R01 Ethics and Trust in The Investment Profession: Instructor's Note

`CFA Level I Ethics Notes
R01 Ethics and Trust in the Investment Profession

1. Introduction
To illustrate the importance of ethical behavior, the curriculum cites the example of an analyst’s action at a financial services
firm. The research department at the firm is responsible for making investment recommendations to clients after sound
analysis and valuation of companies. One of the analysts at the firm misrepresents facts in his report with the objective of
pleasing the management of the subject company. He hoped this would lead to financial benefits for his employer and
himself. Clients who acted on the recommendation incur heavy losses and spread a negative word on several online forums
about the firm. This eventually affects the reputation of the firm, forcing it to downsize and many employees lose their job.
This example illustrates how one member’s unethical actions have a spiraling effect on the firm and other employees for no
fault of theirs.
The foundation of the investment management industry is trust and ethical behavior is central to creating that trust.
The top two attributes of an investment management firm are as follows:
 Have transparent and open business practices.

 Has an ethical business practice.
Ethical behavior is not just about adhering to the law, rules, and regulations. It is about identifying potential conflicts and
acting righteously in situations where there are no stated rules.
2. Ethics
The word ethics comes from the Greek word “ethos” meaning character, guiding beliefs, or ideals. There are several
definitions of ethics all of which essentially convey the same meaning.
Ethics can be described as a set of moral principles and rules of conduct that provide guidance for our behavior. Examples of
ethical principles include honesty, transparency, diligence, justice, being open about the costs involved in an investment,
fairness, and respect for the rights of others.
Another definition of ethical conduct is behavior that balances one’s own interest with the direct and indirect consequences of
the behavior on others.
Instructor’s Note:
The ‘others’ are often referred to as stakeholders, i.e. groups of people or individuals who are directly or indirectly impacted
by our decisions. Examples of stakeholders in decisions made by investment industry professionals include colleagues,
clients, employers, the communities in which we live and work, the investment profession, trade associations, regulators, and
other financial market participants.
Specific communities formally define the rules for acceptable and forbidden behavior into a written set of principles called
the code of conduct. Professional associations, universities and companies often adopt a code of ethics and expect their
members to adhere to those rules, at the very least. The members may choose to display higher standards of behavior than
what is stipulated in the code of ethics.
Some communities may also expand on their code of ethics and adopt explicit rules or standards that identify specific
behaviors required of community members. These standards of conduct serve as a benchmark of the minimally acceptable
behavior expected from members of a community.
3. Ethics and Professionalism

A profession is an occupational community having specialized knowledge and skills; which adheres to ethical behavior; and
is subject to some combination of licensed status and technical standards. Examples of professions include doctors, lawyers,
actuaries, accountants, architects, etc.
The number of professions has increased over time due to rising demand from clients and individuals. A profession is
different from craft guilds and trade bodies in two ways, i.e. unlike trade bodies, members of professions are required to
uphold high ethical standards and their mission is to serve society.
How Professions Establish Trust
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The following characteristics help establish confidence and credibility in professionals and their organizations.
a. Professions normalize practitioner behavior by developing professional codes and standards.
b. Professions provide a service to society.
c. Professions are client focused: The major objective of codes and standards is to ensure that professions always act in
the best interest of the client and exercise a reasonable level of care, skill, and diligence with regard providing them
service.
d. Professions have high entry standards.
e. All members of a profession possess a body of expert knowledge.
f. Professions encourage and facilitate continuing education.
g. Professions monitor professional conduct to maintain integrity and reputation of an industry.
h. Professions are collegial and respect the rights, dignity, and autonomy of others.
i. Professions are recognized oversight bodies.
j. Professions encourage the engagement of members to develop expertise and ethics and to advance the profession.
Professions evolve over time as the requirements, technology, and standards change.
4. Professionalism in Investment Management

Most countries require investment professionals to have some form of certification or licensing to practice. Due to regulatory
coordination across borders and the emergence of technology, the investment management profession has become
increasingly global.
Trust in Investment Management
Trust is the key in investment management and the trust is established by acting with care, due diligence, and judgment for
clients. When market participants trust investment management professionals, it leads to efficient capital market and smooth
functioning which in turn helps in the development of the economy.
CFA Institute as an Investment Management Professional Body
CFA Institute is the largest body for investment management professionals. The mission of CFA Institute is “to lead the
investment profession globally, by promoting the highest standards of ethics, education, and professional excellence for the
ultimate benefit of society.” CFA Institute candidates and charterholders are required to meet the highest standards among
those established by CFA Institute, regulators, or the employer. The CFA Institute Code and Standards aims at aligning the
interests of firms and clients.
CFA charterholders and CFA Program candidates are required to “adhere to the Code and Standards and to sign annually a
statement attesting to that continued adherence”. Charterholders and candidates must “maintain and improve their
professional competence and strive to maintain and improve the competence of other investment professionals”.
5. Challenges to Ethical Conduct

Some of the challenges to ethical conduct include the following:
Overestimating one’s morality: People believe they are more ethical than they actually are. This overconfidence in
themselves can sometimes lead to faulty decision-making. It is often seen that emotions cloud rational thinking, prompting
one to make decisions that may not be the most ethical choice.
Situational influences: These are external factors such as cultural, social, and environmental factors that influence one’s
thinking, behavior, and decision-making. Some of the common situational influences are:
 Money and prestige: Both money and prestige push people to act in their own self-interests and take actions that are
less ethical. The promise of a large financial bonus or a promotion, can impact people’s thinking ability and cause
them to act in their own short-term interests and ignore the long-term consequences of their actions.
 Loyalty to employer, employee, and colleagues: Loyalty can have both positive and negative effects. For instance,
some colleagues may encourage you to behave more ethically and enroll in the CFA Program to advance your
career. On the other hand, colleagues who do not adhere to the Code and Standards may encourage you to simply act
in accordance with the local law, even though it may fall short of ethical conduct.

 Compliance culture: A strong compliance policy is important for ethical decision-making; however, processes
focused solely on compliance oversimplify decision-making and do not help the larger cause.
6. Ethical vs. Legal Standards

There is a grey area between what is legally accepted and what is ethical. Acting in accordance with the law and acting
ethically are not necessarily the same. There are four possible outcomes for any action from a legal and ethical perspective:
 Not legal but ethical: For example, civil disobedience or protesting peacefully against an issue may not be legal, but
it is ethical. Another example of an illegal but ethical act is that of whistleblowing. Whistleblowing is raising the
curtain off an illegal or corrupt activity.
 Not legal and not ethical.
 Legal and ethical.
 Legal but not necessarily ethical: Some countries do not have laws that prohibit trading while in possession of
material nonpublic information. While this act of trading is legal from the local country’s perspective, it is
considered unethical by the CFA Institute and other investment professionals.
There are several reasons why laws are not sufficient to ensure ethical conduct among market participants, as discussed
below:
 Laws and regulations are often created in response to existing market practices. A new law might address an existing
ethical problem but create an opportunity for other unethical behavior in future.
 Laws can be interpreted differently. Market participants may choose to interpret the law to their advantage or delay
compliance where there is no punitive action.
 Laws can vary across jurisdictions. This may encourage questionable practice to move to places that are less
restrictive in nature.
Ethical conduct encourages us to:
 Go beyond what is legally required.

 Consider the impact on all stakeholders.
 Make good choices, even in the absence of clear laws and regulations.
7. Ethical Decision-Making Framework

Firms must strive to develop a strong ethical culture and encourage investment professionals to apply ethical decision-making
skills every day; so much so that it becomes second nature. Working and operating in an environment that fosters integrity
and accountability motivates its employees to do the right thing will go a long way in preventing unethical actions.
Setting up an ethical framework reinforces investment professionals to do the right thing. The ethical framework:
 Helps in evaluating a situation from multiple perspectives after considering the larger picture in such a way that it
benefits stakeholders in the long term. Often, the impact of a decision or all aspects of a situation is not clear in the
short term and decisions taken in haste may harm stakeholders unintentionally.
 Helps decision makers justify actions to a broader group of stakeholders.
The following ethical decision-making framework is presented in the curriculum.
 Identification phase: Identify all the relevant facts and distinguish between facts and personal opinion, judgements,
and biases. This includes information one has and what one would like to have.
o Identify relevant facts such as details of the employer, information on an IPO or a deal, rules and
regulations of the industry, etc.
o Identify the stakeholders such as employer, market participants, clients, supervisor, investors, family, etc.
o Identify relevant ethical principles for the situation. This may include loyalty to employer, clients’ interests
taking precedence before everything else, and maintaining the confidentiality of information.
o Identify any potential conflicts of interest, or conflicts in your duties to employers/clients. Examples of
potential conflict of interest include duties to one client versus other clients of the firm, financial rewards
linked to the success of a deal versus duty to employer, and duty to supervisor versus the need to impress.

