© CFA Institute. For candidate use only. Not for distribution.

ETHICAL AND
PROFESSIONAL
STANDARDS AND
QUANTITATIVE
METHODS

CFA® Program Curriculum
2020 • LEVEL I • VOLUME 1


© CFA Institute. For candidate use only. Not for distribution.

© 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, 2008, 2007, 2006
by CFA Institute. All rights reserved.
This copyright covers material written expressly for this volume by the editor/s as well
as the compilation itself. It does not cover the individual selections herein that first
appeared elsewhere. Permission to reprint these has been obtained by CFA Institute
for this edition only. Further reproductions by any means, electronic or mechanical,
including photocopying and recording, or by any information storage or retrieval
systems, must be arranged with the individual copyright holders noted.
CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute. To view a list of CFA Institute trademarks and the
Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org.
This publication is designed to provide accurate and authoritative information in regard
to the subject matter covered. It is sold with the understanding that the publisher
is not engaged in rendering legal, accounting, or other professional service. If legal
advice or other expert assistance is required, the services of a competent professional
should be sought.
All trademarks, service marks, registered trademarks, and registered service marks
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purposes only.
ISBN 978-1-946442-76-5 (paper)
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© CFA Institute. For candidate use only. Not for distribution.

CONTENTS
How to Use the CFA Program Curriculum  
Background on the CBOK  
Organization of the Curriculum  
Features of the Curriculum  
Designing Your Personal Study Program  
Feedback  

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Ethical and Professional Standards
Study Session 1

Ethical and Professional Standards   

Reading 1


Ethics and Trust in the Investment Profession  
Introduction  
Ethics   
Ethics and Professionalism  
How Professions Establish Trust  
Professions Are Evolving  
Professionalism in Investment Management  
Trust in Investment Management  
CFA Institute as an Investment Management Professional Body  
Challenges to Ethical Conduct  
Ethical vs. Legal Standards  
Ethical Decision-­Making Frameworks  
The Framework for Ethical Decision-­Making  
Applying the Framework  
Conclusion  
Summary  
Practice Problems  
Solutions  

5
5
7
9
9
11
12
12
13
15
17

19
20
22
27
28
30
32

Reading 2

Code of Ethics and Standards of Professional Conduct  
Preface  
Evolution of the CFA Institute Code of Ethics and Standards of
Professional Conduct  
Standards of Practice Handbook  
Summary of Changes in the Eleventh Edition  
CFA Institute Professional Conduct Program  
Adoption of the Code and Standards  
Acknowledgments  
Ethics and the Investment Industry  
Why Ethics Matters  
CFA Institute Code of Ethics and Standards of Professional Conduct  
Preamble  
The Code of Ethics  
Standards of Professional Conduct  

35
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indicates an optional segment


3

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Practice Problems  
Solutions  
Reading 3

Guidance for Standards I–VII  
Standard I: Professionalism  
Standard I(A) Knowledge of the Law  
Guidance  
Recommended Procedures for Compliance  

Application of the Standard  
Standard I(B) Independence and Objectivity  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard I(C) Misrepresentation  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard I(D) Misconduct  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard II: Integrity of Capital Markets  
Standard II(A) Material Nonpublic Information  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard II(B) Market Manipulation  
Guidance  
Application of the Standard  
Standard III: Duties to Clients  
Standard III(A) Loyalty, Prudence, and Care  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard III(B) Fair Dealing  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  

Standard III(C) Suitability  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard III(D) Performance Presentation  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard III(E) Preservation of Confidentiality  
Guidance  
Recommended Procedures for Compliance  
indicates an optional segment

Contents

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Contents

© CFA Institute. For candidate use only. Not for distribution.

Application of the Standard  
Standard IV: Duties to Employers  
Standard IV(A) Loyalty  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard IV(B) Additional Compensation Arrangements  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard IV(C) Responsibilities of Supervisors  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard V: Investment Analysis, Recommendations, and Actions  
Standard V(A) Diligence and Reasonable Basis  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard V(B) Communication with Clients and Prospective Clients  
Guidance  

Recommended Procedures for Compliance  
Application of the Standard  
Standard V(C) Record Retention  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard VI: Conflicts of Interest  
Standard VI(A) Disclosure of Conflicts  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard VI(B) Priority of Transactions  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard VI(C) Referral Fees  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate  
Standard VII(A) Conduct as Participants in CFA Institute Programs   
Guidance  
Application of the Standard  
Standard VII(B) Reference to CFA Institute, the CFA Designation, and
the CFA Program  
Guidance  
Recommended Procedures for Compliance  
Application of the Standard  
indicates an optional segment


iii

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Contents

Practice Problems  
Solutions  


209
219

Reading 4

Introduction to the Global Investment Performance Standards (GIPS)  
Why Were the GIPS Standards Created?  
Who Can Claim Compliance?  
Who Benefits from Compliance?  
Composites  
Verification  
The Structure of the GIPS Standards  
Practice Problems  
Solutions  

