Standard 1(A) – Knowledge of the Law

At the end of this reading, you should  be able to:

• LOS 60a: evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct;
• LOS 60b: explain how the practices, policies, and conduct do or do not violate the CFA Institute Code of Ethics and Standards of Professional Conduct

Members and Candidates must follow and understand all applicable laws, rules, and regulations (including CFA Institute Code and Standards) of any government, regulatory body, licensing agency, or professional association controlling their professional activities.  

Members and Candidates must follow the more stringent law, rule, or regulation in the event of a dispute. They must not knowingly engage in or facilitate any violation of such laws, rules, or regulations and must distance themselves from any such violation.

Inaction on the part of a member and continued association with persons engaged in unlawful or unethical behavior could be construed as involvement or assistance in the illegal or unethical behavior.

Application 1: Knowledge of The Law (Dissociating from Activity)

Sara Tsaiko has recently been hired as a performance analyst at Think Inc, a European hedge fund specializing in global macro strategies. Tsaiko is tasked with compiling a report on the fund manager’s annual performance. Previously, a senior performance analyst – Martha Kraus, used to compile these reports. Tsaiko goes through previous reports and notices that the annual returns over the last several years have been materially overstated. Tsaiko is hesitant to inform her immediate supervisor of her findings and initially addresses this with Kraus. Kraus informs Tsaiko that there are no anomalies in her performance measurement calculations. Kraus insists that Tsaiko should replicate the calculation methods used in her previous reports. Tsaiko follows through with Kraus’ request.

Why is Tsaiko in violation of Standard I(A) – Knowledge of the Law?

1. She performed analysis on previous performance reports without informing Kraus.
2. She failed to dissociate from the activity immediately – she should have declined to complete the report after discovering the deliberate overstatement.
3. She fails to disclose her findings to her supervisor or compliance department.

Solution

The correct answer is C. 

Tsaiko has violated Standard I(A) – Knowledge of the Law. Tsaiko had reason to believe that Kraus deliberately overstated returns over several reporting periods. At this point, Tsaiko is not in violation of Standard I(A).

Tsaiko addresses her concerns to Kraus and follows through with her recommendation. To comply with Standard I(A) – Knowledge of the Law, Tsaiko should have reported her concerns to her supervisor (in this case, Kraus is not her supervisor) or with the compliance department if she had suspicions of any wrongdoing. By applying methods that overstate returns, Tsaiko is now in violation of Standard I(A). If the compliance department or supervisor finds no issue in the performance calculations, Tsaiko needs to dissociate from this activity. This could involve asking for another assignment or leaving her job at Think Inc in extreme cases.

Application 2: Following the Stricter Requirement

Charles Findlay is the CFO of Excel Financial – a corporate finance firm headquartered in New York. Findlay is leading the IPO underwriting process for a major client. New York regulation forbids managers from participating in IPO for their accounts. The underwriting process is split between Excel Financial and FJ Capital, headquartered in Ankara, Turkey. Turkey has no rules or regulations on executives participating in IPOs for their investment accounts. Findlay allocates a percentage of the IPO issuance to himself and other managers of FJ Capital.

Has Findlay violated Standard I(A) – Knowledge of the Law?

1. No, because the Standard does not forbid managers from participating in IPO’s.
2. Yes, because Findlay does not follow the stricter rule of no participation in IPO’s.
3. No, because the underwriting process is shared between FJ Capital and Excel Financial, Findlay is free to choose between what laws and regulations to follow.

Solution

The correct answer is B. 

Standard I(A) – Knowledge of the Law does not forbid investment managers from participating in IPO’s. Findlay has violated Standard I(A) – Knowledge of the law because he did not comply with the stricter rule. Findlay should always comply with more strict laws or regulations.

Application 3: Knowledge of The Law (Dissociating from Activity)

Simon Sikasa, a CFA candidate, is an employee at DSS Investments Inc. Sikasa has discovered that the company charges its clients at a rate greater than the cost of providing the service as per the client agreement. Sikasa has informed his supervisor of the fact.  If the supervisor does not take any corrective measures to address this issue, what action should Sikasa most likely take?

1. Report this issue to the company’s board of directors.
2. Dissociate themselves from the activities of the firm.
3. Take no action because the clients are not aware of these costs.

Solution

The correct answer is B.

Sikasa should dissociate himself from the firm’s activities and report the matter to the board of directors and regulators. Members and candidates must not knowingly engage in or facilitate any violation of such laws, rules, or regulations and must distance themselves from any such violation.

A is incorrect. Reporting the issue to the board of directors is not enough. If the issue is not addressed, in addition to reporting the matter to the board of directors, the employee should dissociate himself from such activities.

C is incorrect. Inaction on the part of the candidate and continued association with persons engaged in unlawful or unethical behavior could be construed as involvement or assistance in the illegal or unethical behavior.