe the six components of the Code of Ethics and the
seven Standards of Professional Conduct.
CFA® Program Curriculum, Volume 1, page 15
THE CODE OF ETHICS
Members of CFA Institute (including CFA charterholders) and candidates for the CFA
designation (“Members and Candidates”) must:1
Act with integrity, competence, diligence, and respect, and in an ethical manner with
the public, clients, prospective clients, employers, employees, colleagues in the
investment profession, and other participants in the global capital markets.
Place the integrity of the investment profession and the interests of clients above their
own personal interests.
Use reasonable care and exercise independent professional judgment when conducting
investment analysis, making investment recommendations, taking investment actions,
and engaging in other professional activities.
Practice and encourage others to practice in a professional and ethical manner that will
reflect credit on themselves and the profession.
Promote the integrity and viability of the global capital markets for the ultimate benefit
of society.Maintain and improve their professional competence and strive to maintain and
improve the competence of other investment professionals.
THE STANDARDS OF PROFESSIONAL CONDUCT
I. Professionalism
II. Integrity of Capital Markets
III. Duties to Clients
IV. Duties to Employers
V. Investment Analysis, Recommendations, and Actions
VI. Conflicts of Interest
VII. Responsibilities as a CFA Institute Member or CFA Candidate
LOS 1.b: Explain the ethical responsibilities required of CFA Institute members and
candidates in the CFA Program by the Code and Standards.
CFA® Program Curriculum, Volume 1, page 15
STANDARDS OF PROFESSIONAL CONDUCT2
I. PROFESSIONALISM
A. Knowledge of the Law. Members and Candidates must understand and
comply with all applicable laws, rules, and regulations (including the CFA
Institute Code of Ethics and Standards of Professional Conduct) of any
government, regulatory organization, licensing agency, or professional
association governing their professional activities. In the event of conflict,
Members and Candidates must comply with the more strict law, rule, or
regulation. Members and Candidates must not knowingly participate or
assist in and must dissociate from any violation of such laws, rules, or
regulations.
B. Independence and Objectivity. Members and Candidates must use
reasonable care and judgment to achieve and maintain independence and
objectivity in their professional activities. Members and Candidates must
not offer, solicit, or accept any gift, benefit, compensation, or consideration
that reasonably could be expected to compromise their own or another’s
independence and objectivity.
C. Misrepresentation. Members and Candidates must not knowingly make
any misrepresentations relating to investment analysis, recommendations,
actions, or other professional activities.
D. Misconduct. Members and Candidates must not engage in any professional
conduct involving dishonesty, fraud, or deceit or commit any act that
reflects adversely on their professional reputation, integrity, or competence.
II. INTEGRITY OF CAPITAL MARKETSA. Material Nonpublic Information. Members and Candidates who possess
material nonpublic information that could affect the value of an investment must
not act or cause others to act on the information.
B. Market Manipulation. Members and Candidates must not engage in practices
that distort prices or artificially inflate trading volume with the intent to mislead
market participants.
III. DUTIES TO CLIENTS
A. Loyalty, Prudence, and Care. Members and Candidates have a duty of loyalty
to their clients and must act with reasonable care and exercise prudent judgment.
Members and Candidates must act for the benefit of their clients and place their
clients’ interests before their employer’s or their own interests.
B. Fair Dealing. Members and Candidates must deal fairly and objectively with all
clients when providing investment analysis, making investment
recommendations, taking investment action, or engaging in other professional
activities.
C. Suitability.
1. When Members and Candidates are in an advisory relationship with a
client, they must:
a. Make a reasonable inquiry into a client’s or prospective clients’
investment experience, risk and return objectives, and financial
constraints prior to making any investment recommendation or
taking investment action and must reassess and update this
information regularly.
b. Determine that an investment is suitable to the client’s financial
situation and consistent with the client’s written objectives,
mandates, and constraints before making an investment
recommendation or taking investment action.
c. Judge the suitability of investments in the context of the client’s total
portfolio.
2. When Members and Candidates are responsible for managing a portfolio
to a specific mandate, strategy, or style, they must make only investment
recommendations or take only investment actions that are consistent with
the stated objectives and constraints of the portfolio.
