Level I Ethics practice questions

The Code of Ethics requires members and candidates to place the integrity of the investment profession and the interests of clients above their own personal interests. Directing valuable, oversubscribed IPO shares to personal and insider accounts ahead of clients is self-dealing that subordinates client interests.

• Option A is wrong because it cites a Standard (conflict disclosure) rather than the Code principle at issue; disclosure does not cure the self-dealing that puts personal interests ahead of clients.
• Option B is wrong because fair dealing in disseminating recommendations is a separate Standard; the key issue here is prioritizing client interests over personal gain, which the Code explicitly requires.

GIPS requires the firm to be the distinct business entity held out to clients; entities operating under the same brand and sharing the same decision‑making should be included in the firm definition. Claiming compliance at the composite level is prohibited.

• Option B is wrong because differing client types alone do not justify excluding a division when brand and decision‑making are shared.
• Option C is wrong because GIPS compliance cannot be claimed for a composite; compliance is firm‑wide.

Standard I(A) Knowledge of the Law requires members and candidates to comply with the most strict requirement among applicable law, regulation, and the CFA Institute Code and Standards. Because the Code and Standards are stricter here (requiring full disclosure of material conflicts to clients and prospects before acting), Kim must disclose the conflict and refrain from making the recommendation until disclosure is made.

• Option A is wrong because following a less strict local law when the Code and Standards are stricter violates Standard I(A).
• Option C is wrong because disclosure must occur before providing investment recommendations or taking action; post-trade disclosure is insufficient under the Code and Standards.

This is a violation of Standard II(A) Material Nonpublic Information. The supplier’s private confirmation of a major order cancellation is both material (likely to affect the stock price and investor decisions) and nonpublic (disclosed privately under a confidentiality obligation). Acting on such information to change recommendations and trade is prohibited.

• Option A: Misapplies mosaic theory. Mosaic permits using public information plus nonmaterial nonpublic pieces. Here, the supplier’s confirmation is material and nonpublic, so mosaic does not apply.
• Option B: Incorrectly focuses on the source. Standard II(A) applies to material nonpublic information from any source, not just the issuer.

Standard III(B) Fair Dealing requires members to deal fairly and objectively with all clients when disseminating investment recommendations or taking investment action. For oversubscribed offerings, firms should use a documented, equitable allocation policy applied consistently, without favoring certain clients due to fees, size, or relationships. The correct approach is to allocate fairly and objectively among eligible, interested clients.

• Option A: Favors the most profitable clients, which is unfair preferential treatment based on fee status and violates III(B).
• Option B: Selective early notification gives certain clients a time advantage, which is unfair treatment and violates III(B).
• Option C: Correct; a documented, consistently applied pro rata (or similar) policy treats all eligible clients fairly.

Under Standard IV(B)–Additional Compensation Arrangements, members must obtain their employer’s written consent before accepting any compensation, consideration, or benefit from third parties that might create a conflict with the employer’s interests. Rosa accepted the arrangement without prior written consent, violating her duty to her employer.

• Option A: Incorrect because informal disclosure to teammates is not sufficient; the Standard requires written employer consent before acceptance.
• Option C: Incorrect because after-the-fact disclosure does not satisfy the requirement for prior written consent before acceptance and commencement.

Standard V(A) Diligence and Reasonable Basis requires members to have a reasonable and adequate basis supported by appropriate research and investigation. When using third-party research, they must judge its soundness and independence; reputation alone is insufficient, and full replication is not required.

• Option A is wrong because relying on reputation and disclosures alone fails to assess methodology, assumptions, and the analysts’ objectivity and track record.
• Option B is wrong because the Standard does not require full replication of all models; a documented reasonableness review suffices.

Correct: Option C. Standard VI(C) Referral Fees requires members to disclose to clients and prospective clients, and to their employer, the nature, terms, and estimated value of any referral arrangement so clients can evaluate potential biases before relying on the recommendation.

• Option A is wrong because obtaining employer permission alone does not satisfy VI(C), and omitting proactive client disclosure of the nature, terms, and value fails the Standard.
• Option B is wrong because disclosure must be proactive and sufficiently detailed; limiting disclosure to only upon client inquiry is inadequate.

Under Standard VII(B), candidates may state their candidacy accurately (e.g., “Level II candidate in the CFA Program”) but must not imply they hold the CFA designation or that award is pending.

Correct: “Level II candidate in the CFA Program” states status accurately without implying the charter has been earned.

• Option A is wrong because it pairs “CFA” with a level (implies the designation) rather than stating candidacy; use of “CFA” is restricted to charterholders.
• Option B is wrong because “CFA (pending)” is prohibited; there is no “pending” status for the designation and it implies guaranteed award.

The described behavior aligns directly with the Code’s requirement to maintain and improve one’s professional competence and to strive to improve the competence of other investment professionals.

• Option B is wrong because independent judgment concerns the quality and objectivity of analysis and decisions, not initiatives focused on skill development and training.
• Option C is wrong because upholding market rules pertains to market integrity and compliance, not professional development activities.