Ethics

A set of moral principles that guide behavior.

Ethics define:

• What is good, acceptable, or required
• What is bad, unacceptable, or forbidden

Analogy:
Ethics are the “moral compass” — they don’t tell you exactly where to go, but they tell you when you’re heading the wrong way.

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Ethical Principles

• Beliefs about appropriate behavior
• Apply across situations
• Often broader than laws or rules

Code of Ethics

• A written set of principles
• Communicates:
  • Values
  • Beliefs
  • Expectations
• Acts as a general guide for behavior
• Written by professional organizations (e.g., CFA Institute)

Insight:
Codes are principle-based, not rule-based.

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Standards of Conduct

• Benchmarks for minimum acceptable behavior
• Clarify and support the Code of Ethics
• Contain explicit rules
• Specify required or prohibited actions

Insight:
Standards are more specific and enforceable than codes.

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Code vs Standards (Very Testable)

Feature	Code of Ethics	Standards of Conduct
Nature	Principles	Rules
Specificity	Broad	Explicit
Purpose	Guide behavior	Enforce behavior
Scope	Values & ideals	Minimum requirements

A profession is an occupational group that:

• Is based on specialized knowledge
• Provides a service to society
• Is bound by a shared code of ethics

📌 Key Differentiator:
What separates a profession from a trade guild is its ethical responsibility to society, not just skill.

Trust is the foundation of professional credibility.

Mechanisms to Build Trust

• High standards of entry
• Continuing education
• Client-first focus
• Shared ethical code
• Monitoring & enforcement
• Accountability
• Engagement, mentoring, volunteering

Analogy:
Trust is like a reputation bank account — built slowly, lost quickly.

Why Ethics Matter More Here Than Most Fields

• Industry relies heavily on trust and credibility
• Many investment products are intangible
• Clients depend on:
  • Professional expertise
  • Superior information access
• Industry connects lenders and borrowers

Insight:
Without trust, capital markets do not function efficiently.

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Economic Impact of Ethical Conduct

If professionals adhere to ethical standards:

• Capital is allocated more efficiently
• Transaction costs decrease
• Market confidence improves
• The entire economy benefits

If trust fails:

• Transactions decline
• Capital misallocation increases
• Economic growth suffers

Overconfidence in Ethics (Exam Favorite)

• Individuals overestimate their ability to make ethical decisions
• Leads to:
  • Carelessness
  • Rationalization
  • Ethical blind spots

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Situational Influences

Ethical lapses often occur due to external pressures, not bad intent.

Common Pressures

• Pressure from coworkers
• Loyalty to supervisors or colleagues
• Desire for money or prestige
• Promotions and career advancement

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Role of Compliance Programs

• Designed to mitigate unethical behavior
• Risk:
  • Employees focus on avoiding punishment
  • Instead of acting ethically

Insight:
Compliance ≠ ethics. Ethics must go beyond rule-following.

Key Distinction (Highly Testable)

• Legal behavior is not always ethical
• Ethical behavior often exceeds legal requirements

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Why Law Alone Is Insufficient

• Laws take time to develop
• Laws differ across jurisdictions
• Laws are open to interpretation
• New laws can unintentionally create new ethical loopholes
• Some unethical acts may be legal in certain countries (e.g., insider trading)

Ethics must go beyond the law.

Analogy:
The law is the minimum speed limit; ethics is choosing not to tailgate even when it’s legal.

A structured approach to handling ethical dilemmas.

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Step 1: Identify

Identify:

• Relevant facts
• Stakeholders
• Duties owed
• Ethical principles involved
• Conflicts of interest

Stakeholders:
Anyone directly or indirectly affected by the decision.

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Step 2: Consider

• Situational influences
• Alternative actions
• Additional guidance (policies, standards, mentors)

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Step 3: Decide and Act

• Choose the most ethical alternative
• Act consistently with ethical principles

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Step 4: Reflect

• Evaluate:
  • Outcome
  • Decision process
• Ask:
  • Was the desired outcome achieved?
  • What can be improved next time?

Insight:
Reflection reinforces ethical learning and future decision-making.

