CFA Level 3 – Ethical and Standards Session 1

CFA Level 3 – Ethical and Standards, Session 1 – Reading 1

(Notes, Practice Questions, Sample Questions)

1. Which of the following is least accurate regarding reasons for imposing a summary suspension upon covered persons?

A)Failure to return the annual professional conduct statement.
B)Misdemeanor charge for the possession of illegal narcotic substances.
C)Disbarment under securities laws

<Explanation> B — A single misdemeanor conviction for possession of illegal narcotics is not grounds for a summary suspension

2. A member or candidate who rejects a disciplinary sanction proposed by a Designated Officer of the Professional Conduct Program:

A)will be suspended from membership or participation in the CFA Program.

B)may request an appeal to a hearing panel.
C)will typically not be subject to further disciplinary procedure unless a new investigation is initiated

<Explanation> B — A member or candidate may accept a proposed disciplinary sanction or request an appeal to a hearing panel
3. Steve Jones is a member of CFA Institute but has not earned the CFA designation yet.

CFA Institute is investigating Jones’ activities. If Jones declines to cooperate, he:

A)is within his right only because it could be self incriminating.
B)is within his right only because he does not have the CFA designation yet.
C)could be summarily suspended from membership

<Explanation> C — Refusing to cooperate with a CFA Institute investigation of a member’s behavior could lead to suspension of membership. If the member has earned the right to use the CFA designation, the punishment could be suspension of use of the designation
4. A CFA charterholder may NOT be suspended without a hearing for which of the following reasons?

A)Failing to respond in writing to charges filed by his/her immediate supervisor.
B)Being convicted of murder.
C)Failing to complete the annual professional conduct questionnaire two years in a row

<Explanation> A — The CFA Institute member may respond in writing to charges from a supervisor, but this is not a requirement, and it is not a basis for suspension without a hearing. All of the others constitute grounds for suspension without a hearing

5. With respect to filing complaints concerning the professional conduct of a CFA Institute member, which of the following is CORRECT?

A)Only other members can write the Professional Conduct Program staff with a complaint concerning the conduct of another member.
B)Anyone can write the Professional Conduct Program staff with a complaint concerning the conduct of any member.
C)Anyone can write the Standards and Policy Committee staff with a complaint concerning the conduct of any member

<Explanation> B — This is from page ix of the Standards of Practice Handbook. Complaints may be filed by anyone and are to be written to the Professional Conduct Program staff
6. Which of the following statements regarding disciplinary procedures is least accurate?

A)A hearing may be held by telephone.
B)The findings of a hearing panel are final and conclusive.
C)The findings of a summary suspension review panel are final and conclusive

<Explanation> B — The findings of a hearing panel may be subject to appeal to the Professional Standards and Policy Committee (PSPC) in exceptional or unusual circumstances. The findings of a summary suspension review panel are final and conclusive
7. Which of the following correctly lists disciplinary sanctions in order of severity, lowest to highest, that the Designated Officer may take as a result of an investigation?

A)Suspension of the CFA designation, public censure, revocation of the CFA designation.
B)Public censure, suspension of the CFA designation, revocation of the CFA designation.
C)Suspension of membership, revocation of membership, public censure

<Explanation> B — Public censure is less severe than suspension from using the CFA designation, and suspension is less severe than revocation
8. With respect to the CFA Institute enforcement of the Code and Standards, which of the following is NOT a possible disciplinary sanction?

A)Payment of a fine.
B)Private censure.
C)Refusing to allow a candidate for the CFA designation to take one of the exams

