- Investment Banking Relationships
- Performance Measurement and Attribution
- Public Companies
- Credit Rating Agency Opinions
- Influence during the Manager Selection
- Issuer-Paid Research
- Travel Funding
- Example 1 (Travel Expenses)
- Example 2 (Research Independence)
- Example 3 (Research Independence and Intrafirm Pressure)
- Example 4 (Research Independence and Issuer Relationship Pressure)
- Example 5 (Research Independence and Sales Pressure)
- Example 6 (Research Independence and Prior Coverage)
- Example 7 (Gifts and Entertainment from Related Party)
- Example 8 (Gifts and Entertainment from Client)
- Example 9 (Travel Expenses from External Manager)
- Example 10 (Research Independence and Compensation Arrangements)
- Example 11 (Influencing Manager Selection Decisions)
- Example 12 (Fund Manager Relationships)
- Example 13 (Intrafirm Pressure)
Guidance
Standard I(B) states the responsibility of CFA Institute members and candidates to maintain independence and objectivity so that their clients will have the benefit of their work and opinions unaffected by any potential conflict of interest or other circumstance adversely affecting their judgment. Every member and candidate should endeavor to avoid situations that could cause or be perceived to cause a loss of independence or objectivity in recommending investments or taking investment action.
Members and candidates are personally responsible for maintaining independence and objectivity when preparing research reports, making investment recommendations, and taking investment action on behalf of clients. Recommendations must convey the member’s or candidate’s true opinions, free of bias from internal or external pressures, and be stated in clear and unambiguous language.
External sources may try to influence the investment process by offering analysts and portfolio managers a variety of benefits. Corporations may seek expanded research coverage, issuers and underwriters may wish to promote new securities offerings, brokers may want to increase commission business, and independent rating agencies may be influenced by the company requesting the rating. Benefits may include gifts, invitations to lavish functions, tickets, favors, or job referrals. Modest gifts and entertainment are acceptable, but special care must be taken by members and candidates to resist subtle and not-so-subtle pressures to act in conflict with the interests of their clients. Members and candidates must reject any offer of gifts or entertainment that could reasonably be expected to threaten their independence and objectivity.
Receiving a gift, benefit, or consideration from a client can be distinguished from gifts given by entities seeking to influence a member or candidate to the detriment of other clients. In a client relationship, the client has already entered some type of compensation arrangement with the member, candidate, or his or her firm. A gift from a client could be considered supplementary compensation rather than an attempt to influence a member or candidate to favor the gift-giving client to the detriment of other clients. Prior to accepting “bonuses” or gifts from clients, members and candidates should disclose to their employers such benefits offered by clients. If notification is not possible prior to acceptance, members and candidates must disclose to their employer benefits previously accepted from clients. Disclosure allows the employer to make an independent determination about the extent to which the gift may affect the member’s or candidate’s independence and objectivity.
Investment Banking Relationships
Members and candidates may also come under pressure from their own firms to, for example, issue favorable research reports or recommendations for certain companies with potential or continuing business relationships with the firm. Members and candidates acting in a sales or marketing capacity must be especially mindful of their objectivity in promoting appropriate investments for their clients.
In some firms, research analysts frequently work closely with their investment banking colleagues to help evaluate prospective investment banking clients. Although collaboration between research analysts and investment banking colleagues may benefit the firm and enhance market efficiency (e.g., by allowing firms to assess risks more accurately and make better pricing assumptions), it requires firms to carefully balance the conflicts of interest inherent in the collaboration. Having analysts work with investment bankers is appropriate only when the conflicts are adequately and effectively managed. Any such conflict that is not avoided must be disclosed; see Standard VI(A) Avoid or Disclose Conflicts.
Performance Measurement and Attribution
Members and candidates working in a firm’s investment performance measurement department may also be presented with situations that challenge their independence and objectivity. As performance analysts, their analyses may reveal instances where managers may appear to have strayed from their mandate. Additionally, the performance analyst may receive requests to alter the construction of composite benchmarks owing to negative results for a selected account or fund. The member or candidate must not allow internal or external influences to affect their independence and objectivity as they faithfully complete their performance calculation and analysis-related responsibilities.