D. Performance Presentation. When communicating investment performance
information, Members or Candidates must make reasonable efforts to ensure that
it is fair, accurate, and complete.
E. Preservation of Confidentiality. Members and Candidates must keep
information about current, former, and prospective clients confidential unless:
1. The information concerns illegal activities on the part of the client or
prospective client,
2. Disclosure is required by law, or
3. The client or prospective client permits disclosure of the information.IV. DUTIES TO EMPLOYERS
A. Loyalty. In matters related to their employment, Members and Candidates must
act for the benefit of their employer and not deprive their employer of the
advantage of their skills and abilities, divulge confidential information, or
otherwise cause harm to their employer.
B. Additional Compensation Arrangements. Members and Candidates must not
accept gifts, benefits, compensation, or consideration that competes with or
might reasonably be expected to create a conflict of interest with their
employer’s interest unless they obtain written consent from all parties involved.
C. Responsibilities of Supervisors. Members and Candidates must make
reasonable efforts to ensure that anyone subject to their supervision or authority
complies with applicable laws, rules, regulations, and the Code and Standards.
V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS
A. Diligence and Reasonable Basis. Members and Candidates must:
1. Exercise diligence, independence, and thoroughness in analyzing
investments, making investment recommendations, and taking investment
actions.
2. Have a reasonable and adequate basis, supported by appropriate research
and investigation, for any investment analysis, recommendation, or action.
B. Communication with Clients and Prospective Clients. Members and
Candidates must:
1. Disclose to clients and prospective clients the basic format and general
principles of the investment processes they use to analyze investments,
select securities, and construct portfolios and must promptly disclose any
changes that might materially affect those processes.
2. Disclose to clients and prospective clients significant limitations and risks
associated with the investment process.
3. Use reasonable judgment in identifying which factors are important to
their investment analyses, recommendations, or actions and include those
factors in communications with clients and prospective clients.
4. Distinguish between fact and opinion in the presentation of investment
analysis and recommendations.
C. Record Retention. Members and Candidates must develop and maintain
appropriate records to support their investment analysis, recommendations,
actions, and other investment-related communications with clients and
prospective clients.
VI. CONFLICTS OF INTEREST
A. Disclosure of Conflicts. Members and Candidates must make full and fair
disclosure of all matters that could reasonably be expected to impair their
independence and objectivity or interfere with respective duties to their clients,
prospective clients, and employer. Members and Candidates must ensure thatVideo covering
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such disclosures are prominent, are delivered in plain language, and
communicate the relevant information effectively.
B. Priority of Transactions. Investment transactions for clients and employers
must have priority over investment transactions in which a Member or Candidate
is the beneficial owner.
C. Referral Fees. Members and Candidates must disclose to their employer, clients,
and prospective clients, as appropriate, any compensation, consideration, or
benefit received by, or paid to, others for the recommendation of products or
services.
VII. RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE
A. Conduct as Participants in CFA Institute Programs. Members and
Candidates must not engage in any conduct that compromises the reputation or
integrity of CFA Institute or the CFA designation or the integrity, validity, or
security of CFA Institute programs.
B. Reference to CFA Institute, the CFA Designation, and the CFA Program.
When referring to CFA Institute, CFA Institute membership, the CFA
designation, or candidacy in the CFA Program, Members and Candidates must
not misrepresent or exaggerate the meaning or implications of membership in
CFA Institute, holding the CFA designation, or candidacy in the CFA Program.
MODULE 2.1: STANDARDS I(A) AND I(B)
LOS 2.a: Demonstrate a thorough knowledge of the CFA Institute Code
of Ethics and Standards of Professional Conduct by applying the Code
and Standards to specific situations.
LOS 2.b: Recommend practices and procedures designed to prevent
violations of the Code of Ethics and Standards of Professional Conduct.
