Estimated study time: 45 minutes
Content:
At Level 3, the CFA Institute Code of Ethics and Standards of Professional Conduct is tested differently than at Levels 1 and 2. Rather than simple rule identification, candidates must apply ethical standards to complex portfolio management scenarios and write reasoned justifications. The exam rewards nuanced analysis — recognizing when a situation involves multiple competing standards and articulating the correct hierarchy of duties.
The Code of Ethics establishes six core principles: acting with integrity, competence, diligence, and respect; placing clients' interests above personal interests; practicing independently and objectively; maintaining and improving professional competence; promoting the integrity of capital markets; and maintaining confidentiality. At Level 3, these principles surface in portfolio-level decisions — trading for multiple client accounts simultaneously, managing conflicts in discretionary mandates, and navigating soft-dollar arrangements across an institutional book.
Standard III (Duties to Clients) is heavily tested at Level 3. III(A) Loyalty, Prudence, and Care requires fiduciaries to manage assets for the benefit of clients, not the firm. In a portfolio context, this means avoiding strategies that generate commissions but don't serve clients' IPS objectives. III(B) Fair Dealing governs how investment recommendations are disseminated across client accounts — all clients must receive fair opportunity to act on changes, and favorable allocations cannot be steered to preferred accounts. III(C) Suitability requires that every investment decision be consistent with the client's written IPS — risk tolerance, return objectives, liquidity needs, time horizon, tax situation, and unique constraints must all be respected before executing trades.
Standard IV (Duties to Employers) intersects frequently with portfolio management. The duty of loyalty (IV(A)) means members cannot take client lists, models, or proprietary data when leaving a firm — but they can retain knowledge. Independence and objectivity (Standard I(B)) is tested in contexts like investment banking pressure on research, gifts from broker-dealers, and allocation of IPO shares. Standard VI (Conflicts of Interest) — particularly the priority of transactions provision — requires that client trades execute before personal trades when the member's own recommendation is involved.
Constructed-response answers on ethics require the following structure: identify the specific standard(s) violated or at risk, cite the relevant provision, explain the facts that create the violation, and state what the member should have done differently. Vague answers that say "this is unethical" without citing standards earn zero credit.
Key Terms:
Quiz Questions:
Q1. A portfolio manager at a large asset management firm receives a research report from a sell-side broker containing a buy recommendation on a technology stock. She updates her model and prepares to add the stock to all suitable client portfolios. Before notifying clients, she purchases shares of the stock for her own account. Which Standard does this most directly violate?
A) Standard III(A) — Loyalty, Prudence, and Care B) Standard VI(B) — Priority of Transactions C) Standard I(B) — Independence and Objectivity D) Standard III(B) — Fair Dealing
Answer: B — Standard VI(B) requires that client transactions take priority over personal trades when the member is acting on a recommendation they are about to disseminate. By trading personally before her clients, she front-runs her own recommendation.
---
Q2. A wealth manager is transitioning to a new firm. Before leaving, she copies her entire client contact list and their portfolio data to a personal device. She argues that she developed the relationships personally and is entitled to bring them. Which of the following best characterizes this action under CFA Standards?
A) Permissible, because client relationships belong to the advisor who developed them B) Permissible, provided she notifies clients of her departure before leaving C) A violation of Standard IV(A), because client data is firm property D) A violation of Standard III(A), because she is harming clients by disrupting service
Answer: C — Standard IV(A) Loyalty prohibits taking firm property — including client lists, account data, and proprietary models — when departing. She may notify clients of her departure and solicit them after leaving, but she cannot take the data itself.
---
Q3. An institutional portfolio manager receives a request from a corporate pension plan sponsor to tilt the fund's equity holdings toward the sponsor's own stock, arguing it demonstrates "alignment of interests." The manager complies without modifying the IPS. Which standards are most clearly violated?
A) Standard III(A) and Standard III(C) B) Standard IV(A) and Standard VI(A) C) Standard I(B) and Standard II(A) D) Standard III(B) and Standard VI(B)
Answer: A — Standard III(A) (Loyalty, Prudence, and Care) is violated because the manager is acting to benefit the sponsor rather than the plan beneficiaries. Standard III(C) (Suitability) is violated because the concentrated position in sponsor stock changes the portfolio's risk profile without IPS amendment and independent assessment.
---
Q4. A buy-side analyst uncovers a piece of information from a company's former employee about an upcoming product recall. The information has not been publicly announced. She combines it with publicly available data to conclude that the stock is overvalued. She then sells the stock from client portfolios. Which of the following is correct?
A) This is permissible under mosaic theory because she used public information as well B) This is a violation because former employee information is always considered material C) This is a violation if the employee information is both material and nonpublic D) This is permissible because she did not receive the information from an insider
Answer: C — Mosaic theory permits combining non-material nonpublic information with public data. However, if the former employee's information about the recall is material (i.e., would affect the stock price if disclosed), using it to trade violates Standard II(A) regardless of how it was received.
---
Q5. In a constructed-response question, a candidate is asked to evaluate whether a portfolio manager violated the Code of Ethics when she executed a block trade for 10 accounts and allocated the best-price fills to a preferred institutional client. What is the strongest structure for a full-credit answer?
A) State that this is "probably unethical" and explain the general concept of fairness B) Cite Standard III(B) Fair Dealing, explain that fill allocation must be pro-rata or by a pre-disclosed method, identify the specific violation, and state the required corrective action C) Identify that the manager favored one client and recommend she be reported to regulators D) Explain that institutional clients may receive priority because they generate more revenue
Answer: B — CFA constructed-response grading rewards precision. A full-credit answer names the specific Standard, applies it to the facts, explains what the violation consists of, and states what should have been done. Vague ethical arguments without standard citations receive partial or no credit.
---