2010 Level III Mock Exam questions and answers and REFERENCE

2010 Level III Mock Exam questions and answers and REFERENCES


Questions 1 through 6 relate to Ethical and Professional Standards.

Frank Litman Case Scenario
Frank Litman, CFA, has recently been hired as a portfolio manager for Twain
Investments, a small regional asset management firm. For the past ten years, Litman has
managed a limited number of accounts belonging to family and friends. He started
managing these accounts when he was enrolled in graduate school. All the accounts are
too small to meet Twain’s minimum balance requirement of $5 million, and generate
only modest fees for Litman. Litman disclosed the arrangement to the Human Resource
(HR) manager when he interviewed for the position of portfolio manager. The HR
manager agreed that the accounts were too small and would probably never be large
enough to meet Twain’s minimum requirement. Upon accepting the position with Twain,
Litman met with each of his non-Twain clients and recommended that they find another
financial advisor. Each of them asked Litman to continue managing their money as a
personal favor, arguing that a different advisor would undoubtedly charge higher fees.
Following the meetings, Litman sent separate letters to both the Twain HR manager and
his non-Twain clients explaining his employment relationship to each.

The following month, Litman updated the promotional material he shares with all of his
clients and prospects. The material summarizes Litman’s portfolio trading strategy,
which he developed by analyzing twenty years of historical data. In his analysis, Litman
determined that his strategy, which invests in large-capitalization U.S. stocks, would have
outperformed the S&P 500 Index over the last 20 years—with an average annual return
of 10.91 percent versus 10.42 percent for the S&P 500. The concluding paragraph of the
brochure states, ―We believe using this trading strategy over the long term will lead to
superior performance compared with the S&P 500.‖ The brochure includes a footnote in
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small print stating, ―Results are gross before tax so may be higher than what actual results
would have been over the given period. Past performance cannot guarantee future
results. ‖

At Twain, Litman has discretionary authority over the portfolios of individual stocks and
bonds for about 30 clients. His ten largest clients vary widely in age, occupation, and
wealth. For a variety of reasons, each of these accounts requires significant attention.
The remaining two-thirds of Litman’s clients are stable, long-term investors, all of whom
are saving for retirement. Litman performs comprehensive quarterly reviews with the
owners of the ten largest accounts and similar annual reviews with the remaining clients.
Recently, he made an exception to this rule when he learned that one of his smaller, less
active clients had unexpectedly inherited $600,000 from an aunt’s estate. Litman met
with the client and performed a comprehensive review of the client’s financial situation
even though only three months had passed since their last meeting.

With a new CEO, Twain, which adheres to the Asset Manager Code of Professional
Conduct, experiences significant change during the year when management hires a
compliance officer. The compliance officer immediately begins to update the firm’s
policies and procedures. After a thorough analysis, the firm decides to outsource its
back-office operations and hires an independent consultant to review client portfolio
information. At the same time, they add several research and investment staff and
upgrade the information management system. They eliminate paper records in favor of
electronic copies and develop a business-continuity plan based on current staffing.

Eighteen months later, the compliance officer resigns. Rather than hire an external
replacement, management designates one of Twain’s senior portfolio managers as the
new compliance officer. The compliance officer reviews both firm and employee
transactions and reports to the chief executive officer.

1. Which of the following is the most correct action for Litman to follow in order to
comply with the Standards in regards to Twain and non-Twain clients?

A. Do nothing.
B. Inform his immediate supervisor.
C. Obtain written consent from both Twain and non-Twain clients.

Answer: C

‖Guidance for Standards I – VII‖
2010 Modular Level III, Vol. 1, pp. 75, 89-91
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by interpreting the Code and Standards in various situations
involving issues of professional integrity.

According to Standard IV (B), Litman must obtain written permission from all
parties involved.