CFA® Program Curriculum, Volume 1, page 21
I Professionalism
I(A) Knowledge of the Law. Members and Candidates must understand and comply with all applicable
laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional
Conduct) of any government, regulatory organization, licensing agency, or professional association
governing their professional activities. In the event of conflict, Members and Candidates must comply with
the more strict law, rule, or regulation. Members and Candidates must not knowingly participate or assist in
and must dissociate from any violation of such laws, rules, or regulations.
PROFESSOR’S NOTE
While we use the term “members” in the following, note that all of the Standards apply to
candidates as well.
Guidance—Code and Standards vs. Local Law
Members must know the laws and regulations relating to their professional activities in all
countries in which they conduct business. Members must comply with applicable laws andregulations relating to their professional activity. Do not violate Code or Standards even if the
activity is otherwise legal. Always adhere to the most strict rules and requirements (law or
CFA Institute Standards) that apply.
Guidance—Participation or Association With Violations by
Others
Members should dissociate, or separate themselves, from any ongoing client or employee
activity that is illegal or unethical, even if it involves leaving an employer (an extreme case).
While a member may confront the involved individual first, he must approach his supervisor
or compliance department. Inaction with continued association may be construed as knowing
participation.
Recommended Procedures for Compliance—Members
Members should have procedures to keep up with changes in applicable laws, rules,
and regulations.
Compliance procedures should be reviewed on an ongoing basis to ensure that they
address current law, CFAI Standards, and regulations.
Members should maintain current reference materials for employees to access in order
to keep up to date on laws, rules, and regulations.
Members should seek advice of counsel or their compliance department when in doubt.
Members should document any violations when they disassociate themselves from
prohibited activity and encourage their employers to bring an end to such activity.
There is no requirement under the Standards to report violations to governmental
authorities, but this may be advisable in some circumstances and required by law in
others.
Members are strongly encouraged to report other members’ violations of the Code and
Standards.
Recommended Procedures for Compliance—Firms
Members should encourage their firms to:
Develop and/or adopt a code of ethics.
Make available to employees information that highlights applicable laws and
regulations.
Establish written procedures for reporting suspected violation of laws, regulations, or
company policies.
Members who supervise the creation and maintenance of investment services and products
should be aware of and comply with the regulations and laws regarding such services and
products both in their country of origin and the countries where they will be sold.
Application of Standard I(A) Knowledge of the Law3
Example 1:
Michael Allen works for a brokerage firm and is responsible for an underwriting of securities.
A company official gives Allen information indicating that the financial statements Allenfiled with the regulator overstate the issuer’s earnings. Allen seeks the advice of the
brokerage firm’s general counsel, who states that it would be difficult for the regulator to
prove that Allen has been involved in any wrongdoing.
Comment:
Although it is recommended that members and candidates seek the advice of legal counsel,
the reliance on such advice does not absolve a member or candidate from the requirement to
comply with the law or regulation. Allen should report this situation to his supervisor, seek an
independent legal opinion, and determine whether the regulator should be notified of the
error.
Example 2:
Kamisha Washington’s firm advertises its past performance record by showing the 10-year
return of a composite of its client accounts. However, Washington discovers that the
composite omits the performance of accounts that have left the firm during the 10-year period
and that this omission has led to an inflated performance figure. Washington is asked to use
promotional material that includes the erroneous performance number when soliciting
business for the firm.
Comment:
Misrepresenting performance is a violation of the Code and Standards. Although she did not
calculate the performance herself, Washington would be assisting in violating this standard if
she were to use the inflated performance number when soliciting clients. She must dissociate
herself from the activity. She can bring the misleading number to the attention of the person
responsible for calculating performance, her supervisor, or the compliance department at her
firm. If her firm is unwilling to recalculate performance, she must refrain from using the
misleading promotional material and should notify the firm of her reasons. If the firm insists
that she use the material, she should consider whether her obligation to dissociate from the
activity would require her to seek other employment.
Example 3:
An employee of an investment bank is working on an underwriting and finds out the issuer
has altered their financial statements to hide operating losses in one division. These misstated
data are included in a preliminary prospectus that has already been released.
Comment:
The employee should report the problem to his supervisors. If the firm doesn’t get the
misstatement fixed, the employee should dissociate from the underwriting and, further, seek
legal advice about whether he should undertake additional reporting or other actions.