 Consideration phase: Seek guidance (preferably from someone outside the firm) to navigate through situational
influences and personal biases that may affect decision-making.
o Examples of situational influences include how much fees the firm will earn from a deal, how much bonus
or compensation one expects to receive because of working on an IPO/deal, or associating one’s self-worth
to working on a prestigious account/deal.
o Examples of where one could seek guidance include the firm’s compliance department, peers, the CFA
Institute Code and Standards, or a supervisor.
 Decide and act: Make a decision and act.
 Reflect: Once the decision is made, assess the decision to see if it had the desired outcome. If not, then analyze the
reasons: were the stakeholders identified, was there any conflict of interest, were the ethical principles identified, did
you seek guidance on how to deal with situational influences and personal behavioral biases?
Sometimes the information is not sufficient to make a decision in which case the process becomes iterative as you seek
guidance to gather more relevant information.

R02 Code of Ethics and Standards of Professional Conduct Profession

Introduction
The Code of Ethics and Standards of Professional Conduct (Code and Standards) stipulate rules and guidelines for CFA
Institute members and candidates on how to conduct themselves in a professional and ethical manner, with integrity, under all
circumstances for the benefit of society.
CFA Institute Professional Conduct Program

All CFA Institute members and candidates enrolled in the CFA program are required to comply with the Code and Standards.
The Professional Conduct Program (PCP), in conjunction with the Disciplinary Review Committee (DRC), is responsible for
enforcement of the Code and Standards.
 The DRC is a volunteer committee of CFA charterholders who serve on panels to review conduct and partner with
professional conduct staff to establish and review professional conduct policies.
 The CFA Institute Bylaws and Rules of Procedure for Professional Conduct form the basic structure for enforcing
the Code and Standards.
Professional Conduct inquiries can be prompted by several reasons:
 Self-disclosure: On the annual Professional Conduct Statement, members disclose if they have been a subject of
civil litigation or criminal investigation.
 Written complaints: The PCP staff may receive written complaints.
 Evidence of misconduct: The PCP staff may come across violations through media or any public source.
 Report by a CFA exam proctor: If a candidate violated any rules on exam day and is reported by the proctor.
 CFA Institute may conduct analysis of scores and exam materials after the exam, as well as monitor online and
social media to detect disclosure of confidential exam information. For instance, if a friend sits for the exam in
Australia and discusses specific questions online after the exam while you are in the United States where the exam
hasn’t started, it can be considered a violation of the Code and Standards.
After an inquiry is initiated, the professional conduct team conducts an investigation. If the professional conduct staff
believes a violation of the Code and Standards has occurred, they propose sanctions which can include: public censure,
suspension of membership and use of the CFA designation, and revocation of the CFA charter. Candidates may be suspended
or prohibited from further participation in the CFA program.
The member or candidate has the opportunity to accept or reject any charges and the proposed sanctions. If the
member/candidate accepts the violation, then the sanctions will be imposed. If the member/candidate does not accept the
charges or the proposed sanctions, the matter is referred to the DRC, which reviews materials and presentations from
professional conduct staff and from the member or candidate. The panel’s task is to determine whether a violation of the
Code and Standards or testing policies has occurred and, if so, what sanction should be imposed.
Code of Ethics
Members of the CFA Institute (including CFA charterholders) and candidates for the CFA designation (“Members and
candidates”) must:
Act with integrity, competence, diligence, and respect and in an ethical manner with the public, clients, prospective clients,
employers, employees, colleagues in the investment profession, and other participants in the global capital markets.
Place the integrity of the investment profession and interests of clients above their own personal interests.
Use reasonable care and exercise independent professional judgment when conducting investment analysis, making
investment recommendations, taking investment actions, and engaging in other professional activities.
Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the
profession.
Promote the integrity and viability of the global capital markets for the ultimate benefit of society.

Maintain and improve their professional competence and strive to maintain and improve the competence of other investment
professionals.
The six components of Code of Ethics, outlined above, are important and should be memorized.
Standards of Professional Conduct

There are seven Standards of Professional Conduct. Each standard has sub-sections. The standards are covered in detail in the
next reading.
I. Professionalism
II. Integrity of Capital Markets
III. Duties to Clients
IV. Duties to Employers
V. Investment analysis, Recommendations, and Actions
VI. Conflicts of Interest
VII. Responsibilities as a CFA Institute Member, or CFA Candidate
I. Professionalism
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.
B. Independence and Objectivity
Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in
their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or
consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.
C. Misrepresentation
Members and Candidates must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions, or other professional activities.
D. Misconduct
Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any
act that reflects adversely on their professional reputation, integrity, or competence.
II. Integrity of Capital Markets
A. Material Nonpublic Information
Members and Candidates who possess material nonpublic information that could affect the value of an investment must not
act or cause others to act on the information.
B. Market Manipulation
Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent
to mislead market participants.
III. Duties to Clients
A. Loyalty, prudence, and care
Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent
judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their
employer’s or their own interests.
B. Fair Dealing

Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making
investment recommendations, taking investment action, or engaging in other professional activities.
C. Suitability
1. When Members and Candidates are in an advisory relationship with a client, they must:
a. Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return
objectives, and financial constraints prior to making any investment recommendation or taking investment
action and must reassess and update this information regularly.
b. Determine that an investment is suitable to the client’s financial situation and consistent with the client’s
written objectives, mandates, and constraints before making an investment recommendation or taking
investment action.
c. Judge the suitability of investments in the context of the client’s total portfolio.
2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style,
they must make only investment recommendations or take only investment actions that are consistent with the stated
objectives and constraints of the portfolio.
D. Performance Presentation
When communicating investment performance information, Members and Candidates must make reasonable efforts to ensure
that it is fair, accurate, and complete.
E. Preservation of Confidentiality
Members and Candidates must keep information about current, former, and prospective clients confidential unless:
1. The information concerns illegal activities on the part of the client or prospective client,
2. Disclosure is required by law, or
3. The client or prospective client permits disclosure of the information.
IV. Duties to Employers
A. Loyalty
In matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive
their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their
employer.
B. Additional Compensation Arrangements
Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might
reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from
all parties involved.
C. Responsibilities of Supervisors
Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority
complies with applicable laws, rules, regulations, and the Code and Standards.
V. Investment Analysis, Recommendations, and Actions
A. Diligence and Reasonable Basis
Members and Candidates must:
1.
Exercise diligence, independence, and thoroughness in analyzing investments, making investment
recommendations, and taking investment actions.
2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment
analysis, recommendation, or action.
B. Communication with Clients and Prospective Clients
Members and Candidates must:
1. Disclose to clients and prospective clients the basic format and general principles of the investment processes they
use to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that
might materially affect those processes.

2.Disclose to clients and prospective clients significant limitations and risks associated with the investment process.
3.Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations,
or actions and include those factors in communications with clients and prospective clients.
4. Distinguish between fact and opinion in the presentation of investment analysis and recommendations.
C. Record Retention
Members and Candidates must develop and maintain appropriate records to support their investment analyses,
recommendations, actions, and other investment-related communications with clients and prospective clients.
VI. Conflicts of Interest
A. Disclosure of Conflicts
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.
B. Priority of Transactions
Investment transactions for clients and employers must have priority over investment transactions in which a Member or
Candidate is the beneficial owner.
C. Referral Fees
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.
VII.Responsibilities as a CFA Institute Member or CFA Candidate
A. Conduct as participants in CFA Institute Programs
Members and Candidates must not engage in any conduct that compromises the reputation or integrity of CFA Institute or the
CFA designation or the integrity, validity, or security of CFA Institute programs.
B. Reference to CFA Institute, the CFA designation, and the CFA program
When referring to CFA Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA Program,
Members and Candidates must not misrepresent or exaggerate the meaning or implications of membership in CFA Institute,
holding the CFA designation, or candidacy in the CFA Program.