Public Companies
Analysts may be pressured to issue favorable reports and recommendations by the companies they follow. Left unmanaged, pressures that threaten independence place research analysts in a difficult position and may jeopardize their ability to act independently and objectively. One of the ways that research analysts have coped with these pressures is to use subtle and ambiguous language in their recommendations or to temper the tone of their research reports. Such subtleties, however, are lost on some investors who reasonably expect research reports and recommendations to be straightforward and transparent and to communicate clearly an analyst’s views based on unbiased analysis and independent judgment.
In making an investment recommendation, the analyst is responsible for anticipating, interpreting, and assessing a company’s prospects and stock price performance in a factual manner. Due diligence in financial research and analysis involves gathering information from a wide variety of sources, including public disclosure documents (such as proxy statements, annual reports, and other regulatory filings), company management and investor relations personnel, suppliers, customers, competitors, and other relevant sources. Research analysts may justifiably fear that companies will limit their ability to conduct thorough research by denying analysts who have “negative” views direct access to company managers and/or barring them from conference calls and other communication venues. This concern may make it difficult for them to conduct the comprehensive research needed to make objective recommendations. Members and candidates should work with issuers they cover to make clear their responsibility to produce independent and objective research. For further information and guidance, members and candidates should refer to the CFA Institute publication "Best Practice Guidelines Governing Analyst/Corporate Issuer Relation." 1
Credit Rating Agency Opinions
Credit rating agencies provide a service by grading the fixed-income products offered by companies. Members and candidates employed at rating agencies should ensure that procedures and processes at the agencies prevent undue influences from a sponsoring company during the analysis. Members and candidates must abide by their agencies’ and the industry’s standards of conduct regarding the analytical process and the distribution of their reports. The work of credit rating agencies also raises concerns similar to those inherent in investment banking relationships. Analysts may face pressure to issue ratings at a specific level because of other services the agency offers companies—namely, advising on the development of structured products. The rating agencies need to develop the necessary firewalls and protections to allow the independent operations of their different business lines.
When using information provided by credit rating agencies, members and candidates should be mindful of the potential conflicts of interest. And because of the potential conflicts, members and candidates may need to independently validate the rating granted.
Influence during the Manager Selection/Procurement Process
Members and candidates may find themselves on either side of the manager selection process. An individual may be on the hiring side as a representative of a pension organization or an investment committee member of an endowment or a charitable organization. Other members and candidates may be representing their organizations in attempts to earn new investment allocation mandates. The responsibility of members and candidates to maintain their independence and objectivity extends to the hiring or firing of those who provide business services beyond investment management.
When serving in a hiring capacity, members and candidates must not solicit gifts, contributions, or other compensation that affects their independence and objectivity or that reasonably could be expected to influence their decision-making process. Solicitations do not have to benefit members and candidates personally to conflict with Standard I(B). Requesting contributions to a favorite charity or political organization may also be perceived as an attempt to influence the decision-making process. When working to earn a new investment allocation, members and candidates must not offer gifts, contributions, or other compensation to influence the decision of the hiring representative. Offering these items with the intent to impair the independence and objectivity of another person would not comply with Standard I(B). Such prohibited actions may include offering donations to a charitable organization or political candidate referred by the hiring representative.
A clear example of improperly influencing hiring representatives was displayed in the “pay-to-play” scandal involving government-sponsored pension funds in the United States. Managers looking to gain lucrative allocations from the large funds made requested donations to the political campaigns of individuals directly responsible for the hiring decisions. This scandal and similar events have led to new laws requiring additional reporting concerning political contributions and bans on hiring—or hiring delay requirements for—managers who made campaign contributions to representatives associated with the decision-making process.
Issuer-Paid Research
Many companies, seeking to increase visibility both in the financial markets and with potential investors, have hired analysts to produce research reports analyzing their companies. These reports bridge the gap created by the lack of sell-side coverage and can be an effective method of communicating with investors.