Ethics vs Law

Aspect	Ethics	Law
Scope	Broad moral principles	Legal minimum
Flexibility	Universal	Jurisdiction-specific
Timing	Immediate	Slow to evolve
Standard	Higher	Lower

Ethical Decision Making Framework

Step	Action
Identify	Facts, stakeholders, conflicts
Consider	Alternatives, influences
Decide & Act	Choose ethical action
Reflect	Evaluate outcome

Trust-Building Mechanisms

Mechanism	Purpose
High entry standards	Ensure competence
Continuing education	Maintain expertise
Code of ethics	Normalize behavior
Monitoring	Accountability
Engagement	Strengthen profession

• Ethics guide behavior beyond legal requirements
• Codes express values; standards define minimum conduct
• Professions exist to serve society, not just members
• Trust is essential to capital market function
• Ethical failures reduce economic efficiency
• Individuals often overestimate ethical judgment ability
• Situational pressures are a major cause of ethical lapses
• Legal conduct is not always ethical
• Ethics must go beyond compliance
• A structured ethical framework improves decision-making

Who Must Comply

• CFA Institute members
• CFA candidates

Compliance is mandatory, not optional.

Candidates are held to the same ethical expectations as members.

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Disciplinary Review Committee (DRC)

• Responsible for enforcing the Code and Standards
• Reviews cases and determines sanctions

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Professional Conduct Program (PCP)

• CFA Institute staff responsible for:
  • Monitoring compliance
  • Investigating potential violations
  • Responding to conduct-related inquiries

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How an Inquiry Can Be Initiated

An investigation may begin through:

• Self-disclosure
• Written complaint
• Public information (news, court cases)
• Report by CFA exam proctor
• Exam analysis or social media review after the exam

Social media activity after an exam is monitored and can trigger an inquiry.

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PCP Investigation Outcomes

After investigation, PCP may conclude:

1. No disciplinary action
2. Cautionary letter
3. Disciplinary action

If disciplinary action is proposed:

• Candidate/member may:
  • Accept the sanction
  • Reject and appeal to a hearing panel

Analogy:
Think of the PCP as internal auditors and the DRC as the enforcement court.

The Code of Ethics establishes core ethical principles that guide behavior.

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Code of Ethics — Principle 1

Act with integrity, competence, diligence, respect, and in an ethical manner with:

• Public
• Clients
• Prospective clients
• Employers
• Employees
• Colleagues
• Other market participants

📌 Key Idea:
Ethical behavior applies to all stakeholders, not just clients.

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Principle 2

Place the integrity of the investment profession and the interests of clients above personal interests

• Client-first mentality
• No personal benefit at the expense of clients or markets

Analogy:
Clients sit in the front seat; personal interests go in the trunk.

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Principle 3

Use reasonable care and exercise independent professional judgment when:

• Conducting analysis
• Making recommendations
• Taking investment actions
• Performing professional activities

Blindly following models, supervisors, or consensus violates this principle.

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Principle 4

Practice and encourage others to practice ethically and professionally

• Responsibility extends beyond personal behavior
• Encourages ethical culture within firms

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Principle 5

Promote the integrity and viability of global capital markets

• Ethical conduct supports:
  • Market confidence
  • Fairness
  • Efficiency

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Principle 6

Maintain and improve professional competence and help others do the same

• Commitment to:
  • Lifelong learning
  • Continuing education
  • Professional development

Competence is an ethical obligation, not just a career choice.

The 7 Standards translate ethical principles into enforceable rules.

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The Seven Standards (High-Level Overview)

1. Professionalism
2. Integrity of Capital Markets
3. Duties to Clients
4. Duties to Employers
5. Investment Analysis, Recommendations & Actions
6. Conflicts of Interest
7. Responsibilities as a CFA Institute Member or Candidate

Each standard has sub-standards tested heavily in vignette format.

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Code vs Standards (Very Testable)

Feature	Code of Ethics	Standards of Conduct
Nature	Principles	Rules
Detail	Broad	Specific
Purpose	Guide behavior	Enforce behavior
Enforcement	Indirect	Direct

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Why the Code & Standards Matter

• Promote trust in:
  • Investment professionals
  • Capital markets
• Protect:
  • Clients
  • Employers
  • The profession
• Establish minimum expectations across jurisdictions

The Standards often go beyond local laws.