R03 Guidance for Standards I-VII

Introduction
This is a long reading, which provides guidance and recommended compliance procedures for each standard. Several
examples are also given on how the standards should be applied. IFT Notes focus on the guidance and recommended
compliance procedures. Read the examples (applications of the standards) from the curriculum.
Standard I: Professionalism
Standard 1 (A) Knowledge of the Law
Members and Candidates must understand and comply with all applicable laws, rules, and regulations 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 more strict 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
Interpretation:
You, as a member or candidate, must be aware of all laws where you conduct business. Stating that you are not aware of the
laws and hence a violation occurred, will not be acceptable.
Guidance:
 Relationship between the Code and Standards and Applicable Law : Assume you are an investment adviser based in
Malaysia. You are a Malaysian citizen and your clients are also based in Malaysia. Here the Malaysian law is the
‘applicable law’. As a Level I candidate, the Code and Standards must also be considered. Let’s assume that
Malaysian laws prohibit participation of investment advisers in IPOs but the Code and Standards allow participation
under specified circumstances, then you have to follow the stricter law – the Malaysian law in this case. If there is
no applicable law or regulation, then Members and Candidates must follow the Code and Standards.
 Investment products and applicable laws: Follow the more strict law.
 Participation in or association with violations by others : You are responsible for violations in which you knowingly
participate or assist. Knowingly is the key word here. Assume you are part of a group and you have reasonable
grounds to believe a violation is taking place. Under such circumstances:
o First, make an attempt to stop the behavior by bringing it to the notice of your supervisor/compliance
department.
o Seek the advice of independent legal counsel if the compliance department was not helpful.
o Dissociate yourself with that activity. Dissociation varies based on your role in the organization; it could
be:
 Removing your name from the investment reports and recommendations.
 Asking for a different assignment.
 Refusing to accept a new client or continuing to advise the current client.
o In extreme cases, leave the organization.
 Not taking an action after reporting a violation (and continuing association with the illegal activity), can be
considered as participating in the illegal or unethical conduct.
 If you are not sure that a violation is taking place, then the appropriate action would be to seek the advice of
legal/compliance counsel.
 CFA Institute does not compel you to report violations to the government or regulatory organization unless required
by law.
Recommended procedures for compliance:
 Stay informed: Have a procedure or regular training to keep employees informed of the changes in applicable laws,
rules, regulations etc.
 Review procedures: Periodically review firm’s written compliance procedures to ensure it conforms to the
applicable law.
 Maintain current files: Latest copies of applicable rules and regulations should be available for reference.

 Legal counsel: If in doubt how to respond to a possible violation, seek the advice of legal/compliance personnel.
 Dissociation: Document the violation if you are dissociating from an illegal activity; urge the firm to take steps to
cease the activity, and resign in extreme cases.
 Advise/encourage your firm to:
o Develop and/or adopt a code of ethics.
o Provide information on applicable laws: make all the information regarding laws and rules available in a
central location.
o Establish procedures for reporting violations: make it easy to report violations.
Standard 1 (B) Independence and Objectivity

Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in
their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or
consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.
Interpretation:
Maintain independence and objectivity. Do not compromise your independence and objectivity under any circumstance as it
can hurt not just your firm, but the whole industry. For instance, assume you are writing a research report and the firm you
are covering gives you an expensive gift. Accepting the gift may shroud your judgment to be impartial and give an objective
report.
Guidance:
 Buy-side clients: Assume you work in the research department of a large brokerage (buy-side) firm and you cover
pharmaceutical firms. Your research reports are disseminated to institutional clients (buy-side clients) such as
mutual funds. Mutual funds with large positions in pharma stocks might try to influence you to write positive
reports. However, it is important for you, not to succumb to pressure. Independence and objectivity must be
maintained.
 Investment banking relationships: Now assume your firm also has an investment banking (IB) division. Pfizer is a
client of the firm, and the IB division is working closely on Pfizer’s secondary offering. The IB division may
influence research analysts to issue favorable research reports. But, as an analyst, you must maintain your
objectivity.
 Public companies: Public companies may try to influence analysts to write positive research reports.
 Issuer-paid research: Assume a company is not being widely followed. If this company approaches you to write a
research report for them, and compensates you, then there is a potential conflict of interest. The best practice for
independent analysts is to negotiate a flat fee for the report. The fee should be independent of the eventual
recommendation. Disclosure of the type of compensation is also important.
 Travel funding: It is best for candidates to use commercial transportation paid for by their firm, and not the client. If
commercial transportation is unavailable, members and candidates may accept modestly arranged travel, to
participate in appropriate information-gathering events, such as a property tour.
 Credit rating agency opinions: Credit rating agencies provide ratings for fixed-income products. If you are working
at a rating agency, you may be offered incentives and compensation by the sponsoring company (companies issuing
bonds) to issue a favorable rating. However, you should be objective about the analysis and ensure the processes at
your agency do not result in a conflict of interest.
 Influence during the manager selection/procurement process : Assume a large pension fund is in the process of
selecting an asset management company (AMC) to manage their assets. In order to get this business, AMCs may try
to influence the hiring manager at the pension fund by giving gifts, etc. Irrespective of which side you are in the
process (pension fund or AMC which is seeking business), do not solicit gifts or contributions either directly or
indirectly that may affect your independence.
 Brokerage houses: Members and candidates hire secondary fund managers to manage specific assets, for trading and
reporting. There may be attempts to influence them with gifts or compensation. It is important for members to not
accept such gifts and stay objective about the hiring decision.
Recommended Procedures for Compliance:

 Protect the integrity of opinions.

 Create a restricted list for companies where a firm wants to disseminate only factual information, and no negative or
positive opinion.
 Restrict special cost arrangements: use corporate aircraft only if commercial transportation is not available.
 Limit gifts: a strict limit for token gifts that can be accepted must be established.
 Restrict investments: Enforce prior approval for employees purchasing equity or equity-related IPOs.
 Review procedures.
 Establish an independence policy.
 Appointed officer: appoint a senior officer to ensure compliance with the firm’s code of ethics.
Standard 1 (C) Misrepresentation
Members and Candidates must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions, or other professional activities.
A misrepresentation is any untrue statement, or omission of fact, or any statement that is otherwise false or misleading.
Interpretation:
The foundation of any client-customer relationship is trust. If trust is lost because of misrepresenting facts, it not only hurts
you, but also hurts confidence in the entire profession and integrity of capital markets as well.
Guidance:
 Impact on investment practice: Assume your firm has been managing a large cap equity fund for several years and
has added a small cap fund last year. If the firm claims it has years of experience managing small cap funds/stocks,
then it would be misrepresenting facts.
o Members and candidates must not misrepresent facts including their qualifications, or credentials. For
instance, if you have cleared only two levels of the CFA program, you cannot claim to be a CFA
charterholder.
o When issuing a research report, you may be using third-party information. You must exercise care and
diligence when using third-party information such as credit ratings, research, or marketing materials, to
ensure there is no misrepresentation.
o If you are using external managers to manage specific areas, you must not represent their investment
practices as your own.
 Performance reporting:
o If you have chosen a benchmark for your portfolio, are the strategies of both comparable? Are you
choosing a benchmark because it makes the portfolio’s performance look better?
o You must ensure the performance evaluation of your portfolio has a reasonable basis.
o Provide pricing information of securities to clients on a consistent basis. Do not change pricing providers
solely on the basis of higher value of a security. This is especially true of illiquid securities. This will be
misrepresenting information as investors make the decision of whether or not to hold an illiquid security
based on the information provided.
 Social media: The language used on social media platforms such as Facebook and Twitter is often informal.
However, members and candidates must ensure the information provided is the same as in traditional modes of
communication. The format must adhere to the Code and Standards, even though there is a great deal of anonymity.
 Omissions: Facts or outcomes must not be omitted, especially when it comes to performance measurement and
attribution. For example, assume a manager had exceptional performance in the past three years, but negative returns
in the three years preceding it. He must present the performance for the entire period and not omit years of bad
performance; that is called cherry picking (or selective presentation).
 Plagiarism: Plagiarism is using the work of others without acknowledging or attributing the source of information.
Examples include:
o Using the research report of another firm, and then redistributing it by changing the names.
o A research report based on multiple sources of information without naming the sources.
o Excerpts from articles with little or no change in wording.

