A client tells you he has material nonpublic information about an upcoming merger and plans to trade on it. Your firm's policies are clear, but your duty is to your client. What is your first required action under the CFA Institute Standards of Professional Conduct? If you thought "immediately report to compliance," you just fell for a trap. The correct first step is to seek to prevent the client from acting. This distinction between prevention and reporting is exactly where candidates lose points.
Quick answer
To pass the CFA Level I Ethics section, you must apply the CFA Institute Code of Ethics and seven Standards of Professional Conduct to complex scenarios. The core principle is to always adhere to the stricter of local law or the Standards, and to generally prioritize duties in this order: protect the integrity of capital markets, then serve client interests, then be loyal to your employer.
Key facts
- Weighting
- 15-20% of the CFA Level I exam score.
- Topics
- Code of Ethics, 7 Standards of Professional Conduct, Global Investment Performance Standards (GIPS).
- Question Format
- Scenario-based multiple-choice questions requiring judgment.
- Passing Score
- A Minimum Passing Score (MPS) is set by CFA Institute after each exam; there is no fixed percentage.
- Study Hours
- Candidates average 300+ hours for Level I, with 45-60 hours often dedicated to Ethics.
- Official Body
- CFA Institute.
Why Is the Ethics Section So Important on the CFA Exam?
The Ethical and Professional Standards section is the foundation of the CFA charter. It carries a 15-20% weight, meaning a poor performance here can easily lead to a failing score, even if you excel in other areas. More importantly, CFA Institute has been known to use a candidate's Ethics score as a determining factor for those on the pass/fail borderline, a practice sometimes called the "ethics adjustment."Success requires understanding the principles behind the rules. The exam will not ask you to recite a Standard. It will give you a paragraph-long story about an analyst facing a dilemma and ask you to diagnose the violation and prescribe the correct action. The highest-weight areas are consistently Standards I (Professionalism), II (Integrity of Capital Markets), and III (Duties to Clients), as they form the core of professional practice.
What Are the Core CFA Ethical Frameworks?
Your decision-making in any ethics scenario is guided by three core components: the Code of Ethics, the seven Standards of Professional Conduct, and the GIPS standards. Think of the Code as the high-level principles and the Standards as the specific, enforceable rules.The CFA Institute Code of Ethics
These six principles are the bedrock of the profession. You should know their intent perfectly.- Act with integrity, competence, diligence, and respect.
- Place the integrity of the profession and client interests above personal interests.
- Use reasonable care and exercise independent professional judgment.
- Practice and encourage others to practice in a professional and ethical manner.
- Promote the integrity and viability of the global capital markets.
- Maintain and improve professional competence.
The Seven Standards of Professional Conduct
These are the detailed rules you will apply on the exam. For each Standard, pay close attention to the official Guidance and Recommended Procedures for Compliance, as questions are built from these sections.I. Professionalism
- A. Knowledge of the Law: This is the "stricter-of" rule. You must follow the stricter of local law or the Code and Standards. If your firm's compliance procedures conflict with the Standards, the Standards prevail.
- B. Independence and Objectivity: You must not offer, solicit, or accept any gift or compensation that could compromise your independence. Modest gifts are okay; lavish ones are not.
- C. Misrepresentation: Do not knowingly make any misrepresentations. This includes plagiarism and guaranteeing investment returns.
- D. Misconduct: Do not engage in any conduct involving dishonesty, fraud, or deceit that reflects adversely on your professional integrity.
Exam trap:
A question describes an analyst in a country where a certain law is less strict than the CFA Standards. The tempting wrong answer is "The analyst complied with local law." This is almost always incorrect. The correct application is to adhere to the higher CFA Standard.
| Scenario | Incorrect Action (Common Trap) | Correct Action (Required by Standard I.A) |
|---|---|---|
| Local law permits using less-detailed performance attribution reports. | Provide the legally-permissible, less-detailed report. | Follow the stricter CFA Standard requiring more complete reporting. |
| Local law has lax rules on disclosing referral fees. | Only disclose fees when explicitly required by local law. | Disclose all referral fees as required by the stricter CFA Standard. |
II. Integrity of Capital Markets
- A. Material Nonpublic Information: You cannot act or cause others to act on MNPI. If you possess it, you must make reasonable efforts to achieve public dissemination by the issuer. You do not release it yourself.
- B. Market Manipulation: You cannot engage in practices that distort prices or artificially inflate trading volume. This includes spreading false rumors to drive a stock price.
III. Duties to Clients
- A. Loyalty, Prudence, and Care: Your client's interests come first. This includes exercising the care a prudent person would. This duty is to all clients, not just your largest accounts.
- B. Fair Dealing: Deal fairly and objectively with all clients. For example, when allocating shares of a hot IPO, you must have a fair system in place; you cannot give them all to your favorite clients.
- C. Suitability: You must ensure investments are suitable for a client's specific situation, objectives, and constraints, which are documented in the Investment Policy Statement (IPS). This applies on an ongoing basis.