227
227
228
228
229
229
230
231
232

Reading 5

Global Investment Performance Standards (GIPS)  
Preface  

History  
Introduction  
Preamble—Why Is a Global Investment Performance Standard
Needed?  
Objectives  
Overview  
Historical Performance Record  
Compliance  
Effective Date  
Implementing a Global Standard  
Sponsors  
Provisions of the Global Investment Performance Standards  
Fundamentals of Compliance  
Input Data  
Calculation Methodology  
Composite Construction  
Disclosure  
Presentation and Reporting  
Real Estate  
Private Equity  
Wrap Fee/Separately Managed Account (SMA) Portfolios  
GIPS Valuation Principles  
Fair Value Definition  
Valuation Requirements  
Valuation Recommendations  
GIPS Advertising Guidelines  
Purpose of the GIPS Advertising Guidelines  
Requirements of the GIPS Advertising Guidelines  
Verification  
Scope and Purpose of Verification  

Required Verification Procedures  
Performance Examinations  
GIPS Glossary  
Appendix A: Sample Compliant Presentations  

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indicates an optional segment

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Contents

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v

Appendix B: Sample Advertisements  
Appendix C: Sample List of Composite Descriptions  
Practice Problems  
Solutions  

297
300
304
306


Study Session 2

Quantitative Methods (1)  

311

Reading 6

The Time Value of Money  
Introduction  
Interest Rates: Interpretation  
The Future Value of a Single Cash Flow  
The Frequency of Compounding  
Continuous Compounding  
Stated and Effective Rates  
The Future Value of a Series of Cash Flows  
Equal Cash Flows—Ordinary Annuity  
Unequal Cash Flows  
The Present Value of a Single Cash Flow  
Finding the Present Value of a Single Cash Flow  
The Frequency of Compounding  
The Present Value of a Series of Cash Flows  
The Present Value of a Series of Equal Cash Flows  
The Present Value of an Infinite Series of Equal Cash Flows—
Perpetuity  
Present Values Indexed at Times Other than t = 0  
The Present Value of a Series of Unequal Cash Flows  
Solving for Rates, Number of Periods, or Size of Annuity Payments  
Solving for Interest Rates and Growth Rates  

Solving for the Number of Periods  
Solving for the Size of Annuity Payments  
Review of Present and Future Value Equivalence  
The Cash Flow Additivity Principle  
Summary  
Practice Problems  
Solutions  

313
313
314
316
321
323
324
325
325
327
327
327
330
331
331

Statistical Concepts and Market Returns  
Introduction  
Some Fundamental Concepts  
The Nature of Statistics  
Populations and Samples  
Measurement Scales  

Summarizing Data Using Frequency Distributions  
The Graphic Presentation of Data  
The Histogram  
The Frequency Polygon and the Cumulative Frequency Distribution  

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381
382
383

Quantitative Methods

Reading 7

indicates an optional segment

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vi

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Contents

Measures of Central Tendency  
The Arithmetic Mean  
The Median  
The Mode  
Other Concepts of Mean  
Other Measures of Location: Quantiles  
Quartiles, Quintiles, Deciles, and Percentiles  
Quantiles in Investment Practice  
Measures of Dispersion  
The Range  
The Mean Absolute Deviation  
Population Variance and Population Standard Deviation  
Sample Variance and Sample Standard Deviation  
Semivariance, Semideviation, and Related Concepts  
Chebyshev’s Inequality  
Coefficient of Variation  
Symmetry and Skewness in Return Distributions  
Kurtosis in Return Distributions  

Using Geometric and Arithmetic Means  
Summary  
Practice Problems  
Solutions  

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403
408
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411
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419
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422
424
430
434
436
439
449

Reading 8


Probability Concepts  
Introduction  
Probability, Expected Value, and Variance  
Portfolio Expected Return and Variance of Return  
Topics in Probability  
Bayes’ Formula  
Principles of Counting  
Summary  
Practice Problems  
Solutions  

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480
491
491
495
499
502
506

Study Session 3

Quantitative Methods (2)  

511

Reading 9


Common Probability Distributions  
Introduction to Common Probability Distributions  
Discrete Random Variables  
The Discrete Uniform Distribution  
The Binomial Distribution  
Continuous Random Variables  
Continuous Uniform Distribution  
The Normal Distribution  
Applications of the Normal Distribution  
The Lognormal Distribution  
Monte Carlo Simulation  

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indicates an optional segment


Contents

© CFA Institute. For candidate use only. Not for distribution.