o Not naming specific references, but instead attributing to “leading investment analysts”.
o Using charts and graphs without naming their sources.
 Members and Candidates must disclose the source of information used in their reports. If it is paid for, then it must
be disclosed. Sentences reproduced must be within quotes and the author named specifically.
 Work completed for employer: Work (models/reports/research) done within a firm may be used by others in the firm
without attribution. If the person who developed a model has left the firm, the firm can continue using it as it is a
property of the firm without naming the person. However, no one can claim that the work done by the person who
has quit the firm has been done by the one who is now using it.
 Factual presentations: Each member and candidate must be aware of the firm’s and the individual’s capabilities and
limitations. A written list of the firm’s available services should guide the employees who present to clients.
 Qualification summary: Each member and candidate should prepare a summary of his/her qualifications and
experience to present to clients. These must be periodically reviewed.
 Verify outside information: Ensure material from a third-party is accurate before presenting it to clients.
 Maintain web pages: Any information published on a web page must be current, and accurate.
 Plagiarism policy: Maintain copies of research reports/articles used in making your research report, attribute
quotations to their source, and attribute summaries to their sources.
Standard 1 (D) Misconduct
Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any
act that reflects adversely on their professional reputation, integrity, or competence.
Guidance:
Any act that involves lying, cheating, stealing, or other dishonest conduct is a violation of this standard if the offense reflects
adversely on a member’s or candidate’s professional activities. Although CFA Institute discourages any sort of unethical
behavior by members and candidates, the Code and Standards are primarily aimed at conduct and actions related to a
member’s or candidate’s professional life. Some important points based on examples seen often:
 Using alcohol during business hours, though not illegal impairs a person’s ability to think objectively.
 If a member or candidate declares personal bankruptcy, it is not misconduct. But, if the circumstances that led to
bankruptcy include deceit or fraud, then it would be a violation and deemed as misconduct.
 Code of ethics: Adopt a code of ethics that every member must adhere to.
 List of violations: Communicate to all employees a list of potential violations and the associated sanctions.
Employee references: Do background (reference) checks of employees to ensure they have not had a brush with the law in
the past and are eligible to work in the investment profession.
Standard II: Integrity of Capital Markets

Standard II (A) Material Nonpublic Information
Members and Candidates who possess material nonpublic information that could affect the value of an investment must not
act or cause others to act on the information.
Guidance:
 What is material information? This is information that, if disclosed, can have an impact on the price of a security, or
information that investors would want to know before making an investment decision. For example, information that
the CEO of a company was involved in a scandal to manipulate financial statements and is going to be arrested, is
material information. Other common examples include mergers and acquisitions, new product licenses, changes in
management, bankruptcies, legal disputes, etc.
 What constitutes “nonpublic” information? As the name implies, information that has not been made public is called
nonpublic information. For instance, if a pharmaceutical company has just received news that a particular drug has

been approved by FDA and it is not made public yet, then it constitutes nonpublic information. This is also material
information as it is something investors would like to know before investing in the company.
 Mosaic theory: As per the Mosaic theory, analysts are free to act on public and nonmaterial nonpublic information
without risking violation. Let’s take an example from the curriculum. An analyst is researching a company in the
furniture industry. He analyzes the public disclosures, and speaks with many furniture retailers on which he bases
his recommendation report. The information gathered from furniture retailers is an example of nonmaterial
nonpublic information because the information is not public, and not material by itself to influence the stock prices
in any way.
 Social media: Members and candidates must ensure that information obtained from closed groups on social media
(Facebook, LinkedIn) is accessible to the public through other sources.
 Using industry experts: Using experts is appropriate as long as members are not requesting or acting on material
nonpublic information.
 Investment research reports: Assume you are a well-known analyst and your recommendation reports might impact
stock prices. Since you are not an insider and did not base your report on insider information, Standard II (A) does
not apply. In this case, you are not required to make the report public. If the public wants access to the report, they
can be asked to pay for your services.
 Achieve public dissemination: Take steps to publicly disseminate material nonpublic information. Ensure no
investment action is taken based on the information.
 Adopt compliance procedures: Adopt compliance procedures to prevent the misuse of material nonpublic
information. Ex: review employee trading, investment recommendations, and interdepartmental recommendations.
 Adopt disclosure procedures: Same information should be communicated to the market in an equitable manner. The
information received by buy-side clients should be the same as sell-side clients, and the same goes for large firms
and small firms.
 Issue press releases: Press releases must be made before conference calls and analyst meetings so that new
information is disclosed at such gatherings.
 Firewall elements: A firewall is an information barrier created to prevent the flow of material nonpublic information
within a firm; for instance, between the brokerage and investment banking departments of a firm. Listed below are a
few ways a firewall is implemented:
o Review of employee trading.
o Route interdepartmental communications through the compliance or legal department.
o Document how to enforce procedures to limit information flow within the firm.
o Review/restrict proprietary trading when a firm is in possession of material nonpublic information.
 Appropriate interdepartmental communications: Document procedures for how interdepartmental communications
must occur, review trading activity, and what actions to take if violations occur.
 Physical separation of departments: To prevent sensitive information flowing from one department to another. Ex:
IB/corporate finance to be physically separated from sales and research of a brokerage firm.
 Prevention of personnel overlap: An employee should be on only one side of the firewall. For instance, an employee
working in the commercial lending department of a bank must not be associated with its trust/research departments.
 A reporting system: Have a reporting system in which authorized people can review and approve communications
between departments. If sharing of certain information is necessary across the firewall, then a designated officer
must ascertain whether sharing is essential and must monitor the process.
 Personal trading limitations: Enforce restrictions on personal trading by employees. Monitor both proprietary and
personal trading.
 Record maintenance: Maintain records of interdepartmental communication.
 Proprietary trading procedures : Outline procedures for under what situations there should be restrictions on
proprietary trading:
o Market making: Restrictions on trading if the firm is a market maker can be counterproductive as it may be
a signal to traders that the firm is in possession of some material nonpublic information. The firm must take
the contra side of unsolicited customer trades.

o Arbitrage trading: Must not engage in proprietary trading if it is in possession of sensitive information.
 Communicate to all employees : Educate employees through trainings on how to identify material nonpublic
information and how to act (consult a supervisor/compliance officer) if they possess such information. Circulate
written compliance policies and procedures to all employees.
Standard II (B) Market Manipulation
Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent
to mislead market participants.
What it includes:
 Disseminating false information into the market.

 Misleading market participants by distorting prices.
Guidance:
 Information-based manipulation: Spreading false rumors to induce trading by others. For example, an analyst may
pump false information into the market through blogs or some other media to artificially inflate stock prices.
 Transaction-based manipulation: Transactions that artificially affect the prices or volume of a security. For example,
if transactions show a security to be more liquid, then market participants perceive it favorably and may buy. For
example, a large firm may have offices in Tokyo and Chicago. One office may sell a large number of shares and the
other office may buy. While it may appear as if the liquidity/trading volume of the security is up. But, in reality, the
trading was within the firm.
Standard III: Duties to Clients

