CONFLICTS OF INTEREST

Standard VI – CFA Institute Code of Conduct and Standards

Table of contents

1. What is conflict?

2. What does the standard say?

3. Guidance, recommended procedures, and application

– Standard VI (A) – Disclosure of conflicts
– Standard VI (B) – Priority of transactions
– Standard VI (C) – Referral fees

4. Knowledge test
What is conflict?

- Conflict simply means disagreement and it is inevitable in human interactions.

- Conflicts of interest may impair a member’s or candidate’s ability to perform his or her professional responsibilities in an
independent and objective manner.

- Conflicts for investment professionals can be personal or professional. It may include;

Personal financial Compensation Third-party

gain structure arrangements

- CFA Institute understands that it may be impossible to completely avoid conflicts and recommends clear and complete
disclosure of the conflict as necessary in any event it is impossible to avoid the conflict.

Where conflict cannot be completely avoided, ensure full and fair disclosure
What does the standard say?

- Standard VI (A) - Members and Candidates must make full and fair disclosure of all matters that could reasonably be
expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective
clients, and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in
plain language, and communicate the relevant information effectively.

- Standard VI (B) - Investment transactions for clients and employers must have priority over investment transactions
in which a Member or Candidate is the beneficial owner.

- Standard VI (C) - Members and Candidates must disclose to their employer, clients, and prospective clients, as
appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of
products or services.
Ensure full disclosure, prioritize client interests, disclose compensation
STANDARD VI (A) – DISCLOSURE OF CONFLICTS
GUIDANCE

- Fully disclose to clients, potential clients, and employers all actual and potential conflicts of interest so that they can
properly evaluate the objectivity of the investment advice or action taken on their behalf.

- Disclosures must be prominent and must be made in plain language and in a manner designed to effectively communicate
the information.

- Determine how often and in what manner to make relevant disclosures and update disclosures when the nature of a conflict-
of-interest changes materially

A. Disclosure to employers
(i) Provide enough information for employers to assess the impact of the conflict and comply with employer guidelines
to avoid ethical and regulatory violations.
(ii) Take reasonable steps to avoid conflicts and, but if they occur, report them promptly so that the employer can resolve
them as quickly and effectively as possible
Avoid actual conflicts or the appearance of conflicts of interest
GUIDANCE

B. Disclosure to clients
(i) Relationship between an issuer & the member or candidate, or his/her firm should always be disclosed.
(ii) Make disclosures about fee arrangements, subadvisory agreements, or nonstandard fee structures.

C. Cross departmental conflict and stock ownership

(iii) Resolve situations presenting potential conflicts of interest or disclose them
(iv) Sell side: disclose any materially beneficial ownership interest in an investment that you are recommending. Buy-side:
disclose procedures and reporting requirements for personal transactions.

D. Conflicts as a director
(v) When providing investment services and serving as a director, you should be isolated from those making investment
decisions using firewalls or similar restrictions.

Make clear and complete disclosures, and use firewalls as necessary

RECOMMENDED PROCEDURES

i. Disclose special compensation arrangements with the employer that might conflict with client interests,
e.g., bonuses based on short-term performance criteria, commissions, performance fees, & referral fees.
 If your firm does not permit such disclosure document the request and consider dissociating from the
activity.

ii. Firms are encouraged to include information on compensation packages in firms’ promotional literature.

iii. If you manage a portfolio for which the fee is based on capital gains or capital appreciation (a
performance fee), this information should be disclosed to clients.

iv. If you or your firm has outstanding agent options to buy stock as part of the compensation package for
corporate financing activities, the amount and expiration date of these options should be disclosed as a
footnoteInclude
to any research reporton
information published.
compensation package in firm’s promotional literature
STANDARD APPLICATION (1/3)

Hunter Weiss is a research analyst with Farmington Company, a broker and investment banking firm. Farmington’s merger and
acquisition department has represented Vimco, a conglomerate, in all of Vimco’s acquisitions for 20 years. From time to time,
Farmington officers sit on the boards of directors of various Vimco subsidiaries. Weiss is writing a research report on Vimco.

Comment: Weiss must disclose in his research report Farmington’s special relationship with Vimco. Broker/dealer
management of and participation in public offerings must be disclosed in research reports. Because the position of
underwriter to a company entails a special past and potential future relationship with a company that is the subject of
investment advice, it threatens the independence and objectivity of the report writer and must be disclosed.

Disclose any actual or potential conflicts of interest

STANDARD APPLICATION (2/3)

Gary Carter is a representative with Bengal International, a registered broker/dealer. Carter is approached by a stock promoter
for Badger Company, who offers to pay Carter additional compensation for sales of Badger Company’s stock to Carter’s
clients. Carter accepts the stock promoter’s offer but does not disclose the arrangements to his clients or to his employer. Carter
sells shares of the stock to his clients.

Comment: Carter has violated Standard VI(A) by failing to disclose to clients that he is receiving additional
compensation for recommending and selling Badger stock. Because he did not disclose the arrangement with Badger to
his clients, the clients were unable to evaluate whether Carter’s recommendations to buy Badger were affected by this
arrangement. Carter’s conduct also violated Standard VI(A) by failing to disclose to his employer the additional
monetary compensation received.