vii

Summary  
Practice Problems  
Solutions  

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561

Reading 10

Sampling and Estimation  
Introduction  
Sampling  
Simple Random Sampling  
Stratified Random Sampling  
Time-­Series and Cross-­Sectional Data  
Distribution of the Sample Mean  
The Central Limit Theorem  
Point and Interval Estimates of the Population Mean  
Point Estimators  
Confidence Intervals for the Population Mean  
Selection of Sample Size  
More on Sampling  
Data-­
Mining Bias  
Sample Selection Bias  
Look-­

Ahead Bias  
Time-­
Period Bias  
Summary  
Practice Problems  
Solutions  

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576
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579
581
587
589
589
592
593
593
595
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603

Reading 11


Hypothesis Testing  
Introduction  
Hypothesis Testing  
Hypothesis Tests Concerning the Mean  
Tests Concerning a Single Mean  
Tests Concerning Differences between Means  
Tests Concerning Mean Differences  
Hypothesis Tests Concerning Variance and Correlation  
Tests Concerning a Single Variance  
Tests Concerning the Equality (Inequality) of Two Variances  
Tests Concerning Correlation  
Other Issues: Nonparametric Inference  
Nonparametric Tests Concerning Correlation: The Spearman Rank
Correlation Coefficient  
Nonparametric Inference: Summary  
Summary  
Practice Problems  
Solutions  

609
610
611
620
620
628
632
636
636
638
642

643
645
647
648
651
660

Appendices  
668
GlossaryG-1

indicates an optional segment


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

How to Use the CFA
Program Curriculum
Congratulations on your decision to enter the Chartered Financial Analyst (CFA®)

Program. This exciting and rewarding program of study reflects your desire to become
a serious investment professional. You are embarking on a program noted for its high
ethical standards and the breadth of knowledge, skills, and abilities (competencies)
it develops. Your commitment to the CFA Program should be educationally and
professionally rewarding.
The credential you seek is respected around the world as a mark of accomplishment and dedication. Each level of the program represents a distinct achievement in
professional development. Successful completion of the program is rewarded with

membership in a prestigious global community of investment professionals. CFA
charterholders are dedicated to life-­long learning and maintaining currency with the
ever-­changing dynamics of a challenging profession. The CFA Program represents the
first step toward a career-­long commitment to professional education.
The CFA examination measures your mastery of the core knowledge, skills, and
abilities required to succeed as an investment professional. These core competencies
are the basis for the Candidate Body of Knowledge (CBOK™). The CBOK consists of
four components:
■■

A broad outline that lists the major topic areas covered in the CFA Program
( />
■■

Topic area weights that indicate the relative exam weightings of the top-­level
topic areas ( />
■■

Learning outcome statements (LOS) that advise candidates about the specific
knowledge, skills, and abilities they should acquire from readings covering a
topic area (LOS are provided in candidate study sessions and at the beginning
of each reading); and

■■

The CFA Program curriculum that candidates receive upon examination
registration.

Therefore, the key to your success on the CFA examinations is studying and understanding the CBOK. The following sections provide background on the CBOK, the
organization of the curriculum, features of the curriculum, and tips for designing an

effective personal study program.

BACKGROUND ON THE CBOK
The CFA Program is grounded in the practice of the investment profession. Beginning
with the Global Body of Investment Knowledge (GBIK), CFA Institute performs a
continuous practice analysis with investment professionals around the world to determine the competencies that are relevant to the profession. Regional expert panels and
targeted surveys are conducted annually to verify and reinforce the continuous feedback about the GBIK. The practice analysis process ultimately defines the CBOK. The

© 2019 CFA Institute. All rights reserved.

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© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

CBOK reflects the competencies that are generally accepted and applied by investment
professionals. These competencies are used in practice in a generalist context and are
expected to be demonstrated by a recently qualified CFA charterholder.
The CFA Institute staff, in conjunction with the Education Advisory Committee
and Curriculum Level Advisors, who consist of practicing CFA charterholders,
designs the CFA Program curriculum in order to deliver the CBOK to candidates.
The examinations, also written by CFA charterholders, are designed to allow you to
demonstrate your mastery of the CBOK as set forth in the CFA Program curriculum.
As you structure your personal study program, you should emphasize mastery of the
CBOK and the practical application of that knowledge. For more information on the
practice analysis, CBOK, and development of the CFA Program curriculum, please
visit www.cfainstitute.org.