Standard III (A) Loyalty, Prudence, and Care
Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent
judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their
employer’s or their own interests.
Interpretation:
Client interests come first, followed by the employer and, then. personal interests of the member or candidate. The only
exception is that the integrity of capital markets must take precedence over the client’s interests if there is a conflict.
Prudence requires caution and discretion. When handling funds of a client, prudence requires that you treat them with the
same skill, care, and diligence as you would treat your own funds.
Guidance:
 Understanding the application of loyalty, prudence, and care : Investment advisers have different job roles; some
have fiduciary responsibilities that are imposed by law and require a higher level of trust than other business roles.
Irrespective of whether or not they are in a fiduciary role, members and candidates are expected to work in the
client’s best interest, and be loyal, prudent, and exercise care in managing the client’s portfolio.
 Identifying the actual investment client : Identify who is the actual client. It’s often easy to define a client but there
are instances when it may not be clear. For example, if a pension plan hires an investment manager, then the client is
not the pension plan but the beneficiaries of the plan. In this case the hiring entity is not your client. In some cases,
there may not be any direct clients or beneficiaries. Ex: a fund manager managing the fund to an index. In such
cases, fund managers should invest according to the stated mandate.
 Developing the client’s portfolio: Care must be taken in developing portfolios, which are consistent with the clients’
objectives, circumstances, constraints, and risks. Investment decisions should be based on the overall portfolio,
rather than the characteristics of an individual investment.
 Soft commission (dollar) policies: Assume a client has hired you to manage his funds. You have discretion over the
selection of brokers to execute transactions. Conflicts may arise if you use client brokerage (money paid by the
client for trade execution) to purchase research services from the broker. This practice is called “soft dollars” or
“soft commissions.” If you pay a higher brokerage commission than you would normally pay, to allow for the

purchase of goods or services, without a corresponding benefit to the client, you have violated the duty of loyalty to
your client.
 Proxy voting policies: Assume you are an investment manager and you have purchased 1 million shares of General
Electric on behalf of your client. Since you are managing your client’s portfolio, you can vote on behalf of the client.
You should perform a simple cost-benefit analysis to decide whether or not to vote. When you vote it should be in
the best interest of the client (shareholder), not the company management. Your firm’s proxy voting policies should
be disclosed to clients.
 Regular account information: Submit a quarterly statement to the client that includes credits, debits, securities
holdings, and transactions during the period. Indicate whether the client must hold or sell assets. And if sold, where
the proceeds should be invested in and when.
 Client approval: If unsure of what course of action to take with respect to a client, members and candidates must
discuss with the client in writing and take approval.
 Firm policies: Encourage firms to adopt these policies:
o Follow all applicable rules and laws.
o Establish the investment objectives of the client: return requirements, risk profile, experiences, and
constraints.
o Consider all the information when taking actions: the client’s needs and circumstances, the client’s
portfolio, and an investment’s individual characteristics.
o Carry out regular reviews: If a client’s circumstances have changed (sudden need for large sums of money,
or an unexpected inflow of money), then they must be addressed.
o Deal fairly with all clients with respect to investment actions.
o Disclose conflicts of interest.
o Disclose compensation arrangements: If a manager is compensated based on the returns generated for a
client, then it must be disclosed to the client.
o Maintain confidentiality.
Standard III (B) Fair Dealing

Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making
investment recommendations, taking investment action, or engaging in other professional activities.
Interpretation:
The standard focuses on dealing fairly and objectively with all clients. It does not mean equally because the circumstances of
every client will be different. Also, a firm may offer different levels of services. A client paying a higher fee for a
personalized service cannot be treated in an equitable manner with one who is not. Moreover, it is also not possible to
communicate information to all clients at the same time as the modes of communication may vary (e-mail, phone, and fax).
Guidance:
 Investment recommendation is any opinion to buy, sell, or hold a security/investment. Guidelines on how
recommendations must be disseminated to clients:
o All your clients must have a fair opportunity to act on the investment recommendation.
o There should not be selective disclosure such that your large clients receive a report first and the smaller
clients later. There may be practical difficulties in reaching all clients at the exact same time because of
time differences and modes of communication, but an effort must be made to communicate in an equitable
manner.
o There may be instances when you may change your recommendation. Let’s assume you issued a buy
recommendation for a stock erroneously. You changed it later to sell and if there are clients who have acted
on the buy order but are not aware of the change to sell, you must advise them of the change before
accepting the order.
 Guidelines for members and candidates whose primary role is to take actions based on investment recommendations
received either from within the firm or external sources:

o Take care to treat all clients fairly.

o IPO and secondary offerings: Distribute to all clients for whom the investments are appropriate. Allocation
of the stock should be consistent with the policies of the firm.
o Oversubscribed issues: Distribute on a pro rata and round-lot basis. Refrain from buying for individual and
family accounts. But, if a family-member is a fee-paying client, then the family member must be treated on
an equal basis as any other client.
o Block trade: All accounts of clients in a block trade must be given the same execution price and charged the
same commission fee.
o Orders must be time stamped.
o Orders are to be executed on a first-in and first-out basis.
o Disclose to the client the allocation procedures that the firm follows.
o Members and candidates must not withhold securities of IPOs, trading at a premium in the secondary
market, for their benefit.
Recommended procedures for compliance:
 Develop firm policies.
o Limit the number of people who know that a recommendation is going to be disseminated.
o Shorten the time frame between the decision to make an investment recommendation and actual
dissemination.
o Publish guidelines for pre-dissemination behavior: Firms must be encouraged to have guidelines that
prohibit personnel, who know about the recommendation, from taking action or discussing.
o Simultaneous dissemination: Once dissemination to all clients has happened, members and candidates may
follow up with individual clients.
o Maintain a list of clients and their holdings.
o Develop and document trade allocation procedures (discussed above).
 Disclose trade allocation procedures.
 Establish systematic account review : Conduct periodic review to ensure no client is receiving preferential treatment
and trades are based on the account’s objectives. If the manager is selling from one account and buying it for another
account, he must document the reasons for both the transactions.
 Disclose the levels of service and the associated fees to all clients.
Standard III (C) Suitability
1. When members and candidates are in an advisory relationship with a client, they must:
a. Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives,
and financial constraints prior to making any investment recommendation or taking investment action, and must
reassess and update this information regularly.
b. Determine that an investment is suitable to the client’s financial situation and consistent with the client’s written
objectives, mandates, and constraints before making an investment recommendation or taking investment action.
c. Judge the suitability of investments in the context of the client’s total portfolio.
2. When members and candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they
must make only investment recommendations or take only investment actions that are consistent with the stated
objectives and constraints of the portfolio.
Interpretation:
Determine the suitability of an investment before taking action based on the clients’ circumstances and other factors. It is the
responsibility of members and candidates who provide investment advice to a client to determine the suitability of an
investment. Sell-side analysts and other members who execute instructions are not responsible for suitability analysis.
Guidance:
 Developing an investment policy: Gather client information (personal data, objectives, risk, and circumstances) at
the start of the relationship. Develop an IPS that outlines return requirements, risk tolerance, and all investment

constraints. IPS also outlines the roles and responsibilities of the parties in the advisory relationship, when periodic
reviews will be conducted and the IPS reevaluated.
 Updating an investment policy: IPS is to be updated at least annually to reflect changes in market expectations and
circumstances of the client. Needs and circumstances of the clients can change at any time and the investment
recommendations/decisions must take note of this. Examples of changes in an individual’s circumstances: tax status,
number of dependents, liquidity needs, loss of job/change in current income, etc.
 The need for diversification: Combining different investments reduces the risk of a portfolio having all assets in a
single investment. An investment that is relatively risky on its own may be suitable in the context of the entire
portfolio.
 Addressing unsolicited trading requests
o Requests from clients for trades that do not align with the risk and return objectives of a client’s IPS:
Members and candidates must take efforts to balance the client’s request while not deviating from the IPS.
o Unsolicited requests that are not suitable investments: If your clients ask you to make a trade that is not in
accordance with the IPS, then refrain from making the trade until you discuss it with the client. Educate the
client about the deviation from the current IPS.
o If the client insists on making the trade and if you think it will have a material impact on the portfolio,
update the IPS. If the client refuses to have the IPS modified, then determine the future of the advisory
relationship.
 Managing to an index or mandate : Invest according to the mandate. For example, assume you are a portfolio
manager for a small cap fund and your mandate is to include stocks below a certain market capitalization. You
would be deviating from the mandate if you buy large cap stocks even if you expect large caps to perform
exceptionally well.
 Investment policy statement: Both individual and institutional investors must have an IPS. The IPS should outline
the following: client identification, investor objectives, investor constraints, and performance measurement
benchmarks.
 Regular updates: IPS is to be updated on a regular basis (at least annually) to reflect changing circumstances and
capital market expectations.
 Suitability test policies: Firms must be encouraged to have test procedures to determine the suitability of
investments for different types of clients.
Standard III (D) Performance Presentation
When communicating investment performance information, members and candidates must make reasonable efforts to ensure
that it is fair, accurate, and complete.
Guidance:
 Provide credible performance information to clients and prospective clients. Should not state that past performance
can be obtained again.
 Avoid misstating performance or misleading clients.
 If the presentation is brief, make detailed supporting information available to clients and prospects on request.
Applying the GIPS standards is recommended, but not required. Firms that claim compliance without applying GIPS
standards must do the following:
 Consider the knowledge and sophistication of the audience.