Disclose any actual or potential conflicts of interest

STANDARD APPLICATION (3/3)

Carol Corky, a senior portfolio manager for Universal Management, recently became involved as a trustee with the Chelsea
Foundation, a large not-for-profit foundation in her hometown. Universal is a small money manager (with assets under
management of approximately US$100 million) that caters to individual investors. Chelsea has assets in excess of US$2
billion. Corky does not believe informing Universal of her involvement with Chelsea is necessary.

Comment: Corky violated Standard VI(A). Given the large size of the endowment at Chelsea, Corky’s new role as a
trustee can reasonably be expected to be time consuming, to the possible detriment of Corky’s portfolio responsibilities
with Universal. Standard VI(A) obligates Corky to discuss becoming a trustee at Chelsea with her compliance officer or
supervisor at Universal before accepting the position.

Disclose any actual or potential conflicts of interest

STANDARD VI (B) – PRIORITY OF TRANSACTIONS
GUIDANCE

- Client interests have priority. Client transactions must take precedence over transactions made on behalf of the member’s or
candidate’s firm or personal transactions

A. Avoiding potential conflicts

(i) Ensure that clients are not disadvantaged by the trade, and you do not benefit personally from trades undertaken for
clients and ensure that you comply with applicable regulatory requirements.

B. Personal trading secondary to trading for clients

(ii) Having the same investment positions or being co-invested with clients does not always create a conflict.
(iii) Transactions for clients and employers must have priority over transactions investments for which you are the
beneficial owner. Personal transactions should never, adversely affect client investments.

Transaction processing order: clients >> employer >> you (beneficial ownership)
GUIDANCE

C. Standards for non-public information

(i) Do not convey nonpublic information to anyone whose relationship makes you a beneficial owner of the person’s
securities
(ii) Do not convey this information to any other person if the nonpublic information can be material.

D. Impact on all accounts with beneficial ownership

(iii) Undertake transactions in accounts for which you are a beneficial owner only after their clients and employers have
had adequate opportunity to act on a recommendation.
(iv) Family accounts that are client accounts should not be given special treatment or be disadvantaged.
 If you have a beneficial ownership in the account, however, you may be subject to preclearance or reporting
requirements of the employer or applicable law.
Protect non-public information, treat all clients fairly, & comply with applicable
laws
RECOMMENDED PROCEDURES

- Establish review procedures to ensure that conflicts relating to IPOs are identified and appropriately dealt with. Obtain
preclearance by their employers before participation in IPOs.

- Place strict limits on investment personnel acquiring securities in private placements and establish appropriate supervisory
and review procedures to prevent noncompliance.

- Establish blackout periods for staff involved in the decision-making process prior to trades for clients so that managers
cannot take advantage of their knowledge of client activity by “front-running” client trades.

- Supervisors should establish reporting procedures for investment personnel, including disclosure of personal
holdings/beneficial ownerships, confirmations of trades to the firm and the employee, and preclearance procedures.

- Members and candidates should fully disclose to investors their firm’s policies regarding personal investing.

Enforce comprehensive compliance measures and transparency procedures

STANDARD APPLICATION (1/3)

Carol Baker, the portfolio manager of an aggressive growth mutual fund, maintains an account in her husband’s name at
several brokerage firms with which the fund and a number of Baker’s other individual clients do a substantial amount of
business. Whenever a hot issue becomes available, she instructs the brokers to buy it for her husband’s account. Because such
issues normally are scarce, Baker often acquires shares in hot issues, but her clients are not able to participate in them.

Comment: To avoid violating Standard VI(B), Baker must acquire shares for her mutual fund first and acquire them for
her husband’s account only after doing so, even though she might miss out on participating in new issues via her
husband’s account. She also must disclose the trading for her husband’s account to her employer because this activity
creates a conflict.

Disclose any actual or potential conflicts of interest

STANDARD APPLICATION (2/3)

Erin Toffler, a portfolio manager at Esposito Investments, manages the retirement account established with the firm by her
parents. Whenever IPOs become available, she first allocates shares to all her other clients for whom the investment is
appropriate; only then does she place any remaining portion in her parents’ account, if the issue is appropriate for them. She
does this so that no one can accuse her of favoring her parents.

Comment: Toffler has violated Standard VI(B) by breaching her duty to her parents by treating them differently from
her other accounts. As fee-paying clients of Esposito Investments, Toffler’s parents are entitled to the same treatment as
any other client of the firm. If Toffler has beneficial ownership in the account, however, and Esposito Investments has
preclearance and reporting requirements for personal transactions, she may have to preclear the trades and report the
transactions to Esposito.

Disclose any actual or potential conflicts of interest

STANDARD APPLICATION (3/3)

Gary Michaels is an entry-level employee who holds a low-paying job serving both the research and the investment
management department of an active investment mgt firm. He purchases a sports car and begins to wear expensive clothes after
only a year of employment with the firm. The director of the investment management department discovers that Michaels has
made substantial investment gains by purchasing stocks just before they were put on the firm’s recommended “buy” list.
Michaels was regularly given the firm’s quarterly personal transaction form but declined to complete it.