ORGANIZATION OF THE CURRICULUM
The Level I CFA Program curriculum is organized into 10 topic areas. Each topic area
begins with a brief statement of the material and the depth of knowledge expected. It
is then divided into one or more study sessions. These study sessions—19 sessions in
the Level I curriculum—should form the basic structure of your reading and preparation. Each study session includes a statement of its structure and objective and is
further divided into assigned readings. An outline illustrating the organization of
these 19 study sessions can be found at the front of each volume of the curriculum.
The readings are commissioned by CFA Institute and written by content experts,
including investment professionals and university professors. Each reading includes
LOS and the core material to be studied, often a combination of text, exhibits, and
in-­text examples and questions. A reading typically ends with practice problems followed by solutions to these problems to help you understand and master the material.
The LOS indicate what you should be able to accomplish after studying the material.
The LOS, the core material, and the practice problems are dependent on each other,
with the core material and the practice problems providing context for understanding
the scope of the LOS and enabling you to apply a principle or concept in a variety
of scenarios.
The entire readings, including the practice problems at the end of the readings, are
the basis for all examination questions and are selected or developed specifically to
teach the knowledge, skills, and abilities reflected in the CBOK.
You should use the LOS to guide and focus your study because each examination
question is based on one or more LOS and the core material and practice problems
associated with the LOS. As a candidate, you are responsible for the entirety of the
required material in a study session.
We encourage you to review the information about the LOS on our website (www.
cfainstitute.org/programs/cfa/curriculum/study-­sessions), including the descriptions
of LOS “command words” on the candidate resources page at www.cfainstitute.org.

FEATURES OF THE CURRICULUM
OPTIONAL

SEGMENT

Required vs. Optional Segments  You should read all of an assigned reading. In some
cases, though, we have reprinted an entire publication and marked certain parts of the
reading as “optional.” The CFA examination is based only on the required segments,
and the optional segments are included only when it is determined that they might


© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

help you to better understand the required segments (by seeing the required material
in its full context). When an optional segment begins, you will see an icon and a dashed
vertical bar in the outside margin that will continue until the optional segment ends,
accompanied by another icon. Unless the material is specifically marked as optional,
you should assume it is required. You should rely on the required segments and the
reading-­specific LOS in preparing for the examination.
Practice Problems/Solutions  All practice problems at the end of the readings as well as
their solutions are part of the curriculum and are required material for the examination.
In addition to the in-­text examples and questions, these practice problems should help
demonstrate practical applications and reinforce your understanding of the concepts
presented. Some of these practice problems are adapted from past CFA examinations
and/or may serve as a basis for examination questions.
Glossary   For your convenience, each volume includes a comprehensive glossary.
Throughout the curriculum, a bolded word in a reading denotes a term defined in
the glossary.
Note that the digital curriculum that is included in your examination registration
fee is searchable for key words, including glossary terms.
LOS Self-­Check  We have inserted checkboxes next to each LOS that you can use to
track your progress in mastering the concepts in each reading.

Source Material  The CFA Institute curriculum cites textbooks, journal articles, and
other publications that provide additional context or information about topics covered
in the readings. As a candidate, you are not responsible for familiarity with the original
source materials cited in the curriculum.
Note that some readings may contain a web address or URL. The referenced sites
were live at the time the reading was written or updated but may have been deactivated since then.
 
Some readings in the curriculum cite articles published in the Financial Analysts Journal®,
which is the flagship publication of CFA Institute. Since its launch in 1945, the Financial
Analysts Journal has established itself as the leading practitioner-­oriented journal in the
investment management community. Over the years, it has advanced the knowledge and
understanding of the practice of investment management through the publication of
peer-­reviewed practitioner-­relevant research from leading academics and practitioners.
It has also featured thought-­provoking opinion pieces that advance the common level of
discourse within the investment management profession. Some of the most influential
research in the area of investment management has appeared in the pages of the Financial
Analysts Journal, and several Nobel laureates have contributed articles.
Candidates are not responsible for familiarity with Financial Analysts Journal articles
that are cited in the curriculum. But, as your time and studies allow, we strongly encourage you to begin supplementing your understanding of key investment management
issues by reading this practice-­oriented publication. Candidates have full online access
to the Financial Analysts Journal and associated resources. All you need is to log in on
www.cfapubs.org using your candidate credentials.

Errata  The curriculum development process is rigorous and includes multiple rounds
of reviews by content experts. Despite our efforts to produce a curriculum that is free
of errors, there are times when we must make corrections. Curriculum errata are periodically updated and posted on the candidate resources page at www.cfainstitute.org.

xi

END OPTIONAL

SEGMENT


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How to Use the CFA Program Curriculum