Issuer-paid research conducted by independent analysts, however, is fraught with potential conflicts. Depending on how the research is written and distributed, investors may be misled into believing that the research is from an independent source when, in reality, it has been paid for by the subject company.
Members and candidates must adhere to strict standards of conduct that govern how the research is to be conducted and what disclosures must be made in the report. Analysts must engage in thorough, independent, and unbiased analysis and must fully disclose potential conflicts of interest, including the nature of their compensation. Otherwise, analysts risk misleading investors. Analysts must exercise diligence, independence, and thoroughness in conducting their research in an objective manner. Analysts must distinguish between fact and opinion in their reports. Conclusions must have a reasonable and adequate basis and must be supported by appropriate research.
Independent analysts must also strictly limit the type of compensation that they accept for conducting issuer-paid research. Otherwise, the content and conclusions of the reports could reasonably be expected to be determined or affected by compensation from the sponsoring companies. Compensation that might influence the research report could be direct, such as payment based on the conclusions of the report, or indirect, such as stock warrants or other equity instruments that could increase in value on the basis of positive coverage in the report. In such instances, the independent analyst has an incentive to avoid including negative information or making negative conclusions. Best practice is for independent analysts, prior to writing their reports, to negotiate only a flat fee for their work that is not linked to their conclusions or recommendations and to disclose that they are being compensated by the issuer for writing the report.
Travel Funding
The benefits related to accepting paid travel extend beyond the cost savings to members or candidates and their firms, such as the chance to talk exclusively with the executives of a company or learning more about the investment options provided by an investment organization. Acceptance also comes with potential concerns; for example, members and candidates may be influenced by these discussions when flying on a corporate or chartered jet or attending sponsored conferences where many expenses, including airfare and lodging, are covered. To avoid compromising their independence and objectivity, best practice dictates that members and candidates always use commercial transportation at their expense or at the expense of their firm rather than accept paid travel arrangements from an outside company. If commercial transportation is unavailable, members and candidates may accept modestly arranged travel to participate in appropriate information-gathering events, such as a property tour.
Compliance Practices
Members and candidates should adhere to the following practices to avoid violations of Standard I(B):
- Comply with firm policies: Members and candidates must comply with firm policies for protecting the integrity of research and the unbiased opinions of analysts. Such policies could include a restricted list of companies with whom the employer has an investment banking or other relationship, if the firm is unwilling to permit dissemination of adverse opinions about these companies.
- Restrict special cost arrangements: When attending meetings at an issuer’s headquarters, members and candidates should pay for commercial transportation and hotel charges. No corporate issuer should reimburse members or candidates for air transportation.
- Limit gifts: Even if a member’s or candidate’s employer does not have a policy on accepting gifts, members and candidates must limit the acceptance of gratuities and/or gifts to token items. Standard I(B) does not preclude customary, ordinary business-related entertainment as long as its purpose is not to influence or reward members or candidates.
Application of the Standard
(Example 17 added January 2019)
Example 1 (Travel Expenses)
Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metals to join a group of his peers in a tour of mining facilities in several western US states. The company arranges for chartered group flights from site to site and for modest accommodations in Spartan Motels, the only chain with accommodations near the mines, for three nights. Taylor allows Precision Metals to pick up his tab, as do the other analysts, with one exception—Adams, an employee of a large trust company who insists on following his company’s policy and paying for his hotel room himself.
Comment: The policy of the company where Adams works complies closely with Standard I(B) by avoiding even the appearance of a conflict of interest, but Taylor and the other analysts did not necessarily violate Standard I(B). In general, when allowing companies to pay for travel and/or accommodations in these circumstances, members and candidates must use their judgment. They must be on guard that such arrangements do not impinge on a member’s or candidate’s independence and objectivity. In this example, the trip was strictly for business and Taylor was not accepting irrelevant or lavish hospitality. The itinerary required chartered flights, for which analysts were not expected to pay. The accommodations were modest. In the final analysis, members and candidates must consider both whether they can remain objective and whether their integrity might be perceived by their clients to have been compromised.