Comment: Michaels violated Standard VI(B) by placing personal transactions ahead of client transactions. Also, his
supervisor violated Standard IV(C)–Responsibilities of Supervisors by permitting Michaels to perform his assigned
tasks without having signed the quarterly personal transaction form.

Disclose any actual or potential conflicts of interest

STANDARD VI (C) – REFERRAL FEES
GUIDANCE

- Inform your employer, clients, and prospective clients of any benefit received for referrals of customers and clients.

- Such disclosures allow clients or employers to evaluate (a) any partiality shown in any recommendation of services and (b)
the full cost of the services.

To comply with the standard, you must:

(i) disclose when you pay a fee or provide compensation to others who have referred prospective clients.
(ii) advise the client or prospective client, before entry into any formal agreement for services, of any benefit given or
received for the recommendation of any services.
 This consideration should include all fees, whether paid in cash, in soft dollars, or in kind

Disclose nature of the compensation and estimated dollar value

RECOMMENDED PROCEDURES

- Encourage employers to develop procedures related to referral fees. The firm may completely restrict such fees.

- If the firm does not adopt a strict prohibition of such fees, the procedures should indicate the appropriate steps for
requesting approval.

- Employers should have investment professionals provide to the clients' notification of approved referral fee programs and
provide the employer regular (at least quarterly) updates on the amount and nature of compensation received.

develop referral fees procedures and share relevant referral information with
clients
STANDARD APPLICATION (1/2)

James Handley works for the trust department of Central Trust Bank. He receives compensation for each referral he makes to
Central Trust’s brokerage department and personal financial management department that results in a sale. He refers several of
his clients to the personal financial management department but does not disclose the arrangement within Central Trust to his
clients.

Comment: Handley has violated Standard VI(C) by not disclosing the referral arrangement at Central Trust Bank to his
clients. Standard VI(C) does not distinguish between referral payments paid by a third party for referring clients to the
third party and internal payments paid within the firm to attract new business to a subsidiary. Therefore, Handley is
required to disclose, at the time of referral, any referral fee agreement in place among Central Trust Bank’s departments.
The disclosure should include the nature and the value of the benefit and should be made in writing.

Disclose any actual or potential conflicts of interest

STANDARD APPLICATION (2/2)

Katherine Roberts is a portfolio manager at Katama Investments, an advisory firm specializing in managing assets for high-
net-worth individuals. Roberts asks the trading desk to direct a large portion of its commissions to Naushon, Inc., a small
broker/dealer run by one of Roberts’ business school classmates. Katama’s traders have found that Naushon is not very
competitive on pricing, and although Naushon generates some research for its trading clients, Katama’s other analysts have
found most of Naushon’s research to be not especially useful. Nevertheless, the traders do as Roberts asks, and in return for
receiving a large portion of Katama’s business, Naushon recommends the investment services of Roberts and Katama to its
wealthiest clients. This arrangement is not disclosed to either Katama or the clients referred by Naushon.

Comment: Roberts is violating Standard VI(C) by failing to inform her employer of the referral arrangement..

Disclose any actual or potential conflicts of interest

KNOWLEDGE CHECK
THINK YOU’VE GRASPED THESE?

Anderb is a portfolio manager for XYZ Company. Bates, her supervisor, is responsible for reviewing Anderb’s portfolio
account transactions and her required monthly reports of personal stock transactions. Anderb has been using Jonelli, a broker,
almost exclusively for brokerage transactions for the portfolio account. For securities in which Jonelli’s firm makes a market,
Jonelli has been giving Anderb lower prices for personal purchases and higher prices for personal sales than Jonelli gives to
Anderb’s portfolio accounts and other investors. Anderb has been filing monthly reports with Bates only for those months in
which she has no personal transactions, which is about every fourth month.

Which of the following is most likely to be a violation of the Code and Standards?
a. Anderb failed to disclose to her employer her personal transactions.
b. Anderb owned the same securities as those of her clients.
c. Bates allowed Anderb to use Jonelli as her broker for personal trades.

Option A is correct.
THINK YOU’VE GRASPED THESE?

Jurgen is a portfolio manager at Pinncacle Investment Management Company. One of her firm’s clients has told Jurgen that he
will compensate her beyond the compensation provided by her firm on the basis of the capital appreciation of his portfolio
each year.

Jurgen should:
a. Turn down the additional compensation because it will result in conflicts with the interests of other clients’ accounts.
b. Turn down the additional compensation because it will create undue pressure on her to achieve strong short-term
performance.
c. Obtain permission from her employer prior to accepting the compensation arrangement

Option C is correct.
THINK YOU’VE GRASPED THESE?

Smith is a financial analyst with XYZ Brokerage Firm. She is preparing a purchase recommendation on JNI Corporation.

Which of the following situations is most likely to represent a conflict of interest for Smith that would have to be disclosed?

a. Smith frequently purchases items produced by JNI.

b. XYZ holds for its own account a substantial common stock position in JNI.

c. Smith’s brother-in-law is a supplier to JNI

Option XXX is correct.

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