DESIGNING YOUR PERSONAL STUDY PROGRAM
Create a Schedule  An orderly, systematic approach to examination preparation is
critical. You should dedicate a consistent block of time every week to reading and
studying. Complete all assigned readings and the associated problems and solutions
in each study session. Review the LOS both before and after you study each reading
to ensure that you have mastered the applicable content and can demonstrate the
knowledge, skills, and abilities described by the LOS and the assigned reading. Use the
LOS self-­check to track your progress and highlight areas of weakness for later review.
Successful candidates report an average of more than 300 hours preparing for
each examination. Your preparation time will vary based on your prior education and
experience, and you will probably spend more time on some study sessions than on
others. As the Level I curriculum includes 19 study sessions, a good plan is to devote
15−20 hours per week for 19 weeks to studying the material and use the final four to
six weeks before the examination to review what you have learned and practice with
practice questions and mock examinations. This recommendation, however, may
underestimate the hours needed for appropriate examination preparation depending
on your individual circumstances, relevant experience, and academic background.
You will undoubtedly adjust your study time to conform to your own strengths and
weaknesses and to your educational and professional background.
You should allow ample time for both in-­depth study of all topic areas and additional concentration on those topic areas for which you feel the least prepared.
As part of the supplemental study tools that are included in your examination
registration fee, you have access to a study planner to help you plan your study time.

The study planner calculates your study progress and pace based on the time remaining
until examination. For more information on the study planner and other supplemental
study tools, please visit www.cfainstitute.org.
As you prepare for your examination, we will e-­mail you important examination
updates, testing policies, and study tips. Be sure to read these carefully.
CFA Institute Practice Questions  Your examination registration fee includes digital
access to hundreds of practice questions that are additional to the practice problems
at the end of the readings. These practice questions are intended to help you assess
your mastery of individual topic areas as you progress through your studies. After each
practice question, you will be able to receive immediate feedback noting the correct
responses and indicating the relevant assigned reading so you can identify areas of
weakness for further study. For more information on the practice questions, please
visit www.cfainstitute.org.
CFA Institute Mock Examinations  Your examination registration fee also includes
digital access to three-­hour mock examinations that simulate the morning and afternoon sessions of the actual CFA examination. These mock examinations are intended
to be taken after you complete your study of the full curriculum and take practice
questions so you can test your understanding of the curriculum and your readiness
for the examination. You will receive feedback at the end of the mock examination,
noting the correct responses and indicating the relevant assigned readings so you can
assess areas of weakness for further study during your review period. We recommend
that you take mock examinations during the final stages of your preparation for the
actual CFA examination. For more information on the mock examinations, please visit
www.cfainstitute.org.


© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

Preparatory Providers  After you enroll in the CFA Program, you may receive numerous solicitations for preparatory courses and review materials. When considering a
preparatory course, make sure the provider belongs to the CFA Institute Approved Prep

Provider Program. Approved Prep Providers have committed to follow CFA Institute
guidelines and high standards in their offerings and communications with candidates.
For more information on the Approved Prep Providers, please visit www.cfainstitute.
org/programs/cfa/exam/prep-­providers.
Remember, however, that there are no shortcuts to success on the CFA examinations; reading and studying the CFA curriculum is the key to success on the examination. The CFA examinations reference only the CFA Institute assigned curriculum—no
preparatory course or review course materials are consulted or referenced.
SUMMARY
Every question on the CFA examination is based on the content contained in the required
readings and on one or more LOS. Frequently, an examination question is based on a
specific example highlighted within a reading or on a specific practice problem and its
solution. To make effective use of the CFA Program curriculum, please remember these
key points:

1 All pages of the curriculum are required reading for the examination except for
occasional sections marked as optional. You may read optional pages as background, but you will not be tested on them.

2 All questions, problems, and their solutions—found at the end of readings—are
part of the curriculum and are required study material for the examination.

3 You should make appropriate use of the practice questions and mock examinations as well as other supplemental study tools and candidate resources available
at www.cfainstitute.org.

4 Create a schedule and commit sufficient study time to cover the 19 study sessions,
using the study planner. You should also plan to review the materials and take
practice questions and mock examinations.

5 Some of the concepts in the study sessions may be superseded by updated
rulings and/or pronouncements issued after a reading was published. Candidates
are expected to be familiar with the overall analytical framework contained in the
assigned readings. Candidates are not responsible for changes that occur after the

material was written.

FEEDBACK
At CFA Institute, we are committed to delivering a comprehensive and rigorous curriculum for the development of competent, ethically grounded investment professionals.
We rely on candidate and investment professional comments and feedback as we
work to improve the curriculum, supplemental study tools, and candidate resources.
Please send any comments or feedback to You can be
assured that we will review your suggestions carefully. Ongoing improvements in the
curriculum will help you prepare for success on the upcoming examinations and for
a lifetime of learning as a serious investment professional.

xiii


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© CFA Institute. For candidate use only. Not for distribution.

