Ethical and Professional Standards
Ethics is the heaviest topic on the Level I exam and the one candidates most often underestimate. The material is not hard to read. It is hard to apply. Questions are short cases where two answers look defensible, and the distinction usually turns on one specific Standard rather than on general good behaviour.
What you need to be able to do
- Identify which Standard a scenario engages, before deciding whether it was violated
- Separate what is required from what is merely recommended
- Recognise that disclosure alone rarely cures a conflict: the duty is usually to act, not to announce
- Apply the firm-level nature of a GIPS compliance claim
Where candidates lose marks
Answering from instinct instead of from the Standards. A choice can feel honest and still violate a specific requirement, and the exam tests the requirement.
10 free Ethics practice questions
Real questions from the CFAQuiz bank, one or two per subtopic, with the full explanation. No account needed.
A portfolio manager directs a disproportionately large allocation of oversubscribed IPO shares to her own personal account and to a favored colleague, leaving many clients with minimal allocations. Which principle of the CFA Institute Code of Ethics is most clearly violated?
- A.Disclose conflicts of interest to clients and prospective clients.
- B.Deal fairly and objectively with all clients when disseminating recommendations.
- C.Place the integrity of the investment profession and the interests of clients above their own personal interests.
Show answer and explanation
Correct answer: C
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.
Atlas Capital includes a statement on its Global Equity Composite factsheet: "We are GIPS verified and comply with the GIPS standards for our Global Equity Composite." The firm also places a GIPS logo on the factsheet. To make its claim compliant with the GIPS standards, which action must Atlas take?
- A.Continue to claim compliance for the Global Equity Composite after third‑party verification and use the GIPS logo to signify compliance.
- B.State that the firm is "GIPS verified" and therefore compliant, and defer providing composite information until a client is hired.
- C.State that the firm (not a single composite) complies with the GIPS standards and provide a GIPS‑compliant presentation for the relevant composite to all prospective clients; do not use a GIPS logo.
Show answer and explanation
Correct answer: C
Under GIPS, only a firm (the defined entity) may claim compliance, not a single composite. Verification is optional and does not confer composite‑level compliance, and firms may not use a GIPS logo. Firms must provide a GIPS‑compliant presentation for the relevant composite to all prospective clients.
- Option A is wrong because GIPS compliance cannot be claimed for a single composite and firms may not use a GIPS logo.
- Option B is wrong because verification does not equal compliance and firms must provide a compliant presentation to prospective clients before they become clients.
Kim, CFA, works in Country R where investment advisers are not required by law to disclose significant conflicts of interest to clients. Her firm policy mirrors local law. Kim has a material ownership stake in a company she plans to recommend to clients. Under the Code and Standards, what must Kim do?
- A.Follow local law and firm policy; no disclosure is required unless a client specifically requests it.
- B.Disclose the conflict to clients and prospects before making the recommendation and refrain from proceeding until disclosure is made, because she must follow the stricter requirement of the Code and Standards.
- C.Proceed with the recommendation and disclose the conflict after trade execution to avoid influencing client decisions.
Show answer and explanation
Correct answer: B
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.
Analyst Alvarez uses an expert network to speak with a mid-level operations manager at a publicly traded manufacturer. During the call, the consultant reveals that the company plans to announce a nationwide recall of its flagship product next week due to a safety defect. This information is not yet public and is likely to have a significant negative effect on the share price. What is Alvarez’s most appropriate action under the CFA Institute Standards?
- A.Rely on the mosaic theory and immediately update the firm’s recommendation using the consultant’s insight in combination with public data.
- B.Refrain from trading or changing recommendations, promptly inform compliance, and place the security on the firm’s restricted/watch list until the information is public.
- C.Proceed with trading because the expert did not sign a nondisclosure agreement with Alvarez or the firm.
Show answer and explanation
Correct answer: B
Standard II(A) prohibits trading or causing others to trade on material nonpublic information (MNPI). A pending product recall likely to impact price is both material and nonpublic. The appropriate response is to avoid trading or altering recommendations, notify compliance, and use controls such as a restricted or watch list until public dissemination.
- Option A is wrong: It misapplies the mosaic theory. Mosaic allows combining public information with nonmaterial nonpublic information, not using MNPI. Treating MNPI as permissible under mosaic is a specific misuse of the doctrine.
- Option C is wrong: The absence of a nondisclosure agreement does not legalize use of MNPI. The prohibition turns on the nature of the information (material and nonpublic), not on contractual formalities.
Martin, a portfolio manager, selects a mutual fund share class for a client’s large taxable account. Two otherwise identical share classes are available: an institutional class with no sales load and a low ongoing expense ratio, and a retail class that has a front-end load and higher ongoing 12b-1 fees that pay his firm a revenue-sharing stream. Martin chooses the retail class after disclosing the revenue-sharing arrangement to the client and obtaining the client’s acknowledgment. Martin does not document any client-specific benefit from the more expensive share class. Which statement best describes Martin’s conduct under the CFA Institute Code and Standards?
- A.No violation occurs because Martin disclosed the conflict and the client acknowledged it.