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Common CFA Ethics Exam Traps

• “Everyone does it” → Still a violation
• “It’s legal” → May still be unethical
• “My boss told me to” → Not a defense
• “I didn’t know” → Ignorance is not an excuse

Enforcement structure

Body	Role
PCP	Monitoring & investigation
DRC	Enforcement & sanctions
Hearing Panel	Appeals

Inquiry Triggers

Source	Example
Self-disclosure	Admitting violation
Written complaint	Client complaint
Public info	News articles
Proctor report	Exam misconduct
Social media	Exam content discussion

Code of Ethics Summary

Principle	Core Focus
1	Integrity & respect
2	Client-first
3	Independent judgment
4	Ethical culture
5	Market integrity
6	Professional competence

I(A) Knowledge of the Law

Core Rule

Members and Candidates must understand and comply with:

• All applicable laws & regulations
• CFA Institute Code & Standards

➡️ When laws conflict:
👉 Follow the stricter rule

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Key Rules

• Ignorance of the law = ❌ NOT an excuse
• Must dissociate from illegal or unethical activity
  • Includes resigning if violations persist
• May be required to report violations

Analogy:
If traffic laws conflict, you obey the one with the lowest speed limit.

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I(B) Independence & Objectivity 

Core Rule

Do not allow gifts, compensation, or benefits to compromise judgment.

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Allowed vs NOT Allowed

Item	Allowed?
Flat research fee	✅
Fee tied to buy/sell rating	❌
Modest gifts (disclosed)	✅
Lavish gifts / travel	❌
Compensation influencing hiring/recommendations	❌

Trap:
“Modest” ≠ expensive travel or entertainment.

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I(C) Misrepresentation ⭐⭐⭐

Definition

Any false statement OR omission of material fact.

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Common Exam Areas (Memorize These 6)

1️⃣ Investment Practice

• No false claims about:
  • Credentials
  • Performance
  • Services
• Firm responsible for third-party statements

2️⃣ Performance Reporting

• Use comparable benchmarks
• Be transparent with pricing

3️⃣ Social Media

• Must match info given to clients

4️⃣ Omissions

• Leaving out facts = misrepresentation

5️⃣ Plagiarism

• Must credit sources

6️⃣ Employer Property

• Work belongs to employer (even after leaving)

Analogy:
Leaving out facts is lying by silence.

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I(D) Misconduct

Rule

No behavior involving:

• Dishonesty
• Fraud
• Deceit
• Conduct that harms professional reputation

📌 Applies to both professional AND personal conduct

II(A) Material Nonpublic Information (MNPI) 

Material

Information that:

• Would affect price OR
• Investors would want to know

Nonpublic

• Not available to the market

🚫 Cannot trade or tip others

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Mosaic Theory (Exam Favorite)

✅ Allowed if conclusions are based on:

• Public information
• Non-material nonpublic information
• Analyst’s own analysis

❌ Not allowed if based on MNPI

Analogy:
Cooking a meal from public ingredients is fine — stealing a secret recipe is not.

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II(B) Market Manipulation

Rule

No actions intended to mislead market participants.

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Two Types

Type	Example
Information-based	Spreading false rumors
Transaction-based	Artificial trading to inflate price

Intent to mislead is required

III(A) Loyalty, Prudence & Care 

Core Rule

Act in best interests of clients.

• Client comes before:
  • Employer
  • Self

📌 Not a legal fiduciary duty — but functionally similar

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Common Applications (4 Exam Areas)

1️⃣ Who Is the Client?

• Investors in the fund — not employer

2️⃣ Portfolio Management

• Follow client objectives & constraints
• Evaluate portfolio as a whole

3️⃣ Soft Dollars

• Must benefit the client

4️⃣ Proxy Voting

• Vote responsibly and informed

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III(B) Fair Dealing

Rule

Deal fairly, not necessarily equally.