Ethical and Professional
Standards

STUDY SESSION
Study Session 1

Ethical and Professional Standards

TOPIC LEVEL LEARNING OUTCOME
The candidate should be able to explain the need for high ethical standards in the
investment industry and the ethical responsibilities required by the CFA Institute

Code of Ethics and Standards of Professional Conduct and to demonstrate the application of the Code and Standards. The candidate should also be able to demonstrate
an understanding of the Global Investment Performance Standards.
Trust in the investment profession is achieved only if those practicing within the
industry adhere to the highest levels of ethical conduct and behavior. The CFA Institute
Code of Ethics and Standards of Professional Conduct (Code and Standards) serve as
the ethical foundation for the CFA Institute self-­regulatory program.
The Standards of Practice Handbook provides practical application of the Code
and Standards by explaining the purpose and scope of each standard, presenting recommended procedures for compliance, and providing examples of each standard in
practice.
The Global Investment Performance Standards (GIPS®) establish global standards
for performance reporting by investment managers. By providing a consistent set of
standards and methodology, GIPS facilitate the fair and accurate comparison of managers around the world, while minimizing the potential for ambiguous or misleading
performance reporting practices.
© 2019 CFA Institute. All rights reserved.


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

E thical and P rofessional S tandards

1

STUDY SESSION

Ethical and Professional
Standards


This study session introduces ethics, related challenges to ethical behavior, and the

role played by ethics and professionalism in the investment industry. A framework
to support ethical decision-­making is provided to help guide behavior. The CFA
Institute Code of Ethics and Standards of Professional Conduct (Code and Standards)
are examined, with attention given to each standard and its application. The session
concludes with coverage of the Global Investment Performance Standards.

READING ASSIGNMENTS
Reading 1

Ethics and Trust in the Investment Profession
by Bidhan L. Parmar, PhD, Dorothy C. Kelly, CFA, and
David B. Stevens, CIMC, CFA

Reading 2

Code of Ethics and Standards of Professional Conduct
Standards of Practice Handbook, Eleventh Edition

Reading 3

Guidance for Standards I–VII
Standards of Practice Handbook, Eleventh Edition

Reading 4

Introduction to the Global Investment Performance
Standards (GIPS)


Reading 5

Global Investment Performance Standards (GIPS)

© 2019 CFA Institute. All rights reserved.


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

READING

1

Ethics and Trust in the
Investment Profession
by Bidhan L. Parmar, PhD, Dorothy C. Kelly, CFA, and
David B. Stevens, CIMC, CFA
Bidhan L. Parmar, PhD, is at the University of Virginia (USA). Dorothy C. Kelly, CFA, is at
McIntire School of Commerce, University of Virginia (USA). David B. Stevens, CIMC, CFA,
is at Wells Fargo Private Bank (USA).

LEARNING OUTCOMES
Mastery

The candidate should be able to:
a. explain ethics;
b. describe the role of a code of ethics in defining a profession;

c. describe professions and how they establish trust;
d. describe the need for high ethical standards in investment
management;
e. explain professionalism in investment management;
f. identify challenges to ethical behavior;
g. distinguish between ethical and legal standards;
h. describe a framework for ethical decision making.

INTRODUCTION
As a candidate in the CFA Program, you are both expected and required to meet
high ethical standards. This reading introduces ideas and concepts that will help you
understand the importance of ethical behavior in the investment industry. You will
be introduced to various types of ethical issues within the investment profession and
learn about the CFA Institute Code of Ethics.
The readings covering ethics and professional standards demonstrate that ethical behavior is central to creating trust. Professional behavior is equally important.
Professions help maintain trust in an industry by establishing codes and setting

© 2016 CFA Institute. All rights reserved.

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© CFA Institute. For candidate use only. Not for distribution.
Reading 1 ■ Ethics and Trust in the Investment Profession

standards that put a framework around ethical behavior and technical competence.
Professions also set the wider goal of gaining and maintaining the trust of society as
a whole. In this regard, professions have a sense of purpose that society values.

Imagine that you are employed in the research department of a large financial
services firm. You and your colleagues spend your days researching, analyzing, and
valuing the shares of publicly traded companies and sharing your investment recommendations with clients. You love your work and take great satisfaction in knowing
that your recommendations can help the firm’s investing clients make informed investment decisions that will help them meet their financial goals and improve their lives.
Several months after starting at the firm, you learn that an analyst at the firm has
been terminated for writing and publishing research reports that misrepresented the
fundamental risks of some companies to investors. You learn that the analyst wrote
the reports with the goal of pleasing the management of the companies that were
the subjects of the research reports. He hoped that these companies would hire your
firm’s investment banking division for its services and he would be rewarded with
large bonuses for helping the firm increase its investment banking fees. Some clients
bought shares based on the analyst’s reports and suffered losses. They posted stories
on the internet about their losses and the misleading nature of the reports. When
the media investigated and published the story, the firm’s reputation for investment
research suffered. Investors began to question the firm’s motives and the objectivity of
its research recommendations. The firm’s investment clients started to look elsewhere
for investment advice, and company clients begin to transfer their business to firms
with untarnished reputations. With business declining, management is forced to trim
staff. Along with many other hard-­working colleagues, you lose your job—through
no fault of your own.
Imagine how you would feel in this situation. Most people would feel upset and
resentful that their hard and honest work was derailed by someone else’s unethical
behavior. Yet, this type of scenario is not uncommon. Around the world, unsuspecting
employees at such companies as SAC Capital, Stanford Financial Group, Everbright
Securities, Enron, Satyam Computer Services, Arthur Andersen, and other large companies have experienced such career setbacks when someone else’s actions destroyed
trust in their companies and industries.
Businesses and financial markets thrive on trust—defined as a strong belief in the
reliability of a person or institution. In a 2016 study on trust, investors indicated that
to earn their trust, the top two attributes of an investment manager should be that it
(1) has transparent and open business practices, and (2) has ethical business practices.1

