CSCP Ethics & Professional Responsibilities 4 — Questions and Answers
Question 1: A portfolio manager at an investment adviser learns from a company board member (a personal friend) that the company will miss earnings expectations next quarter. The manager tells the firm's compliance officer. What should the compliance officer do first?
- Allow the manager to trade since the information came from a personal relationship
- Immediately place the company's securities on the firm's restricted list and prevent any trading (Correct answer)
- Wait for the earnings announcement before taking any action
- Report directly to the SEC before conducting any internal review
Correct answer: Immediately place the company's securities on the firm's restricted list and prevent any trading
Upon receiving potential MNPI, the compliance officer should immediately restrict trading through a restricted or watch list pending further investigation.
Question 2: Under FINRA Rule 2010 (Standards of Commercial Honor), registered representatives are held to which standard of conduct?
- Compliance with all applicable federal and state securities laws only
- High standards of commercial honor and just and equitable principles of trade in all business activities (Correct answer)
- The same standard that applies to non-registered employees of the firm
- Standards set by the broker-dealer's internal compliance manual
Correct answer: High standards of commercial honor and just and equitable principles of trade in all business activities
FINRA Rule 2010 requires registered persons to observe high standards of commercial honor and just and equitable principles of trade, a broad ethical standard beyond mere legal compliance.
Question 3: A compliance officer at a large broker-dealer has a romantic relationship with a trader in the equities department. This situation most directly creates a concern about:
- Market manipulation risk in the equities department
- The compliance officer's ability to objectively supervise and discipline the trader (Correct answer)
- A potential violation of Regulation SHO short-selling rules
- Whether the trader's licenses are current under FINRA requirements
Correct answer: The compliance officer's ability to objectively supervise and discipline the trader
A personal relationship between a supervisor and a subordinate they are responsible for overseeing creates an objectivity and independence conflict in the supervisory relationship.
Question 4: The 'Chinese Wall' (information barrier) in a securities firm is primarily designed to prevent:
- Foreign nationals from accessing proprietary trading systems
- The flow of material non-public information between departments such as investment banking and trading (Correct answer)
- Retail clients from accessing institutional research reports
- Compliance officers from reviewing trader communications
Correct answer: The flow of material non-public information between departments such as investment banking and trading
Information barriers are structural controls that prevent MNPI obtained in one department (e.g., investment banking) from flowing to trading desks where it could be misused.
Question 5: A registered investment adviser who has discretionary authority over client accounts must obtain client consent before:
- Rebalancing a portfolio within the agreed-upon asset allocation range
- Engaging in cross transactions between two client accounts where the adviser acts as principal (Correct answer)
- Purchasing exchange-traded funds on behalf of clients
- Moving cash to a money market fund during periods of market volatility
Correct answer: Engaging in cross transactions between two client accounts where the adviser acts as principal
Principal transactions involving an adviser trading from its own account with a client's account require prior written disclosure and client consent under the Investment Advisers Act.
Question 6: When is a securities compliance professional ethically permitted to reveal confidential client information without client consent?
- When a colleague requests the information for client service purposes
- When required by applicable law or a valid legal process such as a court order or regulatory subpoena (Correct answer)
- When the client is suspected of fraud, at the professional's own discretion
- When the client has not communicated with the firm for more than 12 months
Correct answer: When required by applicable law or a valid legal process such as a court order or regulatory subpoena
Confidential client information may be disclosed without consent only when required by law, legal process, or applicable regulatory requirements.
Question 7: Under the Investment Advisers Act of 1940, a registered investment adviser's fiduciary duty to clients includes which two core obligations?
- A duty to maximize returns and a duty to minimize fees
- A duty of care and a duty of loyalty (Correct answer)
- A duty to diversify and a duty to report performance accurately
- A duty to avoid leverage and a duty to hold only rated securities
Correct answer: A duty of care and a duty of loyalty
The SEC has articulated that an investment adviser's fiduciary duty comprises a duty of care (acting in the client's best interest) and a duty of loyalty (eliminating or disclosing conflicts of interest).
CSCP Ethics & Professional Responsibilities 4
A portfolio manager at an investment adviser learns from a company board member (a personal friend) that the company will miss earnings expectations next quarter.
The manager tells the firm's compliance officer.
What should the compliance officer do first?