<Explanation> A — CFA Institute does not impose fines. All of the other choices are possible sanctions. CFA Institute may suspend a candidate from further participation in the CFA program
9.1 Lin Liu, a Level III candidate, sat for the CFA examination in June in Hong Kong. Liu was very nervous before and during the exam because she did not study the material as well as she had planned. She feels particularly weak in the use of complex derivatives to modify portfolio risk and return and hopes the exam will not have many questions on that topic.Liu arrived at the exam center very early and planned to do some last minute studying in the exam room. She had a large backpack with her that contained all of her study notes. When she arrived at the exam center, the proctor who was checking candidates in at the door told Liu that she could not bring her backpack or study notes into the exam room but would need to leave them somewhere outside the exam center. Liu left the exam room and continued to study until the very last minute. She didn’t know where to leave her backpack. She remembered that there was a small closet in the Ladies Lavatory, which was just outside the exam room. She decided to leave her backpack and notes hidden there.
Liu showed her current passport and approved calculator to the proctor and was sent to her assigned seat. She was seated at the end of a row with another candidate to her right. Wang Chou, lead proctor, read the opening statement to candidates as the exam booklets were distributed. Wang cautioned candidates not to open the exam booklet until he instructed them to do so.When Masako Yamasaki, the section proctor, distributed the exam booklets, Liu quickly opened hers and began to read the first question. Yamasaki rushed over and told Liu to close her exam booklet until Wang instructed candidates to open the booklets. Liu closed her book and waited patiently for Wang to make his announcement. When instructed to open her booklet, Liu quickly began taking the exam. Liu’s actions at the start of the exam cause Yamasaki to pay close attention to her during the exam.
About 50 percent of the morning session consisted of questions about derivatives. Liu became increasingly nervous about her ability to answer these questions correctly. She remembered that she had left her notes in the Ladies Lavatory and decided she had nothing to lose by going to the lavatory and looking at her notes. She raised her hand and received permission from Yamasaki to go to the lavatory. She retrieved her notes from the closet where she had hidden them when Yamasaki entered the lavatory and found her with her notes. Yamasaki informed Liu that she would confiscate the notes and inform the CFA Institute of Liu’s actions in a proctor report. Liu then gathered her belongings and left the exam center.Are CFA candidates subject to the same disciplinary action for violations of the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards) for their actions during the CFA examination as other members of the CFA Institute?

A)Yes, CFA candidates are subject to the same disciplinary action for violations of the CFA Institute Code and Standards for their actions during the CFA examination.
B)No, CFA candidates are not subject to the same disciplinary action for violations of the CFA Institute Code and Standards during the exam since they are not members of the CFA Institute.
C)No, CFA candidates are not subject to the same disciplinary action for violations of the CFA Institute Code and Standards during the exam but other sanctions may still be imposed upon them

<Explanation> A — Yes, Rule 1 of the Rules of Procedures for Proceedings Related to Professional Conduct (Rules of Procedures) identify all of the following as “covered persons” subject to disciplinary sanction for violations of the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards): CFA Institute members, CFA charterholders, and candidates in the CFA Program. Therefore, regardless of their membership status, candidates are required to adhere to the Code and Standards. Standard II (B.2), Professional Misconduct specifically references candidate’s responsibility not to engage in any conduct or commit any act that compromises the integrity of the CFA designation or the integrity or validity of the examinations leading to the award of the right to use the CFA designation. Candidates’ actions at the exam site or while taking the exam are covered by this standard. Candidates are subject to disciplinary action, including expulsion from candidacy in the CFA program.
9.2 Several weeks after the exam, Liu received a letter from the Designated Officer of the CFA Institute’s Professional Conduct Program concerning Liu’s use of notes during the exam. When a proctor (complaining party) informs the CFA Institute Professional Conduct Program of a potential violation of the Code and Standards during the examination, the CFA Institute’s Rules of Procedure permit the Designated Officer to do all of the following EXCEPT:

A)provide the candidate with a notice of inquiry explaining the nature of the investigation.
B)disclose the name, address and phone number of the proctor (complaining party) to the candidate regardless of the complaining party’s wishes.
C)designate another person to act on his or her behalf

<Explanation> B — Under the CFA Institute Rules of Procedure, the identity of the complaining party may be kept confidential at the complaining party’s request. During the CFA exam, proctors and other exam administration personnel are the complaining parties when they complete proctor reports on suspected violations of the CFA Institute Code of Ethics and Standards of Professional Conduct or the examination rules.
9.3 After conducting an investigation into Liu’s actions, including reviewing proctor reports, speaking with proctors, and reviewing Liu’s notes, the Designated Officer notified Liu that she was proposing the following sanction: voiding of exam results and a permanent expulsion from participation in the CFA program. Liu is devastated and determines to appeal the proposed sanction.
Which of the following best describes the option open to Liu to appeal the Designated Officer’s proposed sanction?

