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Reading 1CFA L2 EthicsFull chapter

L2 Ethics — application of Standards in research and asset management

In this chapter: Recurring vignette patterns (research objectivity, soft dollars, allocation, IPO participation) · Material non-public information edge cases · Asset Manager Code

~3 min readLayer 4 · Professional CertificationsFree

L2 ethics moves from memorising Standards (L1) to applying them. Each vignette has a fact pattern with multiple Standards in tension. The right answer minimises violations, not zero violations always.

Foundation

Recurring vignette patterns: **Research objectivity**: - Analyst pressure from corporate finance / banking team. - Standard I(B) Independence + III(C) Suitability + V(A) Diligence. - Fix: independent compensation, separate reporting lines. **Soft dollar arrangements**: - Brokerage commissions used to buy research. - Standard III(A) Loyalty: must benefit clients. - Standard III(D) Performance presentation. - Soft Dollar Standards (CFA Institute) — research must directly aid investment decision. **Trade allocation**: - Pro-rata across clients, not based on fees. - IPO allocations: pre-trade allocation policy; can't favour personal accounts. **Material non-public information**: - Mosaic theory: combining public + non-material non-public is OK. - Acting on insider tip: violation regardless of whether you sought it.

Deep Dive

Asset Manager Code (AMC) — for firms (vs individuals): - Loyalty to clients. - Investment process and actions. - Trading. - Risk management, compliance, support. - Performance and valuation. - Disclosures. GIPS Standards (Global Investment Performance Standards): - Firm-wide voluntary adoption. - Composite construction: all fee-paying discretionary portfolios in single composite. - Calculation: time-weighted returns, valued daily with significant cash flows. - Disclosures: risk metrics, dispersion, fees, benchmark.

Advanced

L2 ethics traps: - "Most accurate" answer when multiple violations exist — pick most material. - Subtle independence violations — analyst owns small stake doesn't mean material; depends on facts. - Selective disclosure: webinars or one-on-one institutional briefings without simultaneous public release violates fair-dealing. - Trade ahead: personal trading before client trades — easy to spot, hard to defend.

Regulatory references
  • CFA Institute Standards of Practice Handbook
  • SEBI Research Analyst Regulations 2014
  • GIPS Standards
  • Asset Manager Code
Common mistakes & pitfalls
  • Treating gifts/inducements as OK if "modest" without firm policy — always check threshold.
  • Forgetting that disclosure does not cure all violations — independence breaches need structural fix.
  • Confusing GIPS with audit — GIPS is performance-presentation standard, not financial audit.

Frequently asked

Does GIPS apply to individuals?
GIPS applies firm-wide. Once adopted, must include all fee-paying discretionary composites. Individuals can claim GIPS-compliance only if firm complies.
When is "research access" trip OK?
When fully disclosed, doesn't materially compromise independence, and within firm-policy limits. Premium travel/hotels usually crosses line.

Practice questions

Click each question to reveal the answer and explanation.

Q 1
Mosaic theory is:
  1. (a)Insider trading
  2. (b)Combining public + non-material non-public information for analysis
  3. (c)Algorithm
  4. (d)Plagiarism
Correct: (b) Combining public + non-material non-public information for analysis
Mosaic theory: aggregating public info + non-material insights. Standard II(A) compliant.
Q 2
Pre-trade allocation policy is required for:
  1. (a)IPOs
  2. (b)Block trades
  3. (c)All client trades, especially IPOs/rights
  4. (d)Personal trades only
Correct: (c) All client trades, especially IPOs/rights
III(B) Fair Dealing: written allocation policy applies broadly; IPOs/rights especially scrutinised.
Q 3
Soft dollars must be used for:
  1. (a)Vacation
  2. (b)Research that benefits clients
  3. (c)Bonuses
  4. (d)Office furniture
Correct: (b) Research that benefits clients
Soft Dollar Standards: research must aid investment decisions; cannot fund firm operations or perks.
Q 4
GIPS composite must include:
  1. (a)Best-performing accounts
  2. (b)All fee-paying discretionary portfolios in strategy
  3. (c)Random sample
  4. (d)Largest accounts
Correct: (b) All fee-paying discretionary portfolios in strategy
GIPS: include all fee-paying discretionary portfolios meeting composite definition. No cherry-picking.
Q 5
AMC applies to:
  1. (a)Individual analysts
  2. (b)Firms managing client assets
  3. (c)Custodians only
  4. (d)Mutual fund directors
Correct: (b) Firms managing client assets
Asset Manager Code: firm-level standard for asset management businesses.
Educational purposes only. The numbers, returns, and examples used in this lesson are illustrative. Past performance does not guarantee future results. Mutual fund and securities investments are subject to market risks. This lesson is not investment advice; for advice tailored to your circumstances, consult a SEBI-registered Investment Adviser. Read our full disclaimer.