Standard V(A) – Diligence and Reasonable Basis

Members and Candidates must:

1. Analyze investments, give investment recommendations, and take investment activities with diligence, independence, and completeness.
2. Have a reasonable and adequate basis for any investment analysis, recommendation, or action, backed by suitable research and investigation.

Diligence and Reasonable Basis informs that recommendations be made based on a firm’s independent research or the quantitative research of other reputable sources.

Application 1: Group Research Opinions

Calvin Samuelson is a junior fixed-income analyst at FreeHouse Securities. He is tasked with writing a report on the Fed interest rate expectations over the next two quarters. Samuelson completes his report and submits it to the investment review committee – as mandated by the firm’s procedures.

An excerpt from the report’s states:

“With the economic slowdown caused by the COVID-19 pandemic, we expect that the Fed will hold the Fed Funds rate steady at 0.25% over the next two quarters.”

The majority of the investment committee does not agree with Samuelson’s conclusions. The committee overwhelmingly believes there will be a strong bounce back in economic activity and share concerns about unanticipated inflation. They believe the Fed will react by increasing the benchmark rate by 25bps over the next two quarters.

Samuelson does not agree with the consensus conclusion and believes that there is no reasonable and adequate basis for the committee’s conclusions but proceeds to leave his name on the report.

Has Samuelson violated Standard V(A) – Diligence and Reasonable Basis?

1. Yes, because his report is supposed to reflect his views and conclusions.
2. No, because the firm’s internal policies require a consensus opinion.
3. Yes, because he fails to dissociate from the report when he believes that there is no reasonable basis for the conclusions of the report.

Solution

The correct answer is C.

Samuelson has violated Standard V(A) – Diligence and Reasonable Basis by failing to dissociate from the report. The conclusions of any research report or investment recommendation are inherently subjective.

In this case, the investment committee may have valid reasons for conclusions that differ from Samuelson’s. The firm can publish a report substantially different from Samuelson’s findings if there is a reasonable and adequate basis for its conclusions. If Samelson believes there is no reasonable basis for the conclusions, he should dissociate from the report – by declining to have his name on the published report.

Application 2: Reliance on Third-Party Research

Phillip Russo is the CEO of a mid-sized asset management firm. His firm relies heavily on external research to inform the firm’s investment recommendations and actions. Russo’s firm subscribes to a service from a reputable boutique research firm. The research firm has recently been awarded a prize for its stellar research coverage of the North American durable goods sector. Russo is confident in the rigor and quality of the research published by the firm and does not perform any independent due diligence to determine the quality and accuracy of the data received. Russo always attributes the source of the research and explains this to his clients.

Which of Russo’s actions are most likely a violation of the CFA Institute’s Standards?

1. None of his actions violates any standards.
2. His use of external research to inform the firm’s investment actions.
3. His failure to perform due diligence on external research.

Solution

The correct answer is C.

Russo has violated Standard V(A) – Diligence and Reasonable Basis by failing to perform due diligence on external research. Russo can use external research if he attributes the research to its original author or publishing entity.

LOS 5(a): Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards of Professional Conduct.

LOS 5(b): Explain how the practices, policies, or conduct does or does not violate the CFA Institute Code of Ethics and Standards of Professional Conduct.