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Application of the Code and Standards: Level III

5 minutes 5 Questions

In the CFA Level III curriculum, the Application of the Code and Standards focuses on integrating ethical principles into portfolio management and decision-making processes. At this advanced level, candidates are expected to demonstrate not only an understanding of the CFA Institute Code of Ethics …

Application of the Code and Standards: Level III

Understanding and applying the CFA Institute's Code of Ethics and Standards of Professional Conduct is crucial for all CFA charterholders and candidates. At Level III, the focus is on identifying and addressing complex ethical situations that may arise in the investment profession.

The Code of Ethics and Standards of Professional Conduct set forth the ethical principles and professional standards that guide the behavior of CFA Institute members and candidates. These include:
- Acting with integrity, competence, diligence, and respect
- Placing the integrity of the profession and the interests of clients above personal interests
- Maintaining and improving professional competence
- Promoting the integrity and viability of the global capital markets for the ultimate benefit of society

At Level III, candidates are expected to analyze and evaluate ethical dilemmas in the context of the investment profession. This involves:
1. Identifying the relevant ethical principles and standards
2. Considering the interests of all stakeholders
3. Evaluating alternative courses of action
4. Choosing the most appropriate course of action that adheres to the Code and Standards

Exam Tips: Answering Questions on Application of the Code and Standards: Level III
1. Read the question carefully and identify the key ethical issues at stake
2. Consider the perspectives of all stakeholders involved
3. Refer to the specific principles and standards relevant to the situation
4. Evaluate the potential consequences of different actions
5. Choose the course of action that best aligns with the Code and Standards, and provides the most benefit or least harm to stakeholders
6. Justify your answer by citing the relevant principles and standards

By thoroughly understanding and applying the Code of Ethics and Standards of Professional Conduct, investment professionals can navigate complex ethical situations, maintain the integrity of the profession, and best serve the interests of their clients and society as a whole.

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CFA Level 3 - Application of the Code and Standards: Level III Example Questions

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Question 1

Tom, a CFA charterholder, works as an investment manager at a large pension fund. During a meeting with a potential new client, the client expresses interest in a specific investment strategy that Tom knows would be unsuitable given the client's risk tolerance and investment objectives. The client is insistent on pursuing this strategy, and Tom's supervisor, who is not a CFA charterholder, suggests that Tom should comply with the client's wishes to secure their business. The strategy would likely generate significant fees for the firm. What should Tom do in this situation to best comply with the CFA Institute Code of Ethics and Standards of Professional Conduct?

Tom should defer to his supervisor's judgment and comply with the client's wishes to pursue the proposed investment strategy, as securing the client's business is a top priority for the firm. He can document his concerns about the strategy's suitability but ultimately follow the client's directive. Tom should inform the client that the proposed investment strategy is not suitable for their risk profile and investment goals, even if it means potentially losing the client's business. He should offer alternative strategies that better align with the client's needs and adhere to his ethical obligations as a CFA charterholder. Tom should present the proposed investment strategy to the client, along with its potential risks and benefits, and let the client make an informed decision. As long as Tom discloses all relevant information, he has fulfilled his ethical duties and can proceed with the client's chosen strategy, even if he personally believes it to be unsuitable.

Correct Answer: Tom should inform the client that the proposed investment strategy is not suitable for their risk profile and investment goals, even if it means potentially losing the client's business. He should offer alternative strategies that better align with the client's needs and adhere to his ethical obligations as a CFA charterholder.

The best answer is that Tom should inform the client that the proposed investment strategy is not suitable for their risk profile and investment goals, even if it means potentially losing the client's business. He should offer alternative strategies that better align with the client's needs and adhere to his ethical obligations as a CFA charterholder. As a CFA charterholder, Tom has a duty to act in the best interest of his clients and to place their interests above his own or his firm's. Recommending an unsuitable investment strategy, even if the client insists on it, would be a violation of this ethical principle. Tom should prioritize providing sound advice over securing business for his firm. The other two options are incorrect because they suggest compromising Tom's ethical standards. Deferring to his supervisor's judgment and complying with the client's wishes, despite knowing the strategy is unsuitable, would be a breach of his fiduciary duty. Similarly, merely presenting the risks and benefits of the strategy and allowing the client to make a decision does not absolve Tom of his responsibility to provide appropriate recommendations that align with the client's risk tolerance and investment objectives.

Question 2

John, a CFA charterholder, is a senior portfolio manager at a well-established investment firm. He manages a large pension fund that primarily invests in blue-chip stocks. During a recent meeting with the pension fund's investment committee, John was informed that the committee is considering investing a portion of the fund's assets in a new alternative investment strategy that involves complex derivatives. The strategy promises to deliver high returns but also carries significant risks. John has concerns about the suitability of this strategy for the pension fund, given its investment objectives and risk tolerance. However, the investment committee is enthusiastic about the potential returns and is pressuring John to allocate a significant portion of the fund's assets to this new strategy. What should John do in this situation to best comply with the CFA Institute Code of Ethics and Standards of Professional Conduct?