- B.Martin violates Standard III(B) Fair Dealing by favoring one segment of clients over another.
- C.Martin violates Standard III(A) Loyalty, Prudence, and Care by not placing the client’s interests first when selecting a higher-cost option without a client benefit; disclosure alone does not cure the conflict.
Show answer and explanation
Correct answer: C
Martin’s decision breaches the duty of loyalty, prudence, and care because he selected a higher-cost share class that benefits his firm without demonstrating a client-specific advantage. Under Standard III(A), members must place client interests first; mere disclosure of a conflict does not permit disadvantaging the client.
- Option A is wrong because disclosure and client acknowledgment do not relieve the duty to act in the client’s best interest; selecting a higher-cost identical product without benefit violates Standard III(A).
- Option B is wrong because the core issue is not disparate treatment among clients (fair dealing) but failing to choose the most appropriate, cost-effective option for this client, which is governed by Standard III(A).
Rosa, a portfolio manager at Norland Advisors, is offered a client-funded bonus equal to 1% of the account’s value if the account outperforms its benchmark over the next year. She verbally informs her immediate team and emails the client accepting the arrangement. She does not obtain written consent from her firm before the arrangement begins. According to the CFA Institute Code and Standards, which statement is most accurate?
- A.No violation because Rosa disclosed the arrangement internally and the bonus aligns her incentives with the client’s goals.
- B.Violation: Before accepting the arrangement, Rosa must obtain her employer’s written consent to any additional compensation that could create a conflict.
- C.No violation if Rosa discloses the arrangement to her employer after the performance period ends.
Show answer and explanation
Correct answer: B
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.
Nguyen, CFA, manages a consumer staples coverage list. Due to a higher-rate environment, she replaces her discounted cash flow (DCF) model with an EV/EBITDA multiples approach for all companies. She continues to publish reports without informing clients of the change, noting no change in most recommendations. Which statement best reflects her compliance with Standard V?
- A.Compliant because both DCF and EV/EBITDA are widely used valuation methods and her conclusions did not materially change.
- B.Violation of Standard V(C) Record Retention for failing to archive model outputs supporting the new valuation.
- C.Violation of Standard V(B) Communication with Clients because she failed to disclose a significant change to the investment process and its limitations/risks.
Show answer and explanation
Correct answer: C
Under Standard V(B), members must disclose to clients the basic format and general principles of the investment process and promptly disclose significant changes, including shifts in valuation approach and related limitations/risks. Failing to inform clients is a violation of V(B).
- Option A is wrong because the fact that both methods are common does not remove the duty to disclose a significant process change to clients.
- Option B is wrong because the core issue is not record retention; it is the failure to communicate a significant change in the investment process (V(B)).
Chen, a portfolio adviser, has an arrangement with a mortgage broker to receive a $400 fee for each client he refers who completes a loan. Chen informed his employer and keeps an internal log of all referral fees received. He does not tell prospective clients about the arrangement when recommending the broker. To comply with the CFA Institute Standards, what must Chen do?
- A.Disclose the referral-fee arrangement only to his employer and maintain an internal log.
- B.Disclose the arrangement to clients after each referral has been completed, such as in periodic client statements.
- C.Provide clients and prospective clients with written, plain-language disclosure of the nature and value of the referral-fee arrangement before or at the time of the recommendation.
Show answer and explanation
Correct answer: C
Correct: Option C. Under Standard VI(C) Referral Fees, members must disclose to clients and prospective clients, in writing, the nature and value of any compensation received for referrals before or at the time of the recommendation so clients can evaluate the impartiality of the advice.
- Option A: Discloses only to the employer; Standard VI(C) also requires disclosure to clients and prospects, not just internally.
- Option B: Delays disclosure until after the referral; Standard VI(C) requires disclosure before or at the time of the recommendation so clients can decide with full knowledge.
A firm is finalizing a marketing brochure and wants to reference the CFA designation held by several employees. Which usage of the CFA mark complies with Standard VII(B)?
- A.“Our CFA-certified portfolio managers have a proven edge.”
- B.“Portfolio managers John Rivera, CFA charterholder, and Mei Wong, CFA charterholder.”
- C.“Our firm employs 12 CFAs.”
Show answer and explanation
Correct answer: B
Standard VII(B) requires that the marks be used as adjectives, not nouns, and prohibits altering the marks or using terms such as “certified.” The construction “CFA charterholder” is an approved, proper use of the mark as an adjective modifying “charterholder.”
- Option A is wrong because “CFA-certified” alters the mark and implies a certification; “certified” is prohibited.
- Option C is wrong because it uses “CFA” as a noun and in plural form (“CFAs”), both of which are prohibited.
An analyst organizes monthly internal teach-ins to help junior colleagues master research methods and also completes additional continuing education to expand her own skills. Which principle of the CFA Institute Code of Ethics is best demonstrated?
- A.Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.
- B.Use reasonable care and exercise independent professional judgment in investment analysis and recommendations.
- C.Promote the integrity of, and uphold the rules governing, capital markets.
Show answer and explanation
Correct answer: A
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.
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