Although these attributes are valued by customers and clients in any industry, this
reading will explore why they are of particular importance to the investment industry.
People may think that ethical behavior is simply about following laws, regulations,
and other rules, but throughout our lives and careers we will encounter situations in
which there is no definitive rule that specifies how to act, or the rules that exist may be
unclear or even in conflict with each other. Responsible people, including investment
professionals, must be willing and able to identify potential ethical issues and create
solutions to them even in the absence of clearly stated rules.

1  CFA Institute From Trust to Loyalty: A Global Survey of What Investors Want (2013): />from-­trust-­to-­loyalty


Ethics

© CFA Institute. For candidate use only. Not for distribution.

ETHICS
Through our individual actions, each of us can affect the lives of others. Our decisions
and behavior can harm or benefit a variety of stakeholders—individuals or groups
of individuals who could be affected either directly or indirectly by a decision and
thus have an interest, or stake, in the decision. Examples of stakeholders in decisions
made by investment industry professionals include our colleagues, our clients, our
employers, the communities in which we live and work, the investment profession,
trade associations, regulators, and other financial market participants. In some cases,
our actions may benefit all of these stakeholder groups; in other cases, our actions
may benefit only some stakeholder groups; and in still other cases, our actions may
benefit some stakeholder groups and harm others. For example, recall the research
analyst in the introduction who wrote misleading research reports with the aim of
increasing the financial benefit to himself and his employer. In the very short term,
his conduct seemed to directly benefit some stakeholders (certain clients, himself,

and his employer) and to harm other stakeholders (clients who invested based on his
reports). Over a longer time period, his conduct resulted in harm to himself and many
other stakeholders—his employer, his employer’s clients, his colleagues, investors,
and through loss of trust when the story was published, the larger financial market.
Ethics encompasses a set of moral principles and rules of conduct that provide
guidance for our behavior. The word “ethics” comes from the Greek word “ethos,”
meaning character, used to describe the guiding beliefs or ideals characterizing a
society or societal group. Beliefs are assumptions or thoughts we hold to be true. A
principle is defined as a belief or fundamental truth that serves as the foundation for
a system of belief or behavior or a chain of reasoning. Our beliefs form our values—
those things we deem to have worth or merit.
Moral principles or ethical principles are beliefs regarding what is good, acceptable, or obligatory behavior and what is bad, unacceptable, or forbidden behavior.
Ethical principles may refer to beliefs regarding behavior that an individual expects of
himself or herself, as well as shared beliefs regarding standards of behavior expected
or required by a community or societal group.
The study of ethics examines the role of consequences and personal character in
defining what is considered good, or ethical, conduct.
Ethical conduct is behavior that follows moral principles and balances self-­interest
with both the direct and the indirect consequences of the behavior on others. Ethical
actions are those actions that are perceived as beneficial and conforming to the ethical expectations of society. An action may be considered beneficial if it improves the
outcomes or consequences for stakeholders affected by the action. Telling the truth
about the risks or costs associated with a recommended investment, for example, is
an ethical action—that is, one that conforms to the ethical expectations of society in
general and clients in particular. Telling the truth is also beneficial; telling the truth
builds trust with customers and clients and enables them to make more informed
decisions, which should lead to better outcomes for them and higher levels of client/
customer satisfaction for you and your employer.
Widely acknowledged ethical principles include honesty, transparency, fairness
or justice, diligence, and respect for the rights of others. Most societal groups share
these fundamental ethical principles and build on them, establishing a shared set of

rules regarding how members should behave in certain situations. The principles or
rules may take different forms depending on the community establishing them.
Governments and related entities, for example, may establish laws and/or regulations to reflect widely shared beliefs about obligatory and forbidden conduct. Laws and
regulations are rules of conduct specified by a governing body, such as a legislature
or a regulator, identifying how individuals and entities under its jurisdiction should

