Reading 91 — Guidance for Standards I–VII (Part C)

Standard IV(B) — Additional Compensation Arrangements (Recommendations)

• Make an immediate written report to the employer detailing any proposed compensation and services, if additional to those provided by the employer.
• Members and candidates hired to work part time should discuss any arrangements that may compete with their employer's interest at the time they are hired, and abide by any limitations the employer identifies.

• Details of additional compensation, including any performance incentives, should be verified by the offering party.

Standard IV(C) — Responsibilities of Supervisors

Members must make reasonable efforts to prevent employees from violating laws, rules, regulations, or the Code and Standards, and to detect violations.

An adequate compliance system must meet industry standards, regulatory requirements, and the requirements of the Code and Standards.

Members with supervisory responsibility must bring an inadequate compliance system to firm management's attention and recommend corrective action. A member faced with no compliance procedures, or procedures believed to be inadequate, must decline supervisory responsibility in writing until adequate procedures are adopted.

If there is a violation, respond promptly and conduct a thorough investigation while increasing supervision or placing limitations on the wrongdoer's activities.

A member should recommend that his employer adopt a code of ethics and encourage employers to provide their codes of ethics to clients.

Once a compliance program is instituted, the supervisor should:

• Distribute it to the proper personnel
• Update it as needed
• Continually educate staff regarding procedures
• Issue reminders as necessary
• Require professional conduct evaluations
• Review employee actions to monitor compliance and identify violations

Employers should not commingle compliance procedures with the firm's code of ethics — doing so can dilute the goal of reinforcing one's ethical obligations. While investigating a possible breach, it is appropriate to limit the suspected employee's activities.

Adequate compliance procedures should:

• Be clearly written
• Be easy to understand
• Designate a compliance officer with authority clearly defined
• Have a system of checks and balances
• Outline the scope of procedures
• Outline what conduct is permitted
• Contain procedures for reporting violations and sanctions
• Structure incentives so unethical behavior is not rewarded

Standard V(A) — Diligence and Reasonable Basis

Application depends on the investment philosophy followed, the member's role in the decision-making process, and the resources and support provided by the employer. These factors dictate the degree of diligence and the proper level of investigation required.

Items to consider before making a recommendation or taking action:

• Global and national economic conditions
• The firm's financial results, operating history, and the business cycle stage
• Fees and historical results for a mutual fund
• Limitations of any quantitative models used
• Whether peer-group comparisons for valuation are appropriate

Members should encourage their firms to adopt a policy for periodic review of the quality of third-party research. Criteria for judging quality:

• Review assumptions used
• Determine how rigorous the analysis was
• Identify how timely the research is
• Evaluate objectivity and independence of recommendations

Recommended firm policies and procedures:

• Require that research reports and recommendations have a basis substantiated as reasonable and adequate
• Provide detailed, written guidance for proper research and due diligence
• Use measurable criteria for judging research quality and base analyst compensation on such criteria
• Set minimum acceptable scenario testing for computer-based models, including ranges, accuracy over time, and sensitivity to inputs
• Establish a policy for evaluating outside providers of information addressing reasonableness, accuracy, and review frequency
• Adopt criteria for evaluating external advisers and how often they will be reviewed

Standard V(B) — Communication With Clients and Prospective Clients

This Standard covers all means and types of communication with clients, not just research reports. Client-facing members must describe the nature and costs of services at the start of a relationship and on an ongoing basis if services or costs change. Specific dollar amounts are not always required, but reasonably detailed cost information must be provided, including third-party costs.

Members must distinguish opinions from facts and always include the basic characteristics of the security analyzed. Expectations based on statistical modeling are not facts.

Members must explain the investment decision-making process. For structured securities, allocation strategies, or other nontraditional investments, communicate specific risk factors and convey potential gains and losses in terms of total returns.

Communicate significant changes in risk characteristics; update clients regularly about changes in the investment process, including newly identified risks and limitations.

When using projections from quantitative models, explain the model's limitations and assumptions, providing context for judging the uncertainty of estimated results.

Inform clients about limitations inherent to an investment, such as:

• Liquidity — the ability to exit an investment readily without significant extra cost.
• Capacity — an investment vehicle's ability to absorb additional investment without reducing achievable returns.