Example 2 (Research Independence)
Dillon, an analyst in the corporate finance department of an investment services firm, is making a presentation to a potential new business client that includes the promise that her firm will provide full research coverage of the potential client.
Comment: Dillon may agree to provide research coverage, but she must not commit her firm’s research department to providing a favorable recommendation. The firm’s recommendation (favorable, neutral, or unfavorable) must be based on an independent and objective investigation and analysis of the company and its securities.
Example 3 (Research Independence and Intrafirm Pressure)
Fritz is an equity analyst at Hilton Brokerage who covers the mining industry. He has concluded that the stock of Metals & Mining is overpriced at its current level, but he is concerned that a negative research report will hurt the good relationship between Metals & Mining and the investment banking division of his firm. In fact, a senior manager of Hilton Brokerage just sent him a copy of a proposal his firm made to Metals & Mining to underwrite a debt offering. Fritz needs to produce a report right away and is concerned about issuing a less-than-favorable rating.
Comment: Fritz’s analysis of Metals & Mining must be objective and based solely on consideration of company fundamentals. Any pressure from other divisions of his firm is inappropriate. This conflict could have been eliminated if, in anticipation of the offering, Hilton Brokerage had placed Metals & Mining on a restricted list.
Example 4 (Research Independence and Issuer Relationship Pressure)
Fritz is an equity analyst at Hilton Brokerage who covers the mining industry. Fritz has concluded that Metals & Mining stock is overvalued at its current level, but he is concerned that a negative research report might jeopardize a close rapport that he has nurtured over the years with Metals & Mining’s CEO, chief financial officer, and investment relations officer. Fritz is concerned that a negative report might also result in management retaliation—for instance, cutting him off from participating in conference calls when a quarterly earnings release is made, denying him the ability to ask questions on such calls, and/or denying him access to top management for arranging group meetings between Hilton Brokerage clients and top Metals & Mining managers.
Comment: Fritz’s analysis must be objective and based solely on consideration of company fundamentals. Any pressure from Metals & Mining is inappropriate. To support the integrity of his conclusions, Fritz should fully document his work, including how his investment recommendation is based on relative valuation.
Example 5 (Research Independence and Sales Pressure)
In her role supporting the sales effort of a corporate bond department, Warner offers credit guidance to fixed-income investors. Her compensation is closely linked to the performance of the corporate bond department. Near the quarter’s end, Warner’s firm has a large inventory position in the bonds of Milton, Ltd., and has been unable to sell the bonds because of Milton’s recent announcement of an operating problem. Salespeople have asked her to contact large clients to push the bonds.
Comment: Unethical sales practices create significant potential violations of the Code and Standards. Warner’s opinion of the Milton bonds must not be affected by internal pressure or compensation. In this case, Warner must refuse to push the Milton bonds unless she is able to justify that the market price has already adjusted for the operating problem.
Example 6 (Research Independence and Prior Coverage)
Jorund, a securities analyst following airline stocks, is a rising star at her firm. Her boss has been carrying a “buy” recommendation on International Airlines and asks Jorund to take over coverage of the airline. He tells Jorund that under no circumstances should the prevailing buy recommendation be changed.
Comment: Jorund must be independent and objective in her analysis of International Airlines. If she believes that her boss’s instructions have compromised her, she has two options: She can tell her boss that she cannot cover the company under these constraints, or she can take over coverage of the company, reach her own independent conclusions, and if they conflict with her boss’s opinion, share the conclusions with her boss or other supervisors in the firm so that they can make appropriate recommendations. Jorund must issue only recommendations that reflect her independent and objective opinion.
Example 7 (Gifts and Entertainment from Related Party)
Grant directs a large amount of his commission business to a New York–based brokerage house. In appreciation for all the business, the brokerage house gives Grant two tickets to the World Cup in South Africa, two nights at a nearby resort, several meals, and transportation via limousine to the game.
