Standard 1(A) – Knowledge of the Law

Members and Candidates must understand and comply with all applicable laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional Conduct) of any government, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of conflict, Members and Candidates must comply with the stricter law, rule, or regulation. Members and Candidates must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.

It is the responsibility of Members and Candidates to understand the laws and regulations of the countries and jurisdictions in which they practice. Members and Candidates should comply with the laws and regulations that impact their professional conduct. When in doubt Members and Candidates should refer to the compliance procedures offered by their firm. Additionally, Members and Candidates should remain up to date with any changes in laws and regulations that govern their profession.

Code and Standards & Applicable (Local) Laws

Members and Candidates may live or work in countries or jurisdictions where there are no regulations and laws relating to a particular action or that are different from the Code and Standards. When there is a difference between the Code and Standards and the applicable (local) law, Members and Candidates must adhere to the stricter between the two.

Participation or Association with Violations by Others

Members are directly responsible for their unethical behavior or violations that they are willing participants in. If a Member believes that there is unethical behavior or illegal wrongdoing, Members and Candidates should separate themselves from this activity. In extreme cases, this may involve leaving their employer.

The following steps should be taken if there is suspicion of any violations:

• Bringing any unethical or illegal activity to the attention of a supervisor or the compliance department of the firm.
• If this is unsuccessful, dissociate from the activity. Failure to dissociate from the activity will be deemed as the Member or Candidate being a knowing participant by the Institute.

Investment Products & Applicable Laws

All Members and Candidates involved in the creation and sale of investment products should be aware of all laws and regulations of the countries in which they make their sales or origination of purchased products. Members and Candidates should make reasonable attempts to investigate that other firms that they engage with comply with all laws and regulations.

Compliance Recommendations – Members and Candidates

• Members and Candidates should be vigilant in monitoring any changes in laws and regulations.
• Members and Candidates should encourage their employers to periodically review their compliance procedures.
• Members and Candidates should consult the compliance department if they have any doubts or suspicions about any unethical practices.
• Members and Candidates should encourage their compliance department to keep up-to-date copies of compliance procedures.

Compliance Recommendations – Firms

• Firms are encouraged to adopt a code of ethics.
• Firms should make it easily available, and disseminate compliance procedures, rules laws, and regulations.
• Firms should adopt reporting guidelines that provide Members and Candidates the necessary information required to report any violations.

Application 1: Following the Stricter Requirement

James Kimbo, a Level III candidate, and Ian Frank, CFA work for a multinational asset management firm, Evolve Asset Partners. Frank is a senior portfolio manager who is responsible for the asset allocation of the Developing & Frontier Markets portfolio. Kimbo is a junior research analyst who works in the Ghanaian office. The rules and regulations on insider trading in the Ghanaian market are non-existent; it is not illegal or criminal to use insider information to make any investment actions. Kimbo maintains close personal relationships with company insiders of several companies that he frequently covers.

Kimbo has recently had a meeting with an executive of MetalX – a firm in which Evolve Asset Partners holds a significant stake. In the meeting, the executive informs Kimbo that the firm has acquired the right to explore an untapped mineral deposit. This information is not publicly known, and Kimbo is aware that this information could positively affect the company’s Frontier portfolio. Kimbo includes this information in his weekly investor report. This report is strictly disseminated to Ghanian clients. 

Are any of Kimbo’s actions in violation of Standard I(A) – Knowledge of the Law?

1. No. Kimbo is permitted to share his findings on MetalX with Ghanian investors in the absence of rules and regulations on insider trading in the Ghanian market.
2. Yes. Kimbo has violated Standard I(A) – Knowledge of the Law.
3. No. Kimbo is permitted to use material nonpublic information in his investor report.

Solution

The correct answer is B.

Despite Ghana having no laws and regulations on inside trading, Kimbo violates Standard I(A) – Knowledge of the Law. The Standard emphasizes that Members and Candidates must “comply with the stricter rule or regulation.” In this case, the Code and Standards are stricter than Ghanaian law. Kimbo should be aware of this and comply with the Code and Standards set by the Institute. 

Furthermore, the information that Kimbo receives from the executive is considered material nonpublic information. Kimbo sharing this information is a violation of Standard II(A) – Material Nonpublic Information. Kimbo is prohibited from sharing information that may cause others to act on the information.

Application 2: Knowledge of the Law (Dissociating from Activity)

Sara Tsaiko has recently been hired as a performance analyst at Think Inc. Think Inc. is a European hedge fund that specializes 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 decides to address this with Kraus initially. 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 immediately dissociate from the activity – she should have declined to complete the report after she discovered 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 continuing to apply methods – that overstate returns – Tsaiko is now in violation of Standard I(A). If the compliance department or supervisor finds that there is no issue in the performance calculations, Tsaiko needs to dissociate from this activity. This could involve asking for another assignment or in extreme cases leaving her job at Think Inc.

Application 3: 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’s for their accounts. The underwriting process is split between Excel Financial and FJ Capital – which is headquartered in Ankara, Turkey. Turkey has no rules or regulations on executives participating in IPO’s for their investment accounts. Findlay goes on to allocate 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.

 Reading 46: Guidance for The Standards of Professional Conduct (I-VII)

LOS 46 (a) Demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.