Example 4:
Laura Jameson, a U.S. citizen, works for an investment advisor based in the United States and
works in a country where investment managers are prohibited from participating in IPOs for
their own accounts.
Comment:
Jameson must comply with the strictest requirements among U.S. law (where her firm is
based), the CFA Institute Code and Standards, and the laws of the country where she is doingbusiness. In this case that means she must not participate in any IPOs for her personal
account.
Example 5:
A junior portfolio manager suspects that a broker responsible for new business from a foreign
country is being allocated a portion of the firm’s payments for third-party research and
suspects that no research is being provided. He believes that the research payments may be
inappropriate and unethical.
Comment:
He should follow his firm’s procedures for reporting possible unethical behavior and try to
get better disclosure of the nature of these payments and any research that is being provided.
I(B) Independence and Objectivity. Members and Candidates must use reasonable care and judgment to
achieve and maintain independence and objectivity in their professional activities. Members and
Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that
reasonably could be expected to compromise their own or another’s independence and objectivity.
Guidance
Do not let the investment process be influenced by any external sources. Modest gifts are
permitted. Allocation of shares in oversubscribed IPOs to personal accounts is NOT
permitted. Distinguish between gifts from clients and gifts from entities seeking influence to
the detriment of the client. Gifts must be disclosed to the member’s employer in any case,
either prior to acceptance if possible, or subsequently.
Guidance—Investment Banking Relationships
Do not be pressured by sell-side firms to issue favorable research on current or prospective
investment-banking clients. It is appropriate to have analysts work with investment bankers in
“road shows” only when the conflicts are adequately and effectively managed and disclosed.
Be sure there are effective “firewalls” between research/investment management and
investment banking activities.
Guidance—Public Companies
Analysts should not be pressured to issue favorable research by the companies they follow.
Do not confine research to discussions with company management, but rather use a variety of
sources, including suppliers, customers, and competitors.
Guidance—Buy-Side Clients
Buy-side clients may try to pressure sell-side analysts. Portfolio managers may have large
positions in a particular security, and a rating downgrade may have an effect on the portfolio
performance. As a portfolio manager, there is a responsibility to respect and foster intellectual
honesty of sell-side research.
Guidance—Fund Manager and Custodial RelationshipsMembers responsible for selecting outside managers should not accept gifts, entertainment, or
travel that might be perceived as impairing their objectivity.
Guidance—Performance Measurement and Attribution
Performance analysts may experience pressure from investment managers who have
produced poor results or acted outside their mandate. Members and candidates who analyze
performance must not let such influences affect their analysis.
Guidance—Manager Selection
Members and candidates must exercise independence and objectivity when they select
investment managers. They should not accept gifts or other compensation that could be seen
as influencing their hiring decisions, nor should they offer compensation when seeking to be
hired as investment managers. The responsibility to maintain independence and objectivity
applies to all a member or candidate’s hiring and firing decisions, not just those that involve
investment management.
Guidance—Credit Rating Agencies
Members employed by credit rating firms should make sure that procedures prevent undue
influence by the firm issuing the securities. Members who use credit ratings should be aware
of this potential conflict of interest and consider whether independent analysis is warranted.
Guidance—Issuer-Paid Research
Remember that this type of research is fraught with potential conflicts. Analysts’
compensation for preparing such research should be limited, and the preference is for a flat
fee, without regard to conclusions or the report’s recommendations.
Guidance—Travel
Best practice is for analysts to pay for their own commercial travel when attending
information events or tours sponsored by the firm being analyzed.
Recommended Procedures for Compliance
Protect the integrity of opinions—make sure they are unbiased.
Create a restricted list and distribute only factual information about companies on the
list.
Restrict special cost arrangements—pay for one’s own commercial transportation and
hotel; limit use of corporate aircraft to cases in which commercial transportation is not
available.
Limit gifts—token items only. Customary, business-related entertainment is okay as
long as its purpose is not to influence a member’s professional independence or
objectivity. Firms should impose clear value limits on gifts.
Restrict employee investments in equity IPOs and private placements. Require pre
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