- D. Performance Presentation: Performance data must be fair, accurate, and complete.
- E. Preservation of Confidentiality: Keep client information confidential unless the client permits disclosure, disclosure is required by law, or the information pertains to illegal activities.
IV. Duties to Employers
- A. Loyalty: You must act for the benefit of your employer and not harm them. This includes not taking confidential materials or soliciting clients before you leave.
- B. Additional Compensation Arrangements: You must not accept compensation that conflicts with your employer's interests without written consent from all parties involved.
- C. Responsibilities of Supervisors: You must make reasonable efforts to ensure anyone you supervise complies with the Code and Standards.
V. Investment Analysis, Recommendations, and Actions
- A. Diligence and Reasonable Basis: Your analysis and recommendations must have a reasonable and adequate basis. The level of diligence depends on the product or service you are offering.
- B. Communication with Clients: Disclose your investment process and distinguish between fact and opinion.
- C. Record Retention: Maintain records to support your analysis. The recommended holding period is seven years.
VI. Conflicts of Interest
- A. Disclosure of Conflicts: You must make full and fair disclosure of all matters that could impair your objectivity. Disclosure must be prominent and effective.
- B. Priority of Transactions: Client transactions come before your employer's transactions, which come before your personal transactions.
- C. Referral Fees: You must disclose any compensation received for recommending products or services.
VII. Responsibilities as a CFA Institute Member or Candidate
- A. Conduct as Participants: Don't cheat on the exam or compromise the integrity of the CFA Program.
- B. Reference to CFA Institute/Designation: Don't misrepresent your status. For example, a Level I candidate cannot imply they are a charterholder.
The Global Investment Performance Standards (GIPS)
GIPS is a set of ethical principles for standardized, industry-wide investment performance reporting. The goal is to ensure that performance data is fair, comparable, and not misleading. While you don't need to know every technical detail for Level I, you must understand its purpose and key concepts.- Why GIPS? To provide clients with credible performance data and allow for fair comparisons between investment managers.
- Who can claim compliance? Only investment management firms can claim compliance, not individuals. Compliance is voluntary and must be on a firm-wide basis.
- Key Concepts: Firms must define themselves correctly, include all fee-paying discretionary portfolios in at least one composite, and use specific calculation methodologies.
Worked example:
Emily, a Level I CFA candidate, works as a research associate for an investment bank. She overhears her manager discussing a confidential, highly positive research report on "Company X" that is due to be published tomorrow. Emily immediately calls her broker and places a large buy order for Company X shares in her personal account.
What Standard(s) has Emily most likely violated?
- Standard II(A) Material Nonpublic Information and Standard VI(B) Priority of Transactions.
- Standard II(A) Material Nonpublic Information and Standard I(D) Misconduct.
- Standard III(A) Loyalty, Prudence, and Care and Standard II(A) Material Nonpublic Information.
- Emily acted on material nonpublic information (the confidential report) for personal gain. This is a clear violation of Standard II(A).
- She also placed a personal trade before her employer's clients could act on the public report. This violates Standard VI(B) Priority of Transactions, which states that client and employer transactions take precedence.
- While her actions might also be misconduct (I.D) or disloyal to her employer (IV.A), the most direct and primary violations are II(A) and VI(B). The exam asks for the most likely violation.
- Standard III(A) is about loyalty to clients, which is not the primary issue in her personal trade.
How to Apply the Hierarchy of Duties
Many exam questions involve conflicting duties. A useful framework for navigating these is to prioritize your responsibilities. While not an official, rigid rule from CFA Institute, this hierarchy helps clarify your thinking in most scenarios.- Integrity of Capital Markets: Your highest duty is to the market itself. Actions that harm market integrity, like insider trading or manipulation, are the most severe violations.
- Duties to Clients: Your clients' interests come before your employer's or your own.
- Duties to Employers: You owe your employer loyalty, but not if it means harming clients or the market.
- Duties to Self: Your personal interests come last.
Think of it as a series of checks. Does this action harm the market? If so, don't do it. If not, does it harm my client? If so, don't do it. This mental model will help you dissect complex scenarios on exam day.
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How to Use This Guide in Your Study Routine
This guide is a high-yield summary, not a replacement for the official curriculum. Use it as a rapid review tool.- Before Practice Sessions: Read this to refresh the rules before starting a block of Ethics questions. VoraPrep's adaptive question bank is perfect for targeting weak areas identified during this review.
- After Mock Exams: If you score poorly on Ethics, use this guide to identify which specific Standards are tripping you up.
- Final Weeks Review: In the final stretch, this becomes your primary tool for a quick, comprehensive review of all key principles.
As you work through practice questions, don't just find the right answer. For every question, force yourself to articulate:
- Which specific Standard(s) apply here?
- Why is the correct answer the most appropriate?
- Why are the other two choices incorrect? What makes them tempting but ultimately wrong?
This process of deconstructing the distractors is how you develop the judgment the exam demands. If you get stuck, you can ask Vory, your 24/7 personal tutor, to walk you through the reasoning step-by-step.