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© CFA Institute. For candidate use only. Not for distribution.
Reading 1 ■ Ethics and Trust in the Investment Profession

behave in certain situations. Most countries have laws and regulations governing the
investment industry and the conduct of its participants. Differences in laws may reflect
differences in beliefs and values.
In some countries, for example, the law requires that an investment adviser act in
the best interests of his or her clients. Other countries require that investment professionals recommend investments that are suitable for their clients. These differing
requirements can also hold true within one country where some advisers are held to
a suitability standard and others to the fiduciary standard of the client’s best interests.
Investment advisers and portfolio managers who are required by law to act in their
clients’ best interests must always put their clients’ interests ahead of their own or
their employers’ interests. An investment adviser who is required by law to act in a
client’s best interest must understand the client’s financial objectives and risk tolerance,
research and investigate multiple investment opportunities, and recommend the investment or investment portfolio that is most suitable for the client in terms of meeting
his or her long-­term financial objectives. In addition, the investment adviser would
be expected to monitor the client’s financial situation and investments to ensure that

the investments recommended remain the best overall option for meeting the client’s
long-­term financial objectives. In countries with only a suitability requirement, it is
legal for investment professionals to recommend a suitable investment to a client even
if other, similar suitable investments with lower fees are available. These differences
in laws reflect differences in beliefs and values.
Specific communities or societal groups in which we live and work sometimes codify their beliefs about obligatory and forbidden conduct in a written set of principles,
often called a code of ethics. Universities, employers, and professional associations
often adopt a code of ethics to communicate the organization’s values and overall
expectations regarding member behavior. The code of ethics serves as a general
guide for how community members should act. Some communities will also expand
on their codes of ethics and adopt explicit rules or standards that identify specific
behaviors required of community members. These standards of conduct serve as
benchmarks for the minimally acceptable behavior of community members and can
help clarify the code of ethics. Members can choose behaviors that demonstrate even
higher standards. By joining the community, members are agreeing to adhere to the
community’s code of ethics and standards of conduct. To promote their code of ethics
and reduce the incidence of violations, communities frequently display their codes in
prominent locations and in written materials. In addition, most communities require
that members commit to their codes in writing on an annual or more frequent basis.
Violations of a community’s established code of ethics and/or standards of conduct can harm the community in a variety of ways. Violations have the potential to
damage the community’s reputation among external stakeholders and the general
public. Violations can also damage the community’s reputation internally and lead to
reduced trust among community members and can cause the organization to fracture
or splinter from within. To protect the reputation of its membership and limit potential
harm to innocent members, the community may take corrective actions to investigate
possible violations, repair any damages, and attempt to discipline the violator or, in
severe cases, revoke the violator’s membership in the community.
EXAMPLE 1 

Ethics

1 Which of the following statements is most accurate? Ethics can be
described as:
A a commitment to upholding the law.


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Ethics and Professionalism

9

B an individual’s personal opinion about right and wrong.
C a set of moral principles that provide guidance for our behavior.
2 Which of the following statements is most accurate? Standards of conduct:
A are a necessary component of any code of ethics.
B serve as a general guide regarding proper conduct by members of a
group.
C serve as benchmarks for the minimally acceptable behavior required of
members of a group.

Solution to 1:
C is correct. Ethics can be described as a set of moral principles that provide
guidance for our behavior; these may be moral principles shared by a community
or societal group.

Solution to 2:
C is correct. Standards of conduct serve as benchmarks for the minimally
acceptable behavior required of members of a group. Some organizations will
adopt only a code of ethics, which communicates the organization’s values and
overall expectations regarding member behavior. Others may adopt both a
code of ethics and standards of conduct. Standards of conduct identify specific

behavior required of community members and serve as benchmarks for the
minimally acceptable behavior of community members.

ETHICS AND PROFESSIONALISM
A profession is an occupational community that has specific education, expert
knowledge, and a framework of practice and behavior that underpins community
trust, respect, and recognition. Most professions emphasize an ethical approach, the
importance of good service, and empathy with the client.
Professions have grown in size and number over the last century: the rise of new
specialist areas of expertise has created new professions. Driving forces of a new
profession include governments and regulators, which encourage the formation of an
ethical relationship between professionals and society at large. There is also demand
for professions from individuals who see an advantage in working as a professional
and from clients who desire to work with professionals.
Professions have not developed in every country. But in most countries, those
who work in specialized areas—such as doctors, lawyers, actuaries, accountants,
architects, and engineers—are subject to some combination of licensed status and
technical standards. These standards distinguish professions from the craft guilds and
trade bodies that were established in many countries. In particular, the requirement
for members of professions to uphold high ethical standards is one clear difference.
Another difference is that trade bodies do not normally have a mission to serve society
or to set and enforce professional conduct rules for practitioners.

3.1  How Professions Establish Trust
For a profession to be credible, a primary goal is to establish trust among clients
and among society in general. In doing so, professions have a number of common
characteristics that, when combined, greatly increase confidence and credibility in
professionals and their organizations.

3