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Key Exam Points

• All clients must have a fair chance to act
• Changes in recommendations must be communicated
• Allocation of securities must be fair
• Family accounts treated like any other client

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III(C) Suitability 

Advisory Relationship Requirements

1️⃣ Understand client:

• Risk tolerance
• Objectives
• Constraints

2️⃣ Ensure investments are suitable
3️⃣ Evaluate suitability at portfolio level

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Mandated Portfolios

• Must follow stated mandate exactly

📌 If client wants unsuitable strategy:

• Discuss
• Possibly update IPS

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III(D) Performance Presentation

Rule

Performance must be:

• Fair
• Accurate
• Complete

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Must Avoid

• Guaranteeing returns
• Misleading past performance

📌 Short presentations allowed if details available on request

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III(E) Preservation of Confidentiality

Must keep client info confidential UNLESS:

• Illegal activity
• Disclosure required by law
• Client permission

IV(A) Loyalty

Rule

Act in employer’s best interest during employment.

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Common Exam Areas

Situation	Rule
Independent practice	Must get employer consent
Leaving firm	No solicitation before leaving
Social media	Follow firm policy
Whistleblowing	Clients & markets come first

📌 Applies to employees, not independent contractors

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IV(B) Additional Compensation Arrangements

Rule

Must obtain written consent from all parties.

• Includes email
• Includes part-time work

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IV(C) Responsibilities of Supervisors

Rule

Must:

• Have compliance systems
• Educate employees
• Detect violations

If violation occurs:
1️⃣ Assess
2️⃣ Report
3️⃣ Prevent recurrence

V(A) Diligence & Reasonable Basis 

Rule

Recommendations must be:

• Thorough
• Independent
• Well-researched

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Special Cases

Situation	Requirement
Third-party research	Validate quality
Quant models	Understand assumptions
External advisors	Due diligence required
Group research	Follow group consensus

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V(B) Communication with Clients

Must Disclose

• Investment process
• Risks & limitations
• Changes to strategy

📌 Must distinguish facts vs opinions

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V(C) Record Retention

Rule

Maintain records supporting:

• Analysis
• Recommendations
• Client communications

📌 Records belong to firm, not individual

VI(A) Disclosure of Conflicts 

Rule

Full and fair disclosure:

• Prominent
• Plain language

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Common Conflicts

• Stock ownership
• Board positions
• Departmental conflicts
• Employer conflicts

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VI(B) Priority of Transactions

Rule

Client trades always come first.

• Beneficial owner includes:
  • Personal accounts
  • Family accounts

📌 Pre-clearance often required

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VI(C) Referral Fees

Rule

Must disclose:

• Who pays
• Amount
• Nature of fee

Purpose → transparency

VII(A) Conduct in CFA Programs 

Prohibited

• Exam assistance
• Sharing exam content
• Violating testing rules

📌 Opinions allowed — specific exam content NOT allowed

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VII(B) Reference to CFA Designation

Rules

• No exaggeration
• No performance guarantees
• No partial designation claims

Correct:

“CFA Level II candidate”

Incorrect:

“CFA Level II”

Standard	Core Focus
I	Professionalism
II	Market integrity
III	Client duties
IV	Employer duties
V	Investment process
VI	Conflicts
VII	CFA integrity

• Always follow the stricter law
• Omission = misrepresentation
• Clients always come first
• Fair ≠ equal
• Suitability is portfolio-level
• Disclose all conflicts
• Client trades take priority
• Ethics violations often involve intent
• CFA designation must never be exaggerated

Before GIPS, firms could present performance in misleading ways:

❌ Common Misleading Practices

1. Representative Account Bias
   • Only the best-performing portfolios are shown.
   • Hides underperforming accounts.
2. Survivorship Bias
   • Poorly performing portfolios are removed from results.
   • Makes performance appear better than reality.
3. Varying Time Periods
   • Firms select only profitable periods.
   • Loss years are excluded.

Analogy:
This is like a student only showing their best quiz scores and hiding all the bad ones. The average looks great, but it’s dishonest.