Selection of relevant factors can be a judgment call; members should maintain records indicating the nature of the research, and be able to supply additional information if requested.

Standard V(C) — Record Retention

Members must maintain research records that support the analyst's conclusions and any investment actions. Such records are property of the firm. All client communications through any medium — including emails and text messages — are records that must be retained.

A member who changes firms must re-create the analysis documentation using publicly available information or information obtained from the company; the member must not rely on memory or materials created at the previous firm.

If no regulatory standards or firm policies are in place, the Standard recommends a seven-year minimum holding period.

The recordkeeping requirement is generally the firm's responsibility.

Standard VI(A) — Avoid or Disclose Conflicts

Avoid actual or potential conflicts where possible; otherwise, disclose them clearly so clients and prospects can judge motives and biases for themselves. Examples include:

• Broker-dealer market-making activities
• Board service
• Ownership of stock in companies the member recommends or that clients hold (the most common conflict)
• Compensation/bonus structures that may incentivize short-term gains over long-term client returns — including special arrangements, bonus programs, commissions, and incentives

Conflicts must be disclosed when acting in an advisory capacity and updated for significant changes. Members must give employers enough information to judge the impact, take reasonable steps to avoid conflicts, and report them promptly.

Standard VI(B) — Priority of Transactions

Client transactions take priority over personal transactions and over transactions made on behalf of the firm. Personal transactions include those where the member is a beneficial owner. Personal trades may only be undertaken after clients and the employer have had an adequate opportunity to act on a recommendation.

Family-member accounts that are client accounts should be treated like any other client account — not disadvantaged. Members must not act on information about pending trades for personal gain. The overriding consideration is that personal trades must not disadvantage any client. When requested, members must fully disclose their firm's personal trading policies.

• Avoid IPO conflicts by not participating in them.
• Encourage firms to adopt the procedures listed below.

• Limit employee participation in equity IPOs.
• Restrict participation in private placements. Apply strict limits and proper supervisory procedures, mirroring IPO concerns.
• Establish blackout/restricted periods. Employees involved in investment decisions should have blackout periods before client trading — no front running. Firm size and security type dictate severity.
• Establish reporting procedures — duplicate trade confirmations, disclosure of personal holdings and beneficial ownership, and preclearance procedures.

Standard VI(C) — Referral Fees

Members must inform employers, clients, and prospects of any benefit received for referrals, allowing them to evaluate the full cost of the service and any potential partiality. All types of consideration must be disclosed.

• Encourage firms to adopt clear procedures regarding compensation for referrals.
• Provide employers with updates at least quarterly.

Firms that do not prohibit referral fees should have clear procedures for approval and policies regarding the nature and value of referral compensation received.

Standard VII(A) — Conduct as Participants in CFA Institute Programs

This Standard applies to conduct that includes:

• Cheating on the CFA exam or any exam
• Revealing anything about broad or specific topics tested, content of exam questions, or formulas required or not required
• Not following rules and policies of the CFA Program
• Giving confidential information about the CFA Program to candidates or the public
• Improperly using the designation to further personal and professional goals
• Misrepresenting information on the Professional Conduct Statement (PCS) or the CFA Institute Professional Development Program

Members and candidates may express opinions about the exam program or CFA Institute, but must not reveal confidential information about the CFA Program. Candidates who violate any CFA exam policies (calculator, personal belongings, Candidate Pledge, etc.) violate Standard VII(A).

Members who volunteer in the CFA Program may not solicit or reveal information about questions considered for or included on a CFA exam, the grading process, or scoring of questions.

Standard VII(B) — Reference to CFA Institute, the CFA Designation, and the CFA Program

Members must not make promotional promises or guarantees tied to the CFA designation, such as over-promising individual competence or over-promising investment results (e.g., higher performance, less risk).

To maintain membership, members must:

• Sign the PCS annually
• Pay CFA Institute membership dues annually

Failure to do so means they are no longer active members.

There is no partial CFA designation. It is acceptable to state that a candidate completed the program in three years if accurate, but claiming superior ability because of this is not permitted.

Members should ensure their firms are aware of proper references to a member's CFA designation or candidacy, since errors in these references are common.