John should compromise with the investment committee by allocating a smaller portion of the pension fund's assets to the alternative investment strategy than initially requested. He should focus on maintaining a good relationship with the committee, even if it means investing in a strategy that he believes may not be entirely suitable for the fund. John can monitor the strategy's performance closely and make adjustments as needed to mitigate potential risks. John should fully comply with the investment committee's request and allocate a significant portion of the pension fund's assets to the new alternative investment strategy, as the potential high returns would benefit the fund's beneficiaries. He should prioritize the investment committee's preferences over his own professional judgment and the fund's stated investment objectives and risk tolerance. John should express his concerns about the suitability of the alternative investment strategy to the investment committee, emphasizing the need to adhere to the pension fund's investment objectives and risk tolerance. He should provide a detailed analysis of the potential risks and benefits of the strategy and recommend an allocation that aligns with the fund's goals and risk profile. If the investment committee insists on an allocation that John believes is unsuitable, he should escalate the matter to the firm's compliance department or senior management and consider refusing to manage the portion of the fund invested in the alternative strategy.

Correct Answer: John should express his concerns about the suitability of the alternative investment strategy to the investment committee, emphasizing the need to adhere to the pension fund's investment objectives and risk tolerance. He should provide a detailed analysis of the potential risks and benefits of the strategy and recommend an allocation that aligns with the fund's goals and risk profile. If the investment committee insists on an allocation that John believes is unsuitable, he should escalate the matter to the firm's compliance department or senior management and consider refusing to manage the portion of the fund invested in the alternative strategy.

The best answer is the one stating that John should express his concerns about the suitability of the alternative investment strategy to the investment committee. As a CFA charterholder, John has a duty to act in the best interests of his clients and to provide independent and objective advice. He should prioritize the pension fund's investment objectives and risk tolerance over the investment committee's enthusiasm for potentially high returns. John should provide a detailed analysis of the risks and benefits of the proposed strategy and recommend an allocation that aligns with the fund's goals and risk profile. If the investment committee insists on an unsuitable allocation, John should escalate the matter to compliance or senior management and consider refusing to manage that portion of the fund. The answer suggesting that John should fully comply with the committee's request prioritizes the committee's preferences over John's professional judgment and the fund's objectives, which goes against the CFA Institute's ethical standards. The answer proposing a compromise by allocating a smaller portion to the alternative strategy still involves investing in a strategy that John believes may not be suitable for the fund. This compromises his ethical duties and professional judgment.

Question 3

Olivia, a CFA charterholder, works as a senior analyst at an investment research firm. Her team is preparing a report on a pharmaceutical company that has recently announced positive results from a clinical trial for a new drug. Olivia's analysis suggests that the drug has the potential to generate significant revenue for the company, but she also discovers that the clinical trial results were based on a relatively small sample size and that the company has a history of aggressive marketing practices. Olivia's supervisor, who is not a CFA charterholder, insists that the report should focus primarily on the positive aspects of the drug and downplay any potential concerns. What should Olivia do in this situation to best comply with the CFA Institute Code of Ethics and Standards of Professional Conduct?

Olivia should ensure that the report provides a balanced and objective analysis of the company and its new drug, including a discussion of the limitations of the clinical trial results and the company's marketing practices. She should not succumb to pressure from her supervisor to present a biased or misleading view. If necessary, Olivia should escalate her concerns to a higher level of management or the compliance department. Olivia should follow her supervisor's guidance and focus primarily on the positive aspects of the drug in the report, as this will help to attract more clients to the firm and generate greater revenue. She can mention the potential concerns briefly in the report but should not emphasize them. Olivia should remove any mention of the small sample size and the company's aggressive marketing practices from the report, as including this information could harm the firm's relationship with the pharmaceutical company and potentially lead to a loss of future business opportunities. She should focus solely on the drug's revenue potential.

Correct Answer: Olivia should ensure that the report provides a balanced and objective analysis of the company and its new drug, including a discussion of the limitations of the clinical trial results and the company's marketing practices. She should not succumb to pressure from her supervisor to present a biased or misleading view. If necessary, Olivia should escalate her concerns to a higher level of management or the compliance department.

Olivia, as a CFA charterholder, is bound by the CFA Institute Code of Ethics and Standards of Professional Conduct, which requires her to maintain independence and objectivity in her professional activities. She should provide a balanced and unbiased analysis of the pharmaceutical company and its new drug, including both the positive revenue potential and the concerns about the clinical trial sample size and the company's marketing practices. Olivia should not succumb to pressure from her supervisor to focus primarily on the positive aspects of the drug and downplay potential concerns, as this would compromise her integrity and objectivity. If her supervisor insists on presenting a biased view, Olivia should escalate her concerns to a higher level of management or the compliance department to ensure that the report meets the ethical standards required by the CFA Institute. The other two options are incorrect because they involve presenting a misleading or biased view of the company and its drug, which would violate the CFA Institute's ethical principles. Focusing solely on the positive aspects or omitting important information about the clinical trial limitations and marketing practices would be unethical and could potentially mislead investors.

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