 Present the performance of the weighted composite of similar portfolios rather than using a single representative
account. Assume there are three portfolios with similar mandates worth 2 million, 10 million, and 8 million. If they
generated returns of 9%, 2%, and 2%, respectively, then take a weighted average of returns.
 Include terminated accounts as part of performance history. Also state when those accounts were terminated.
 Include disclosures that fully explain the performance results being reported.

 Maintain the data and records used to calculate the performance being presented.
Standard III (E) Preservation of Confidentiality
Members and Candidates must keep information about current, former, and prospective clients confidential unless:
1. The information concerns illegal activities on the part of the client.
2. Disclosure is required by the law.
3. The client or prospective client permits disclosure of the information.
Guidance:
 Status of client: Even if an entity is no longer a client, members and candidates must maintain the confidentiality of
client records.
 Compliance with laws: Comply with applicable law. If a client is involved in illegal activities and the applicable law
requires members and candidates to maintain confidentiality, then the information must not be disclosed.
 Electronic information and security: Members and candidates need to be aware of possible accidental disclosures.
They should take care when communicating sensitive client information. For instance, assume two clients an
investment manager is dealing with, have similar names. When sending an e-mail with updated IPS, the investment
manager types in the name of the intended recipient and doesn’t realize that it goes to the other client instead of the
intended recipient. Such mistakes can have dire consequences.
 Professional conduct investigations by CFA Institute : If permissible under law, members and candidates must
cooperate with PCP and provide information about a client in support of an investigation. Any information given to
PCP stays confidential.
 The simplest, most conservative and most effective way to comply with Standard III (E) is to avoid disclosing any
information received from a client, except to authorized fellow employees who are also working for the client.
 Communicating with clients: Follow firm-supported communication methods and compliance procedures when
communicating confidential information.

R04 Introduction to the Global Investment Performance Standards (GIPS)

Introduction
This reading focuses on:
 Why the GIPS standards were created and whom do they apply to?
 What are composites and what is their purpose in performance reporting?
 Who can claim compliance with GIPS, and is there a verification process?
Note: most of the material presented here is taken from the curriculum.
1. Why Were the GIPS Standards Created?
GIPS standards were created to make it easier to compare different investment management firms. Without a standard,
different firms would select the method which would make their performance look better.
The GIPS standards are a practitioner-driven set of ethical principles that establish a standardized, industry-wide approach for
investment firms to follow in calculating and presenting their historical investment results to prospective clients. The GIPS
standards ensure fair representation and full disclosure of investment performance. In other words, the GIPS standards lead
investment management firms to avoid misrepresentations of performance and to communicate all relevant information that
prospective clients should know in order to evaluate past results.
Misleading practices in the absence of GIPS included:
 Representative accounts: Showcasing only the top-performing portfolio to represent the firm’s overall investment
results.
 Survivorship bias: Excluding poorly performing portfolios and presenting an average performance history.
 Varying time periods: Presenting performance for a selected time-period during which the mandate produced
excellent returns.
2. Who Can Claim Compliance?
Any investment management firm can claim compliance. Complying with the GIPS standards is voluntary. Only investment
management firms that actually manage assets can claim compliance. Plan sponsors and consultants cannot claim compliance
unless they manage assets for which they claim compliance.
Compliance is a firm-wide process that cannot be achieved on a single product or composite. A firm has only two options
with regard to compliance with the GIPS standards:
 Fully comply with all requirements of the GIPS standards and claim compliance through the use of the GIPS
Compliance Statement; or
 Not comply with all requirements of the GIPS standards and not claim compliance with, or make any reference to,
the GIPS standards.
3. Who Benefits from Compliance?
Two groups benefit from GIPS compliance: investment management firms and prospective clients.
Following the GIPS standards allows investment management firms to assure prospective clients that the historical track
record they report is both complete and fairly presented. Compliance enables the GIPS-compliant firm to participate in
competitive bids against other compliant firms throughout the world. Achieving and maintaining compliance may also
strengthen the firm’s internal controls over performance-related processes and procedures.
Investors have a greater level of confidence in the integrity of performance presentations of a GIPS-compliant firm.
Investors can easily compare performance presentations from different investment management firms.
Compliance with the GIPS standards does not eliminate the need for due-diligence, but it enhances the credibility of
investment management firms that have chosen to undertake this responsibility.
4. Composites

One of the key requirements of the GIPS standards is the use of composites. A composite is an aggregation of one or more
portfolios managed according to a similar investment mandate, objective, or strategy. Assume a firm manages portfolios
based on one of the following strategies:
 Strategy A: Aggressive growth. Under this strategy the firm selects small-cap stocks with strong growth potential
over the next few years.
 Strategy B. Large cap value. Under this strategy large-cap value stocks are selected.
Give this scenario the firm should create a composite for Strategy A, and another composite for Strategy B.
A composite must include all actual, fee-paying, discretionary portfolios managed in accordance with the same investment
mandate, objective, or strategy. By “actual” we mean these should be real and not dummy/model portfolios to simulate the
returns. Portfolios for which the client does not pay a fee must not be included. For instance, there may be charitable
organizations that do not pay a fee for their assets being managed. These should not be included. By “discretionary”, we
mean the investment management firm has the right to determine and purchase suitable securities for a portfolio. If there is a
portfolio where the client determines what securities should be purchased, then it is non-discretionary.
The determination of which portfolios to include in the composite should be done according to pre-established criteria (i.e. on
an ex-ante basis), not after the fact. This prevents a firm from including only the best-performing portfolios. This is important
because performance numbers are reported based on composites.
5. Verification
Firms that claim compliance with the GIPS standards are responsible for their claim of compliance and maintaining that
compliance. Once a firm claims compliance with GIPS, they may voluntarily hire an independent third-party to perform
verification. Just as GIPS compliance is voluntary, verification is also voluntary. Verification is performed with respect to an
entire firm. It is not done on composites, or individual departments.
Verification must be performed by an independent third party. A firm cannot perform its own verification. Third-party
verification brings additional credibility to a firm’s claim of compliance. To understand why a firm would pay to be verified
if it is voluntary, assume there are two firms, A and B. Firm A claims GIPS compliance and firm B claims GIPS compliance
with third-party verification from a reputed firm. As an investor, which firm would you be more comfortable with?
Obviously firm B, and that gives firm B an advantage over firm A.
Verification tests include:
 Whether the investment firm has complied with all the composite construction requirements of the GIPS standards
on a firm-wide basis, and
 Whether the firm’s policies and procedures are designed to calculate and present performance in compliance with
the GIPS standards.
6. The Structure of the GIPS Standards
The provisions within the 2010 edition of the GIPS standards are divided into nine sections:
1. Fundamentals of Compliance
2. Input Data
3. Calculation Methodology
4. Composite Construction
5. Disclosure
6. Presentation and Reporting
7. Real Estate
8. Private Equity
9. Wrap Fee. Separately Managed Account (SMA) Portfolios