Global Investment Performance Standards (GIPS) are a set of ethical principles that establish a consistent, standardized way for firms to calculate and present investment performance.

GIPS focuses on:

• Transparency
• Consistency
• Comparability
• Fair competition

It is ethics applied to performance reporting.

GIPS aims to:

1. Promote investor interests
2. Instill investor confidence
3. Ensure data is accurate and consistent
4. Obtain worldwide acceptance of standards
5. Promote fair, global competition
6. Encourage industry self-regulation

Exam Insight:
GIPS is about trust in performance numbers, not maximizing returns.

Only firms that actually manage assets can claim compliance.

Entity	Can Claim Compliance?	Reason
Asset management firms	✅ Yes	They manage portfolios
Consultants	❌ No	Unless they manage assets
Software companies	❌ No	They only provide tools
Asset owners (pension funds, endowments)	⚠️ Sometimes	Depends if they compete for business

Asset Owners:

• If they compete for business → They can claim compliance
• If they do not compete → They may follow GIPS for asset owners but cannot claim firm 

Rule	Meaning
Applies to entire firm	No partial compliance
All-or-nothing	Must follow all standards
Voluntary	Not legally required
Highly encouraged	Seen as best practice

Analogy:
You can’t say “I follow most traffic laws.” You either follow the rules or you don’t.

Definition:

A composite is a group of portfolios that follow the same strategy, objective, or mandate.

Rules for Composites:

1. Must include all actual, fee-paying, discretionary portfolios that fit the strategy
2. Every portfolio must belong to at least one composite
3. Portfolio inclusion rules must be:
   • Established beforehand
   • Based on objective criteria

Why this matters:
It prevents firms from “cherry-picking” only top performers.

A firm must adopt the broadest and most meaningful definition of itself.

Includes:

• All geographic offices
• All entities operating under the same brand name
• All investment strategies

Exam Trap:
Firms cannot exclude poorly performing offices to improve results.

A portfolio is discretionary if the manager can implement the strategy freely.

If client restrictions:

• Prevent implementation of the strategy
  → The portfolio becomes non-discretionary
  → It is excluded from composites

Analogy:
If you’re supposed to cook a recipe but someone forbids half the ingredients, you’re no longer fully in control.

What it is:

A firm may hire an independent third party to verify compliance.

Verification confirms:

1. Firm policies and procedures comply with GIPS
2. The firm has complied with all composite construction requirements

Key Rules:

Feature	Rule
Mandatory?	❌ No
Recommended?	✅ Strongly
Applies to	Entire firm
Applies to composites individually?	❌ No

Exam Insight:
Verification ≠ Performance guarantee
It only confirms process compliance, not investment skill.

GIPS ensures:

• No cherry-picking
• No misleading timeframes
• No selective portfolio inclusion
• Full transparency
• Comparable performance across firms

It turns performance reporting into an ethical obligation.

GIPS vs Non-GIPS World

Without GIPS	With GIPS
Cherry-picked portfolios	All eligible portfolios included
Survivorship bias	Mandatory inclusion rules
Selective time periods	Standardized reporting
Inconsistent calculations	Uniform methods
Low trust	High credibility

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Who Can Claim Compliance

Entity	Compliance Claim
Asset manager	✅ Yes
Consultant	❌ No
Software firm	❌ No
Asset owner competing for clients	✅ Yes
Asset owner not competing	⚠️ May follow but not claim

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Composite Rules

Rule	Meaning
Include all discretionary portfolios	No cherry picking
All portfolios in at least one composite	No hiding
Pre-defined inclusion rules	No manipulation

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Verification

Feature	Rule
Mandatory	❌ No
Applies to firm	✅ Yes
Guarantees performance	❌ No
Improves credibility	✅ Yes

• GIPS exists to stop misleading performance reporting
• GIPS is about ethics, transparency, and trust
• Compliance applies to the entire firm
• Compliance is all or nothing
• Only firms that manage assets can claim compliance
• Composites prevent cherry-picking
• All discretionary, fee-paying portfolios must be included
• Verification is voluntary but powerful for credibility
• GIPS improves comparability across global firms
• GIPS is ethics applied to investment performance