CFM Regulatory Compliance & Ethical Standards 3 — Questions and Answers
Question 1: A CFM candidate witnesses a colleague misrepresenting fund performance to a prospective client. According to ethical standards, the candidate should:
- Stay silent to avoid damaging the colleague's career
- Report the misconduct to the compliance department or a supervisor (Correct answer)
- Confront the prospective client directly to correct the misrepresentation
- Wait to see if the colleague corrects the error before taking action
Correct answer: Report the misconduct to the compliance department or a supervisor
Ethical standards require reporting observed misconduct through proper channels, such as compliance or management, to prevent harm to clients.
Question 2: Which regulatory body oversees commodity pool operators (CPOs) and commodity trading advisers (CTAs) in the United States?
- SEC (Securities and Exchange Commission)
- FINRA (Financial Industry Regulatory Authority)
- CFTC (Commodity Futures Trading Commission) (Correct answer)
- OCC (Office of the Comptroller of the Currency)
Correct answer: CFTC (Commodity Futures Trading Commission)
The CFTC has jurisdiction over commodity pool operators and commodity trading advisers dealing in futures, options, and swaps.
Question 3: The 'best execution' obligation requires a fund manager to:
- Always route trades to the broker offering the lowest commission rate
- Seek the most favorable terms reasonably available for fund transactions (Correct answer)
- Execute all trades on national exchanges to ensure price transparency
- Obtain three competing bids before executing any transaction over $100,000
Correct answer: Seek the most favorable terms reasonably available for fund transactions
Best execution requires seeking the most favorable overall terms available, considering price, execution quality, speed, and other factors—not merely the lowest commission.
Question 4: Soft dollar arrangements are regulated under Section 28(e) of the Securities Exchange Act. Under this safe harbor, fund managers may use client commissions to pay for:
- Office rent and general overhead expenses
- Research and brokerage services that benefit the advised accounts (Correct answer)
- Marketing materials and client entertainment costs
- Compliance software and regulatory filing fees
Correct answer: Research and brokerage services that benefit the advised accounts
Section 28(e) provides a safe harbor allowing fund managers to use client commissions for research and brokerage services that directly benefit the managed accounts.
Question 5: An investment fund is subject to AML (Anti-Money Laundering) requirements primarily under which law?
- The Securities Act of 1933
- The Bank Secrecy Act and USA PATRIOT Act (Correct answer)
- The Dodd-Frank Wall Street Reform Act
- The Investment Company Act of 1940
Correct answer: The Bank Secrecy Act and USA PATRIOT Act
AML requirements for investment funds derive primarily from the Bank Secrecy Act and the USA PATRIOT Act, requiring customer identification and suspicious activity reporting.
Question 6: Which of the following best describes the 'prudent investor' standard under the Uniform Prudent Investor Act (UPIA)?
- Fiduciaries must invest only in government-backed securities to minimize risk
- Fiduciaries must consider the entire portfolio and risk/return objectives when making investment decisions (Correct answer)
- Fiduciaries must match the performance of a recognized market benchmark each year
- Fiduciaries must seek court approval before making any investment exceeding $1 million
Correct answer: Fiduciaries must consider the entire portfolio and risk/return objectives when making investment decisions
The UPIA's prudent investor standard requires fiduciaries to consider the entire portfolio's risk and return objectives, not evaluate individual investments in isolation.
Question 7: Under Regulation D of the Securities Act of 1933, private fund offerings are exempt from registration if sold exclusively to:
- Institutional investors with over $1 billion in assets under management
- Accredited investors meeting income or net worth thresholds (Correct answer)
- Non-US persons under Regulation S exemption rules
- Qualified purchasers as defined by the Investment Company Act
Correct answer: Accredited investors meeting income or net worth thresholds
Regulation D exempts private placements from SEC registration when securities are sold to accredited investors who meet income ($200K+) or net worth ($1M+) thresholds.
CFM Regulatory Compliance & Ethical Standards 3
A CFM candidate witnesses a colleague misrepresenting fund performance to a prospective client.
According to ethical standards, the candidate should: