CFA Program Level I

Conflicts of interest and priority of trades: CFA Level I

Standard VI(A) requires members and candidates to avoid, or fully and fairly disclose, matters that could reasonably be expected to impair their independence and objectivity, and the disclosure must be prominent, in plain language and effectively communicated. Standard VI(B) puts client transactions first, employer transactions second and transactions the member beneficially owns last.

What counts as a conflict

A conflict of interest is anything that could reasonably be expected to impair independence and objectivity, or to raise a question about whether judgment is free from bias. Conflicts arise between clients' interests, the employer's interests and personal interests. Compensation structures, especially short-term incentives, are a common source.

Owning shares in a company you recommend, or that clients hold, is the most common conflict needing disclosure. CFA Institute says banning such ownership would be the simplest fix but may be overly burdensome. Instead, members must disclose any beneficial ownership in the investments they recommend.

Avoid first, then disclose properly

Since the 2023 revision, VI(A) says avoid or disclose. Avoiding the conflict and its appearance is preferred where reasonable. When it cannot reasonably be avoided, it must be disclosed fully and clearly, mitigated where possible, and the disclosure updated when the conflict changes materially. Disclosure to an employer must give enough information to judge the conflict's impact.

The disclosure must be prominent and in plain language. CFA Institute's glossary defines prominent language as placed so it can be clearly seen or easily accessed, and not formatted to hide it, for example with a smaller font or by moving it to a footnote or appendix. A conflict mentioned only in small print in an appendix is therefore not adequately disclosed.

Example: an analyst rates a company a buy. His wife then inherits a large holding in it, and he is asked to update the report. At a minimum he must disclose the holding to his employer and in the report. Best practice is to have another analyst write it.

Priority of transactions

VI(B) says transactions for clients and employers have priority over transactions in which the member is a beneficial owner. The guidance puts client transactions ahead of the firm's. The order is clients, then employer, then the member.

A beneficial owner is someone who ultimately owns, controls, can direct or has a material interest in a security. Personal transactions include the member's own accounts, immediate family accounts and accounts in which the member has a direct or indirect financial interest. They may take place only after clients and the employer have had an adequate chance to act on a recommendation.

A family member's account that is a client account is treated like any other client account, with no special treatment and no disadvantage. Common firm controls include limits on IPO and private placement participation, blackout periods, preclearance and duplicate trade confirmations.

Where the exam catches people

Believing an analyst must sell a stock before recommending it: owning it is allowed if the beneficial ownership is disclosed and clients are not disadvantaged.
Believing any written disclosure satisfies VI(A): it must be prominent and in plain language, so a small-font footnote or appendix does not count.
Believing a spouse's holding is not the analyst's conflict: it could reasonably impair objectivity, so at a minimum it must be disclosed to the employer and in the research.
Believing the employer's trades come before clients': the order is clients, then employer, then the member's own transactions.
Believing family accounts must wait behind all other clients: a family member who is a client is treated like any other client.

Written from CFA Institute's documentation

Try 3 questions on this

Pick an answer to see why each option is right or wrong.

Diego Alvarez, CFA, an equity analyst, rates Kinross Logistics a buy. His wife then inherits a large holding of Kinross shares. His employer asks him to update his coverage of Kinross. Under Standard VI(A) Avoid or Disclose Conflicts, what must Alvarez do at a minimum?
Right. In the game that’s Renown for your Ethical and Professional Standards building.
Not that one: A is right. In the game your Ethical and Professional Standards building would lose a little Renown, and this question would come back later.
The answerA.Disclose the holding to his employer and in his published researchA spouse's holding in a company an analyst covers is a conflict that could reasonably be expected to impair his objectivity. CFA Institute's guidance on a closely similar case says that, at a minimum, the analyst must disclose the spouse's holding both to his employer and in the follow-up report.Your answerB.Disclose the holding to his employer onlyTelling the employer is necessary but not sufficient. Clients reading the research also need to know about the conflict, so the holding must be disclosed in the report too.Your answerC.Nothing, since the holding is his wife's and not hisThe Standard reaches beyond shares in the analyst's own name. The guidance's example of an analyst whose wife inherited stock in a covered company requires disclosure.
Show the full explanation and doc quotes
Best practice goes further: ask the employer to assign another analyst to write it.
Written from www.cfainstitute.org/standards/professionals/code-ethics-standards/standards-of-practice-vi-a
Kenji Mori, CFA, an equity analyst, has owned shares of Vantor Systems for several years. He initiates coverage of Vantor with a buy recommendation and states prominently on the report's first page that he owns Vantor shares. His firm has no policy on analysts' holdings, and he makes no trades in Vantor. Did Mori violate the Standards of Professional Conduct?
Right. In the game that’s Renown for your Ethical and Professional Standards building.
Not that one: B is right. In the game your Ethical and Professional Standards building would lose a little Renown, and this question would come back later.
Your answerA.Yes, because he should have sold his shares firstSelling first is one way to avoid the conflict, but it is not required. CFA Institute calls a ban on owning recommended stocks possibly overly burdensome and requires disclosure of the holding, which Mori gave.The answerB.NoOwning shares in a recommended company is the most common conflict under Standard VI(A) Avoid or Disclose Conflicts. The guidance notes that banning such ownership could be overly burdensome and too restrictive; instead, members must disclose any beneficial ownership in investments they recommend.Your answerC.Yes, because he needed each client's written consent firstNo Standard makes an analyst obtain each client's consent before recommending a stock he owns; Standard VI(A) asks for disclosure of the holding.
Show the full explanation and doc quotes
Mori disclosed his holding prominently and made no trades ahead of clients, so he did not violate the Standards.
Written from www.cfainstitute.org/standards/professionals/code-ethics-standards/standards-of-practice-vi-a
Elena Varga, CFA, recommends Dorran Mining shares to clients in a research report. Her firm makes a market in Dorran shares, and she discloses this only in a small-font footnote in the report's appendix. Under Standard VI(A) Avoid or Disclose Conflicts, Varga's disclosure is best described as:
Right. In the game that’s Renown for your Ethical and Professional Standards building.
Not that one: A is right. In the game your Ethical and Professional Standards building would lose a little Renown, and this question would come back later.
The answerA.Inadequate, because it lacks prominenceStandard VI(A) requires conflicts to be avoided or fully and fairly disclosed, and requires disclosures to be prominent, in plain language and effective.Your answerB.Inadequate, because market making must be avoided rather than disclosedVarga does not have to stop recommending Dorran. A firm's market making is a conflict that can be handled by full and fair disclosure; the problem is that her disclosure is buried.Your answerC.Adequate, because the conflict is disclosed in writingPutting the conflict in writing is not enough; Standard VI(A) requires disclosures to be prominent, and a small-font footnote in an appendix is the Code and Standards' own example of language that is not prominent.
Show the full explanation and doc quotes
CFA Institute's glossary defines prominent language as placed where it can be clearly seen, and gives a smaller font or relegation to a footnote or appendix as ways of obscuring it. Varga's footnote fails that test.
Written from www.cfainstitute.org/standards/professionals/code-ethics-standards/glossary-terms-found-in-code-and-standards