R05 The GIPS Standard

Introduction
In this reading we focus on:
 Goals of the GIPS Executive Committee.
 Key features of the GIPS standards and the fundamentals of compliance.
 How historical performance record must be presented.
 The nine major sections of the GIPS standard.
Note: most of the material presented here is taken from the curriculum.
Goals of the GIPS Executive Committee
The goals of the GIPS Executive Committee are presented below:
 To establish investment industry best-practices for calculating and presenting investment performance that promote
investor interests and instill investor confidence.
 To obtain worldwide acceptance of a single standard for the calculation and presentation of investment performance
based on the principles of fair presentation and full disclosure.
 To promote the use of accurate and consistent performance data.
 To encourage fair global competition among investment firms without creating barriers to entry; and
 To foster the notion of industry “self-regulation” on a global basis.
Key Features of the GIPS Standards
The key features of GIPS are as follows:
 The GIPS standards are the ethical standards for investment performance presentation to ensure fair representation
and full disclosure of investment performance. In order to claim compliance, firms must adhere to the requirements
included in the GIPS standards.
 Meeting the objectives of fair representation and full disclosure is likely to require more than simply adhering to the
minimum requirements of the GIPS standards. Firms should also adhere to the recommendations to achieve best
practice in the calculation and presentation of performance.
 The GIPS standards require firms to include all actual, discretionary, fee-paying portfolios in at least one composite
defined by investment mandate, objective, or strategy in order to prevent firms from cherry-picking their best
performance. This means firms must create composites and each actual, fee-paying, discretionary portfolio must be
in at least one composite. If a portfolio is not included in any composite, then the returns associated with it will not
be included.
 The GIPS standards rely on the integrity of input data. The accuracy of input data is critical to the accuracy of
performance presentation. The underlying valuations of portfolio holdings drive the portfolio’s performance. It is
essential that these and other inputs are accurate. The GIPS standards require firms to adhere to certain calculation
methodologies and to make specific disclosures along with the firm’s performance.
 Firms must comply with all requirements of the GIPS standards.
Historical Performance Record
 A firm is required to initially present, at a minimum, five years of annual investment performance that are compliant
with the GIPS standards. If the firm or the composite has been in existence for less than five years, the firm must
present performance since the firm’s inception or the composite’s inception date.
 Later the firm must present an additional year of performance each year, building up to a minimum of 10 years of
GIPS-compliant performance.
 Firms may link non-GIPS compliant performance to their GIPS-compliant performance provided that only GIPS-
compliant performance is presented for periods after 1 January, 2000 and the firm discloses the periods of non-
compliance.

 Firms that manage private-equity, real estate, and/or wrap fee/separately managed account (SMA) portfolios must
also comply with sections 6, 7, and 8 respectively, of the provisions of the GIPS standards that became effective as
of 1 January, 2006.
Consider Firm A which was established in 2013 and decides to become GIPS compliant in 2014. Initially, it must present
performance information for 2013 and 2014. Later, it must keep adding performance data every year until it builds up to a
minimum of 10 years.
Consider Firm B which was established in 2008 and decides to become GIPS compliant in 2014. Initially, it must present
performance information for five years from the period ending in 2010 to the period ending in 2014. Later, it must also add
an additional year until it has 10 years of GIPS-compliant performance.
Compliance
The definition of the firm is the foundation for firm-wide compliance and creates defined boundaries whereby total firm
assets can be determined.
 Firms must take all steps necessary to ensure that they have satisfied all the requirements of the GIPS standards
before claiming compliance.
 Firms are strongly encouraged to perform periodic internal compliance checks.
 Firms may choose to have an independent third-party verification that tests the construction of the firm’s composites
as well as the firm’s policies and procedures as they relate to compliance with the GIPS standards. Verification is
recommended, but it is voluntary and must be done by a third-party verifier.
 In addition to verification, firms may also choose to have specifically focused composite testing (performance
examination) performed by an independent third-party verifier to provide additional assurance regarding a particular
composite.
 The effective date for the 2010 edition of the GIPS standards is 1 January, 2011. Compliant presentations that
include a performance for periods that begin on or after 1 January, 2011 must be prepared in accordance with the
2010 edition of the GIPS standards.
Implementing a Global Standard
 The presence of a local sponsoring organization for investment performance standards is essential for effective
implementation and ongoing support of the GIPS standards within a country. The curriculum lists GIPS country
sponsors for a few countries.
 Country sponsor ensures that the country’s interests are taken into account as the GIPS standards are developed.
 The GIPS executive committee strongly encourages countries without an investment performance standard to
promote the GIPS standards as the local standard. If there is no local standard in a country, then it is ideal for the
country to promote and adopt GIPS as it is a global standard, and when required translate them into the local
language.
 Compliance with applicable law and rules does not necessarily mean compliance with GIPS.
 In cases in which laws and/or regulations conflict with the GIPS standards, firms are required to comply with
the laws and regulations and make full disclosure of the conflict in the compliant presentation. Firms can still
claim compliance with GIPS but they must disclose wherever there is a deviation that the law of the land is being
followed.
R05 The GIPS Standard cont…
Nine Major Sections of the GIPS Standards

The provisions within the 2010 edition of the GIPS standards are divided into nine sections:
1. Fundamentals of Compliance
2. Input Data
3. Calculation Methodology
4. Composite Construction
5. Disclosure


7. Real Estate
8. Private Equity
9. Wrap Fee/Separately Managed Account (SMA) portfolios
The provisions are categorized into requirements and recommendations. All the requirements must be implemented to claim
compliance.
1. Fundamentals of Compliance: Several core principles create the foundation for the GIPS standards, including
properly defining the firm, providing compliant presentations to all prospective clients, adhering to applicable laws
and regulations, and ensuring that information presented is not false or misleading. Two important issues that a firm
must consider when becoming compliant with the GIPS standards are the definition of the firm and the firm’s
definition of discretion. The definition of the firm is the foundation for firm-wide compliance and creates defined
boundaries whereby total firm assets can be determined. The firm’s definition of discretion establishes criteria to
judge which portfolios must be included in a composite and is based on the firm’s ability to implement its
investment strategy. Sample firm definition: XYX Investment Firm is a balanced portfolio investment manager that
invests solely in US-based securities. XYZ Investment Firm is defined as an independent investment management
firm that is not affiliated with any parent organization. The requirements of Provision 0 are presented below
(reproduced from the curriculum).
0.A.1: Firms must comply with all the requirements of the GIPS standards, including any updates, Guidance
Statements, interpretations, Questions & Answers (Q&As), and clarifications published by CFA Institute and the
GIPS Executive Committee, which are available on the GIPS standards website (www.gipsstandards.org) as well as
in the GIPS Handbook.
0.A.2: Firms must comply with all applicable laws and regulations regarding the calculation and presentation of
performance.
If there are no applicable laws and rules, then GIPS compliant firms must follow the GIPS standards. But, if a
country has applicable laws and regulations regarding the calculation and presentation of performance, then the
country laws must be followed and any differences with GIPS must be documented.
0.A.3: Firms must not present performance or performance-related information that is false or misleading.
0.A.4: The GIPS standards must be applied on a firm-wide basis.
0.A.5: Firms must document their policies and procedures used in establishing and maintaining compliance with the
GIPS standards, including ensuring the existence and ownership of client assets, and must apply them consistently.
0.A.6: If the firm does not meet all the requirements of the GIPS standards, the firm must not represent or state that
it is “in compliance with the Global Investment Performance Standards except for . . .” or make any other statements
that may indicate partial compliance with the GIPS standards.
Firms are not allowed to claim partial compliance with the GIPS standards.
0.A.7: Statements referring to the calculation methodology as being “in accordance,” “in compliance,” or
“consistent” with the Global Investment Performance Standards, or similar statements, are prohibited.
0.A.8: Statements referring to the performance of a single, existing client portfolio as being “calculated in
accordance with the Global Investment Performance Standards” are prohibited, except when a GIPS-compliant firm
reports the performance of an individual client’s portfolio to that client.
0.A.9: Firms must make every reasonable effort to provide a compliant presentation to all prospective clients. Firms
must not choose to whom they present a compliant presentation. As long as a prospective client has received a
compliant presentation within the previous 12 months, the firm has met this requirement.
0.A.10: Firms must provide a complete list of composite descriptions to any prospective client that makes such a
request. Firms must include terminated composites on the firm’s list of composite descriptions for at least five years
after the composite termination date.
A composite must be clearly described as to what mandate or strategy it is following: For example, small-cap equity
value, Japan-equity, fixed-income etc. If a composite was terminated, then its performance must be presented for at
least five years after termination to overcome survivorship bias.
0.A.11: Firms must provide a compliant presentation for any composite listed on the firm’s list of composite
descriptions to any prospective client that makes such a request.
A compliant presentation is one that complies with all the GIPS provisions.

