CFA Ethical and Professional Standards 3 — Questions and Answers
Question 1: Standard V(A) – Diligence and Reasonable Basis requires that investment recommendations be supported by:
- At least three independent data sources
- Formal approval from a compliance committee
- Thorough research and a reasonable and adequate basis (Correct answer)
- A quantitative model with documented back-test results
Correct answer: Thorough research and a reasonable and adequate basis
Standard V(A) requires that any recommendation be based on thorough investigation and have a reasonable and adequate basis.
Question 2: A research analyst relies on a third-party model to generate earnings forecasts. Under Standard V(A), the analyst:
- Bears no responsibility for errors in the third-party model
- Must independently verify all assumptions in the third-party model
- Should indicate reliance on third-party work and ensure it is sound (Correct answer)
- Can use the model only if it is approved by CFA Institute
Correct answer: Should indicate reliance on third-party work and ensure it is sound
Members may use third-party research but must indicate the reliance and take reasonable steps to ensure it is sound.
Question 3: Standard V(B) – Communication with Clients requires distinguishing facts from opinions. Which statement in a research report is an opinion?
- The company reported EPS of $3.45 last quarter
- Revenue declined 8% year-over-year
- We believe the stock is undervalued by 20% (Correct answer)
- The firm has $500 million in long-term debt
Correct answer: We believe the stock is undervalued by 20%
Valuation estimates and forward-looking conclusions are opinions, which must be clearly distinguished from factual data.
Question 4: Standard V(C) – Record Retention requires that CFA members maintain records supporting their analyses and recommendations for a minimum of:
- 3 years
- 5 years
- 7 years (Correct answer)
- 10 years
Correct answer: 7 years
Standard V(C) requires records to be maintained for a minimum of seven years.
Question 5: Under Standard VI(A) – Disclosure of Conflicts, when must conflicts of interest be disclosed?
- Only when they result in an actual loss to the client
- In annual regulatory filings but not in client communications
- Promptly and in plain language to clients and prospects (Correct answer)
- Only when directed by the employer's compliance department
Correct answer: Promptly and in plain language to clients and prospects
Standard VI(A) requires prompt, plain-language disclosure of all material conflicts to clients and prospects.
Question 6: A CFA charterholder owns shares in a company she is about to upgrade to a 'Buy' recommendation. Standard VI(A) requires her to:
- Sell her shares before publishing the upgrade
- Disclose the ownership interest in the research report (Correct answer)
- Obtain compliance approval and then abstain from ownership disclosure
- Delay publication until the position is below a 1% ownership threshold
Correct answer: Disclose the ownership interest in the research report
Standard VI(A) requires disclosing the personal ownership conflict; it does not automatically require liquidating the position.
Question 7: Standard VI(B) – Priority of Transactions prohibits members from benefiting personally at the expense of clients. This standard is BEST enforced through:
- Banning all personal trading by investment professionals
- Requiring members to trade only in index funds
- Establishing pre-clearance and blackout period policies (Correct answer)
- Limiting personal holdings to government securities
Correct answer: Establishing pre-clearance and blackout period policies
Pre-clearance requirements and blackout periods are standard compliance mechanisms that enforce the priority of client transactions.
CFA Ethical and Professional Standards 3
Standard V(A) – Diligence and Reasonable Basis requires that investment recommendations be supported by: