Learning Outcomes You should be able to a) Evaluate professional - PDF document

University of Southern California CFA Society of Los Angeles CFA Review Program CFA LEVEL III Ethical and Professional Standards Study Session 2 March 18, 2017 Mark Harbour Level1help@cfalaCFAReview.org Reading Assignments “The Consultant,” Jules A. Huot, Ethics Cases (CFA 1. Institute, 1996; adapted 2005) “Pearl Investment Management (A), (B), and (C),” Glen 2. A. Holden, Jr., Ethics Cases (CFA Institute, 1996; adapted 2005) Asset Manager Code of Professional Conduct, including 3. Appendix A (CFA Institute, Centre for Financial Market Integrity, 2005) 2 1

Part I – Reading 3 Application of the Code and Standards 3 Learning Outcomes You should be able to a) Evaluate professional conduct and formulate an appropriate response to actions that violate the Code of Ethics and Standards of Professional Conduct b) Formulate appropriate policy and procedural changes needed to assure compliance with the Code of Ethics and Standards of Professional Conduct 4 2

Learning Outcomes Framework for Ethical Decision Making  Identify facts and issues  Identify Others to whom duty is owed  Identify Potential Conflicts of Interest  Identify Applicable Ethical Principles  Consider Seeking Additional Guidance  Consider Circumstances that Could Be Affecting Judgment  Consider Alternative Actions  Act and Review the Outcome 5 Ethics in Practice Summary of Important Points A. Ethics and the Investment Profession • What constitutes a profession (as opposed to a business, a trade, or a craft)? Two factors taken together - 1. An established body of knowledge 2. A commitment to a broader good than the practitioner’s self interest • A body of knowledge that continues to grow as new insights are published is foundation of investment analysis (for example, quantitative methods, economics, financial statement analysis, corporate finance, analysis of equity/debt/derivative/alternative investments, portfolio management, portfolio results presentation, industry specific ethics standards) 6 3

Ethics in Practice Summary of Important Points • The “broader good” standard is met by promoting fair and efficient capital markets and focus on the importance of putting clients first • The Code and Standards are aimed at serving the broader good. B. Professional Ethics and Law • Is it enough just to obey the law? • Can ethical obligations exceed legal requirements? • While it may be legally possible to overstate experience to win a client, is it ethical? Being legally correct but ethically wrong can destroy a reputation and disadvantage others who merit honest and equitable treatment 7 Ethics in Practice Summary of Important Points C. Interpreting and Applying the CFA Institute Code and Standards • Ethical reasoning is not mathematically precise even though it is logical • It is based on abstract concepts • Terms like “integrity” and “respect” are not technical terms and cannot be reduced to clear cut definitions • Interpreting them may take thoughtful effort • Judgment is acquired with both education and experience – knowledge + experience judgment “The whole theory of [right] conduct is bound to be an outline only and not an exact system” Aristotle. 8 4

Ethics in Practice Summary of Important Points Useful questions -  Is the course of action consistent with the intent of Code and Standards?  Would the client agree that you are doing the right thing?  How would it be read by the public in a press release?  Is your decision in favor of a course of conduct “commendable” and consistent with being a leader?  Would you be setting a good example for others? D. Preamble to Code – Key Points  Highest standards of ethics, education, and professional excellence  For the ultimate benefit of society  Who is bound (CFA Institute members and candidates)  Sanctions for violations 9 Ethics in Practice Summary  Disciplinary sanctions may be imposed for violations of Code and Standards  Code of Ethics requires: 1. DERIC ( D iligence, E thics, R espect, I ntegrity, C ompetence) Integrity of profession and client’s interests first 2. 3. Reasonable care and independent judgment 4. Ethical behavior (in self and helping others) 5. Promote integrity and uphold rules of capital markets 6. Competence (for self and in helping others) 10 5

Ethics in Practice Summary Standards Standard I Professionalism Standard II Integrity Standard III Duties to Clients and Prospective Clients Standard IV Duties to Employers Standard V Investment Analysis, Recommendations, and Actions Standard VI Conflicts of Interest Standard VII Responsibilities as a CFA Institute Member or CFA Candidate 11 Case Studies  The Consultant  Pearl Investment Management A, B, and C 12 6

The Consultant - Case Facts  Mark Vernley, CFA, is also a petroleum engineer with a doctorate in engineering and 30 years of business experience  Vernley started Energetics, an energy consulting firm, after spending 15 years with an oil company, Deepwell Explorations, followed by 8 years at a major brokerage firm as a securities analyst specializing in energy issues. He is known for his professionalism, expertise and integrity  Vernley has a substantial personal energy company stock portfolio with a large position in Deepwell Explorations and a position in Highridge.  Energetics recently won a consulting contract from Highridge Oil Pipeline to devise a plan to resolve conflicts with Highridge’s clients 13 The Consultant - Case Facts  Under a plan developed by Vernley, Highridge will now have an incentive to operate its pipeline more economically than at present. Oil companies using the pipeline, including Vernley’s old employer, Deepwell Explorations, will share any increase in earnings that results from reduced costs.  After lengthy hearings at a regulatory agency the plan is approved.  Plains Pipeline Systems, a competitor to Highridge, has objected to the regulatory agency because it alleges the plan is flawed because Vernley has a conflict of interest due to his personal energy stock positions.  At a subsequent hearing, the regulatory agency confirmed its prior decision. 14 7

The Consultant - Case Discussion  How could Vernley have avoided allegations of conflict of interest based on his ownership of energy company shares?  Conflicts of Interest in a Personal Portfolio o Avoidance Options - refrain from investing in energy stocks - divest energy stocks - establish blind trust - invest only in energy related mutual funds o Disclosure - should have disclosed holdings thereby enabling the client to evaluate the materiality of Vernley’s holdings and whether the conflict of interest is significant enough to affect Vernley’s ability to give advice or make recommendations that are unbiased and objective 15 The Consultant - Case Discussion Plan for Energetics  Communication – to employees of standards for conformance  Education – adopted standards workshops and training  Establish comprehensive formal compliance program - • Annual certification by employees • Quarterly reporting of employee security transactions • Disclosure of compensation from other sources • Certification of no independent business competitive activity • Membership in organizations that maintain professional standards  Actively pursue an Ethical Culture • Vernley should continue instilling an ethical culture in Energetics by developing a corporate credo and moral system based on professional standards, self interest, values and ideals 16 8

Pearl Investment Management  Pearl Investment Management (A) – Case Facts – Case Discussion  Pearl Investment Management (B) – Case Facts – Case Discussion  Pearl Investment Management (C) – Case Facts – Case Discussion 17 Pearl Investment Management (A) - Case Facts  Peter Sherman, who has an MBA, starts at Pearl Investment Management working in the firm’s back office  Pearl is a CFA shop; Sherman quickly reads and signs Pearl’s personnel policies statement  Sherman enjoys being close to investment information by working at Pearl  Sherman decides to put new found knowledge to work in making personal trades 18 9

Pearl Investment Management (A) - Case Discussion  Standard I (A): Knowledge of the Law – Using knowledge gleaned through employment at Pearl could trigger violation of laws and regulations  Standard IV (C): Responsibilities of Supervisors – Sherman’s supervisors must monitor activities regardless of the fact that Pearl has compliance policy 19 Pearl Investment Management (A) - Case Discussion  Standards III (B) and IV (B): Fair Dealing and Priority of Transactions – Sherman can’t make personal trades that conflict with client interests  Standards IV (A) and III (A): Duty to Employers and Loyalty, Prudence and Care – Sherman can’t communicate information that would breach special position of trust with employer 20 10