0.A.12: Firms must be defined as an investment firm, subsidiary, or division held out to clients or prospective clients
as a distinct business entity.
Scenario: Assume there is a firm called UBL and it has a subsidiary called UBL-Asset Management (UBL-AM). If
investors approach UBL-AM to trade and invest in securities/funds, then UBM-AM is the firm here, and must
comply with the GIPS standards.
0.A.13: For periods beginning on or after 1 January 2011, total firm assets must be the aggregate fair value of all
discretionary and non-discretionary assets managed by the firm. This includes both fee-paying and non-fee-paying
portfolios.
Do not confuse this with a composite. A composite must include only actual, fee-paying discretionary portfolios.
But, when a firm reports its total assets, it must include the fair value of all discretionary and non-discretionary
assets and all fee-paying and non-fee paying portfolios.
0.A.14: Total firm assets must include assets assigned to a sub-advisor provided the firm has discretion over the
selection of the sub-advisor.
0.A.15: Changes in a firm’s organization must not lead to alteration of historical composite performance.
0.A.16: When the firm jointly markets with other firms, the firm claiming compliance with the GIPS standards must
be sure that it is clearly defined and separate relative to other firms being marketed, and that it is clear which firm is
claiming compliance.
Outlined above are requirements. The GIPS standards also include requirements. For example, assume an
investment management company, HS, has different geographical offices, which operate under the same brand name
but as individual investment management companies such as HS Malta plc, HS Spain, HS India Limited, HS
Malaysia Limited. The firm definition should be broad enough to include all geographical offices under one
umbrella. This is just a recommendation, not a requirement.
At Level I you are required to know the details of Provision 0 (Fundamentals of Compliance). For provisions 1 – 8
you just need to know the basic descriptions which are given below:
1. Input data Consistency of input data used to calculate performance is critical to effective compliance with the GIPS
standards and establishes the foundation for full, fair, and comparable investment performance presentations. For
periods beginning on or after 1 January 2011, all portfolios must be valued in accordance with the definition of fair
value and the GIPS valuation principles.
2. Calculation Methodology Achieving comparability among investment management firms’ performance
presentations requires uniformity in the methods used to calculate returns. The GIPS standards mandate the use of
certain calculation methodologies to facilitate comparability.
3. Composite Construction A composite is an aggregation of one or more portfolios managed according to a similar
investment mandate, objective, or strategy. The composite return is the asset-weighted average of the performance
of all portfolios in the composite. Creating meaningful composites is essential to the fair presentation, consistency,
and comparability of performance over time and among firms. Assume there are two portfolios in a composite:
portfolio 1 with a value of $10 million and portfolio 2 with a value of $90 million. The returns of the two portfolios
are 10% and 12% respectively. The overall return of the composite must be closer to 12% as the 12% return has a
90% weightage.
4. Disclosure: Disclosure allows firms to elaborate on the data provided in the presentation and give the reader the
proper context in which to understand the performance. To comply with the GIPS standards, firms must disclose
certain information in all compliant presentations regarding their performance and the policies adopted by the firm.
One of the essential disclosures for every firm is the claim of compliance. Once a firm meets all the requirements of
the GIPS standards, it must appropriately use the claim of compliance to indicate compliance with the GIPS
standards. The allowed format for firms that claim compliance is: <<Name of firm>> claims compliance with the
Global Investment Performance Standards (GIPS) and has prepared and presented this report in compliance with the
GIPS Standards.
After constructing the composites, gathering the input data, calculating returns, and determining the necessary
disclosures, the firm must incorporate this information in presentations based on the requirements in the GIPS
standards for presenting investment performance. No finite set of requirements can cover all potential situations or
anticipate future developments in investment industry structure, technology, products, or practices. When

appropriate, firms have the responsibility to include in GIPS-compliant presentations information not addressed by
the GIPS standards.
6. Real Estate
Unless otherwise noted, this section supplements all of the required and recommended provisions in Sections 0-5.
Real estate provisions were first included in the 2005 edition of the GIPS standards and became effective 1 January,
2006. The 2010 edition of the GIPS standards includes new provisions for closed-end real estate funds. Firms should
note that certain provisions of sections 0-5 do not apply to real estate investments or are superseded by the
provisions within section 6. The provisions that do not apply have been noted within section 6.
7. Private Equity
Unless otherwise noted, this section supplements all of the required and recommended provisions in sections 0-5.
Private equity provisions were first included i n the 2005 edition of the GIPS standards and became effective 1
January 2006. Firms should note that certain provisions in sections 0-5 do not apply to private equity investments or
are superseded by the provisions within section 7. The provisions that do not apply have been noted within section 7.
8. Wrap Fee/Separately Managed Account (SMA) Portfolios <
Unless otherwise noted, this section supplements all of the required and recommended provisions in sections 0-5.
Firms should note that certain provisions in sections 0-5 of the GIPS standards do not apply to wrap fee/SMA
portfolios or are superseded by the provisions within section 8. The provisions that do not apply here have been
noted within section 8.
Sample Presentation
A sample GIPS-compliant presentation report is presented below. Some of the important aspects that you can take note of
are:
 Name of firm: Sample 1 Investment Firm; Composite: Balanced Growth

 Gross return, net return, and no. of portfolios are required data which are presented.
Sample 1 Investment Firm Balanced Growth Composite (from the curriculum)
1 January 2002 through 31 December 2011
Year Composite Composite Custom Composit Benchmar Number Internal Composit Firm
Gross Net Benchmar e k Of Dispersio e Asset
Return Return k 3-Yr St 3-Yr St Portfolio n Assets s
(%) (%) Return (%) Dev (%) Dev (%) s (%) ($ M) ($ M)
200
-10.5
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0

201
1
Sample 1 Investment Firm claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared
and presented this report in compliance with the GIPS standards. Sample 1 Investment Firm has been independently verified
for the periods 1 January 2000 through 31 December 2010. The verification report is available upon request. Verification
assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-
wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with
the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.
Notes:
1. Sample 1 Investment Firm is a balanced portfolio investment manager that invests solely in US-based securities.
Sample 1 Investment Firm is defined as an independent investment management firm that is not affiliated with any
parent organization. Policies for valuing portfolios, calculating performance, and preparing compliant presentations
are available upon request.
2. The Balanced Growth Composite includes all institutional balanced portfolios that invest in large-cap US equities
and investment-grade bonds with the goal of providing long-term capital growth and steady income from a well-
diversified strategy. Although the strategy allows for equity exposure ranging between 50–70%, the typical
allocation is between 55–65%. The account minimum for the composite is $5 million.
3. The custom benchmark is 60% YYY US Equity Index and 40% ZZZ US Aggregate Bond Index. The benchmark is
rebalanced monthly.
4. Valuations are computed and performance is reported in US dollars.
5. Gross-of-fees returns are presented before management and custodial fees but after all trading expenses. Composite
and benchmark returns are presented net of non-reclaimable withholding taxes. Net-of-fees returns are calculated by
deducting the highest fee of 0.83% from the monthly gross composite return. The management fee schedule is as
follows: 1.00% on the first $25 million; 0.60% thereafter.
6. This composite was created in February 2000. A complete list of composite descriptions is available upon request.
7. Internal dispersion is calculated using the equal-weighted standard deviation of annual gross returns of those
portfolios that were included in the composite for the entire year.
8. The three-year annualized standard deviation measures the variability of the composite and the benchmark returns
over the preceding 36-month period.

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`CFA Level I Ethics Notes

R01 Ethics and Trust in the Investment Profession

 Have transparent and open business practices.

3. Ethics and Professionalism

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4. Professionalism in Investment Management

5. Challenges to Ethical Conduct

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6. Ethical vs. Legal Standards

 Go beyond what is legally required.

7. Ethical Decision-Making Framework

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R02 Code of Ethics and Standards of Professional Conduct Profession

CFA Institute Professional Conduct Program

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Standards of Professional Conduct

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R03 Guidance for Standards I-VII

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Standard 1 (B) Independence and Objectivity

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 Protect the integrity of opinions.

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Standard II: Integrity of Capital Markets

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 Disseminating false information into the market.

Standard III: Duties to Clients

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Standard III (B) Fair Dealing

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o Take care to treat all clients fairly.

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 Consider the knowledge and sophistication of the audience.

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R04 Introduction to the Global Investment Performance Standards (GIPS)

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R05 The GIPS Standard

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R05 The GIPS Standard cont…

Nine Major Sections of the GIPS Standards

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6. Presentation and Reporting

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 Name of firm: Sample 1 Investment Firm; Composite: Balanced Growth

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