CFA L1 Ethical and Professional Standards: practice questions with answers

Question 1

Leila Haddad, CFA, is a portfolio analyst at an asset manager. While reviewing trade records, she finds evidence that two colleagues on another desk have been systematically trading for their own accounts ahead of large client orders, which breaks securities law in her jurisdiction. Haddad is not involved in the trading. Under Standard I(A) Knowledge of the Law, Haddad's most appropriate first action is to:

1. A report the colleagues directly to the securities regulator, because the Standard requires members to report all violations to the authorities.
2. B raise the matter with her supervisor or the firm's compliance department and, if it is not addressed, dissociate herself from the activity.
3. C take no action, because the Standard applies only to violations in which she personally takes part.

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Answer: B. Standard I(A) prohibits knowingly participating in or assisting violations of laws, rules or the Code and Standards. When a member learns of ongoing illegal conduct, the recommended response is to bring it to a supervisor or the compliance department and, if the problem is not fixed, to dissociate from it (for example, refusing to be involved, and in extreme cases resigning). Inaction with knowledge can be seen as assistance. The Standards do not require a member to report violations to regulators, although this may be required by law or be appropriate in some cases.

Question 2

Which of the following is most likely a violation of Standard VII(A) Conduct as Participants in CFA Institute Programs or Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program?

1. A A candidate who is registered for the next Level II exam describes herself on her résumé as a "Level II candidate in the CFA Program".
2. B After sitting the Level I exam, a candidate posts online that he found the exam difficult and ran short of time.
3. C A charterholder's marketing brochure states that, because he holds the CFA charter, his clients can expect higher returns than clients of non-charterholders.

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Answer: C. Standard VII(B) prohibits misrepresenting or exaggerating the meaning or implications of CFA Institute membership, the CFA designation or candidacy. Charterholders may describe the designation's requirements and their commitment to ethics, but may not imply that it leads to superior performance. A candidate may refer to the specific level for which he or she is registered. Standard VII(A) prohibits conduct that compromises the reputation or integrity of CFA Institute or the validity, integrity or security of the exams; posting general impressions such as difficulty or time pressure is acceptable, whereas disclosing specific topics, questions or formulas tested would be a violation.

Question 3

Yasmin Farouk, CFA, has just joined Belgrove Capital as a portfolio manager. At her previous firm, she was one of three co-managers of a mid-cap equity fund, and investment decisions were made by the team as a whole. Which action is most likely a violation of Standard III(D) Performance Presentation?

1. A Showing prospects the mid-cap fund's returns, naming the fund and her previous firm, and stating that she was one of its three co-managers.
2. B Telling prospects that the mid-cap fund's five-year return is her personal track record, without mentioning the other co-managers.
3. C Not showing prospects any returns from her previous firm until Belgrove's compliance department has reviewed her presentation.

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Answer: B. Standard III(D) Performance Presentation requires members and candidates, when communicating investment performance information, to make reasonable efforts to ensure that it is fair, accurate and complete. A manager who presents the results of a team-managed fund as her own individual track record misleads prospects about her personal contribution. If she uses the results at all, she should identify the fund and the firm where the returns were earned and disclose that decisions were made by a team of which she was one member.

Question 4

Which of the following statements, each made by a different person, is most likely a violation of Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program?

1. A Lina Sato, a charterholder whose membership is current, writes in her firm's brochure: "Lina is a CFA charterholder."
2. B Rohan Desai, who has passed Level II and is registered for the next Level III exam, signs his emails "Rohan Desai, CFA Level II".
3. C Owen Pryor, a charterholder in good standing, tells a prospect that earning the charter required passing three exams and gaining relevant work experience.

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Answer: B. Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program prohibits members and candidates from misrepresenting or exaggerating the meaning or implications of membership in CFA Institute, holding the CFA designation or candidacy in the CFA Program. There is no designation such as "CFA Level II" or any partial designation, so placing it after his name implies a credential he does not hold. He may correctly state that he has passed Level II, or that he is a Level III candidate in the CFA Program. A member in good standing may refer to herself as a CFA charterholder, and factual descriptions of the program's requirements are acceptable.

Question 5

Kaito Mori, CFA, runs an independent research firm. Halvard Robotics, a small listed company with little analyst coverage, asks Mori to write a research report on the company and offers to pay for it. Which compensation arrangement is most consistent with Standard I(B) Independence and Objectivity?

1. A A flat fee agreed before the work starts, payable whatever the report concludes, with the arrangement disclosed in the report.
2. B A fee paid partly in Halvard share options that vest only if Halvard's share price rises over the next year, disclosed in the report.
3. C A base fee plus a bonus if the report is published with a buy recommendation, disclosed to Halvard's board but not to readers.

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Answer: A. Issuer-paid research is acceptable under Standard I(B) if the analyst stays independent and objective. Best practice is to accept only a flat fee, agreed in advance and not linked to the conclusions or recommendations of the report or to the share price, and to disclose the nature of the compensation clearly in the research. Arrangements that pay more for a favorable recommendation or a rising share price create an incentive to bias the report and are inconsistent with the Standard.

Question 6

Marisol Vega, CFA, is a portfolio analyst in a bank's wealth management division. She plans to offer paid portfolio reviews to individual investors in the evenings and at weekends, a service similar to those her employer sells. Which course of action is most consistent with Standard IV(A) Loyalty?

1. A Start offering the reviews, because the work is done outside office hours and uses none of her employer's resources.
2. B Email her employer to say she is starting the reviews, and begin immediately without waiting for a reply.
3. C Tell her employer the type of services, expected duration and compensation, and not start until the employer consents to the arrangement.

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Answer: C. Standard IV(A) Loyalty prohibits members from engaging in independent practice for compensation that competes with their employer unless the employer consents. A member who plans such practice should notify the employer, describing the types of services, the expected duration and the compensation, and should not render the services until the employer has consented to all of the terms. Doing the work outside office hours or without the firm's resources does not remove the conflict, because the services compete with the employer's business.