A)Liu may request a Hearing Panel.
B)Liu may admit wrongdoing and enter into a stipulation agreement with the Designated Officer for a lesser sanction.
C)Liu may request a Review Panel.

<Explanation> A — After the Designated Officer proposes a sanction for violation of the CFA Institute Code and Standards during an examination, the candidate has 30 days within which to accept or reject the proposed sanction. If the proposed sanction is rejected, the candidate may request a hearing panel, usually consisting of members of the Disciplinary Review Committee. Hearings on exam-related issues are held by telephone.
9.4 Liu requested a Hearing Panel to appeal the Designated Officer’s proposed sanction. The Hearing Panel was convened by telephone and Hearing Panel members heard testimony from Liu and Yamasaki. Liu admitted that she had reviewed her notes, recognized her error and expressed remorse and a commitment to avoid violations of the Code and Standards in the future.
After deliberating in private, the Hearing Panel determined that Liu had violated the Code and Standards and upheld the Designated Officer’s proposed sanction. Subsequently, Liu requested a Review Panel, based on the premise that she was under extreme stress during the exam or she would never had attempted to cheat by reviewing her notes.
A Review Panel has the authority to issue all of the following decisions with respect to sanctions by Hearing Panels EXCEPT:

A)reverse the Hearing Panel’s determination that a candidate or member violated the Code and Standards.
B)refer the matter back for further review.
C)not impose a sanction.

<Explanation> A — The Review Panel does not have the authority to reverse the determination of the Hearing Panel that a violation had occurred. The Review Panel, after reviewing the documents and testimony given at the Hearing Panel and additional written submissions by the covered person and the Designated Officer, may determine that there are exceptional or unusual circumstances that would make the sanction inequitable and may decide to reduce the sanction to be imposed. There is no further appeal once the Review Panel imposes a sanction.

9.5 Throughout the investigation and appeal processes, Liu was concerned that her friends and colleagues would learn that she was under investigation and might be expelled from the CFA Program.
Which of the following circumstances would permit the CFA Institute Professional Conduct Program to disclose information about a professional conduct investigation to external parties?

A)The Designated Officer receives a call from a journalist about a case under investigation.
B)A complaining party wants to know what the Professional Conduct Program is doing to investigate his complaint.
C)Criminal activity is uncovered.

<Explanation> C — Under Rule 11 of the Rules of Procedure for Proceedings Related to Professional Conduct, the Designated Officer and Professional Conduct Program staff must maintain strict confidentiality regarding complaints, investigations, proceedings and records. Exceptions to the confidentiality policy will only be made in the following circumstances: (a) failure to disclose the findings has the potential to cause serious harm to the profession, (b) criminal activity is uncovered, (c) confidentiality is waived by the member or candidate, and (d) disclosure is required by law. However, if a public censure, timed or permanent suspension of membership and the right to use the CFA designation is imposed on a covered person, the CFA Institute may publish the covered person’s name and information about the violation. This information is usually published in the CFA Magazine for violations regarding professional practice and in the Candidate Bulletin for exam-related violations.
9.6 After she received the Notice of Inquiry from the Designated Officer, Liu had fully cooperated with the investigation into her actions during the CFA Exam. If a covered person receives a Notice of Inquiry about an alleged violation of the CFA Institute Code and Standards and fails to cooperate fully with the investigation, which of the following sanctions do the Rules of Procedure permit the Designated Officer to impose?

A)Private Censure.
B)Summary Suspension.
C)1-year Timed Suspension.

<Explanation> B — The Rules of Procedure permit the Designated Officer to impose a Summary Suspension for failure to cooperate with a professional conduct investigation. A Summary Suspension means revocation of membership in the CFA Institute and affiliated organizations, the right to use the CFA designation, and/or participation in the CFA Program. The Summary Suspension for failure to cooperate is effective after the covered person has been notified. The covered person may request a review of the summary suspension within 30-days of notification. If he/she fails to request a review within that time, a request for review will not be accepted until one year has elapsed.
10. Michael Malone, CFA, is an investment analyst for a large brokerage firm in New York who covers the airlines industry. After hours in his personal time, Malone maintains an online blog on which he expresses his personal opinions about various investment opportunities, including, but not limited to, the airlines industry. On his blog, he posts a very negative investment opinion about WestAir stock. Malone knows that WestAir’s stock will be downgraded to a “sell” by his firm next week. Malone has:

A)violated Standard IV(A) Loyalty by divulging confidential information that is the intellectual property of his employer.
B)violated Standard II(A) Material Nonpublic Information by releasing material that could negatively impact the price of the security.
C)violated Standard VI(B) Priority of Transactions by releasing material information to the public before releasing to the firm’s clients.

<Explanation> B — Malone is in violation of Standard II(A) because the information is both material and nonpublic. He is in violation whether or not he divulges the impending downgrade by his firm on his blog, because he is using nonpublic information. A “sell” opinion on a security issued by a large brokerage firm will almost certainly impact the stock’s price
11. Liam McCoy has lunch with a wealthy client whose portfolio he manages. McCoy advises the client to double his current position in the JKM Corporation due to an anticipated increase in sales. In accordance with Standard (V) Investment Analysis, Recommendations and Actions, when McCoy returns to his office he should:

A)identify other clients for whom JKM may be a suitable investment and notify them immediately of his recommendation.
B)document the details of the conversation with the client with regard to his investment recommendation.
C)verify the suitability of the investment recommendation before placing the client’s order.

<Explanation> A — Standard V(C) Record Retention requires that Members and Candidates document all recommendation and communications with clients. McCoy should document the details of the conversation, including any resulting investment decisions and/or actions. The suitability of the investment should have already been considered before the recommendation and McCoy should not execute the order until the client instructs him to. Identifying other clients for this investment would fall under Standard III(B) Fair Dealing
12. In accordance with Standard III (A) Loyalty, Prudence and Care, which of the following statements is least accurate? Members and Candidates should:

A)vote all proxies on behalf of clients in a responsible manner.
B)utilize client brokerage to the sole benefit of the client.
C)submit to clients, at least quarterly, itemized statements detailing all of the period’s transactions

<Explanation> A — Because of the time and expense involved in voting a proxy, Members and Candidates are not required to vote every proxy. A cost benefit analysis can be performed to determine if it is necessary to vote a proxy
13. According to the Code of Ethics, the professional judgment of a member should be:

A)guided by the SEC guidelines.
B)independent.
C)dependent on that of his/her colleagues

<Explanation> B — The Code of Ethics states that the CFA Institute member shall “Use reasonable care and exercise independent professional judgment.” None of the other answers resemble anything in the Code
14. According to the Code of Ethics, which of the following statements is NOT correct? CFA Institute members are required to:

A)use reasonable care and exercise independent professional judgment.
B)maintain and improve their competence and strive to maintain the competence of others in the profession.
C)comply with the CFA Institute Performance Presentation Standards

<Explanation> C — The CFA Institute-PPS are voluntary standards for the industry. Firms are not required to comply with these standards when presenting performance. The other statements are each components of the CFA Institute Code of Ethics
15. The Code of Ethics does NOT explicitly say that a CFA Institute member shall do which of the following?

A)Actively lobby for new laws to protect the public.
B)Exercise independent professional judgment.
C)Act with integrity

<Explanation> A — The Code of Ethics says nothing about a CFA Institute member lobbying for new laws. In fact, legal issues are not a part of the Code. The Standards of Professional Conduct say that the member shall obey laws
16. Which of the following is least likely a component of the Code of Ethics? In dealing with the public, clients, prospects, employers, employees, and fellow members, CFA Institute members shall act with:

A)integrity.
B)respect.
C)humility

<Explanation> C — Although acting with humility may be desirable, CFA Institute members are not required to do so. However, they should act in a manner that reflects credit on themselves and their profession
17. John Elliot, CFA, says that in issues of ethics he always puts the clients first according to the guidelines in the Code of Ethics. In doing so he is:

A)correct.
B)not correct, because no such ordering or priority is given in the Code.
C)not correct, because his first duty is to the public

<Explanation> B — Component one mentions duties to the public, clients, prospects, employers, employees, and fellow members. No ordering of priorities is given
18. Which of the following is NOT an act explicitly referred to in the Code of Ethics?

A)Using reasonable care when making investment recommendations.
B)Giving free introductory seminars on investing to the public.
C)Improve professional competence

<Explanation> B — Although the Code says a member has obligations to the public, educating the general public for whatever reason is not implied

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