Comment: Grant violated Standard I(B) because accepting these substantial gifts may impede his independence and objectivity. Members and candidates must not solicit or accept gifts, contributions, or other compensation that affects their independence and objectivity or that reasonably could be expected to influence their decision-making process. Best practice is to avoid situations that might cause or be perceived to cause a loss of independence or objectivity in recommending investments or taking investment action. By accepting the trip, Grant created a conflict of interest and opened himself up to the accusation that he may give the broker favored treatment in return. At a minimum, Grant must disclose this conflict to his employer and clients.
Example 8 (Gifts and Entertainment from Client)
Green manages the portfolio of Knowlden, a client of Tisbury Investments. Green achieves an annual return for Knowlden that is consistently better than that of the benchmark she and the client previously agreed to. As a reward, Knowlden offers Green two tickets to Wimbledon and the use of Knowlden’s flat in London for a week. Green discloses this gift to her supervisor at Tisbury.
Comment: Green is in compliance with Standard I(B) because she disclosed the gift from one of her clients. Members and candidates may accept bonuses or gifts from clients as long as they disclose them to their employer because gifts in a client relationship are deemed less likely to affect a member’s or candidate’s objectivity and independence than gifts in other situations. Disclosure is required, however, so that supervisors can monitor such situations to guard against employees favoring a gift-giving client to the detriment of other fee-paying clients (such as by allocating a greater proportion of IPO stock to the gift-giving client’s portfolio).
Example 9 (Travel Expenses from External Manager)
Wayne is the investment manager of the Franklin City Employee Pension Plan. He recently completed a successful search for a firm to manage the foreign equity allocation of the plan’s diversified portfolio. He followed the plan’s standard procedure of seeking presentations from a number of qualified firms and recommended that his board select Penguin Advisers because of its experience, well-defined investment strategy, and performance record. The firm claims compliance with the Global Investment Performance Standards (GIPS®) and has been verified. Following the selection of Penguin, a reporter from the Franklin City Record calls to ask whether there was any connection between this action and the fact that Penguin Advisers was one of the sponsors of an “investment fact-finding trip to Asia” that Wayne made earlier in the year. The trip was one of several conducted by the Pension Investment Academy, which had arranged the itinerary of meetings with economic, government, and corporate officials in major cities in several Asian countries. The Pension Investment Academy obtains support for the cost of these trips from a number of investment managers, including Penguin Advisers; the Academy then pays the travel expenses of the various pension plan managers on the trip and provides all meals and accommodations. The president of Penguin Advisers was also one of the travelers on the trip.
Comment: Although Wayne can probably put to good use the knowledge he gained from the trip when selecting external portfolio managers and in other areas of managing the pension plan, his recommendation of Penguin Advisers may be tainted by the possible conflict incurred when he participated in the international trip partly paid for by Penguin Advisers and when he was in the daily company of the president of Penguin Advisers. To avoid violating Standard I(B), Wayne’s basic expenses for travel and accommodations should have been paid by his employer or the pension plan; contact with the president of Penguin Advisers should have been limited to informational or educational events only; and the trip, the organizer, and the sponsor should have been made a matter of public record.
Example 10 (Research Independence and Compensation Arrangements)
Herrero recently left his job as a research analyst for a large investment adviser. While looking for a new position, he was hired as a contractor by an investor relations firm to write a research report on one of its clients, a small educational software company. The investor relations firm hopes to generate investor interest in the technology company. The firm will pay Herrero a flat fee plus a bonus if any new investors buy stock in the company as a result of Herrero’s report.
Comment: If Herrero accepts this payment arrangement, he will be in violation of Standard I(B) because the compensation arrangement can reasonably be expected to compromise his independence and objectivity. Herrero will receive a bonus for attracting investors, which provides an incentive to draft a positive report regardless of the facts and to ignore or play down any negative information about the company. Herrero should accept only a flat fee that is not tied to the conclusions or recommendations of the report. Issuer-paid research that is objective and unbiased can be done under the right circumstances as long as the analyst takes steps to maintain his or her objectivity and includes in the report proper disclosures regarding potential conflicts of interest.
Example 11 (Influencing Manager Selection Decisions)
Mandel is a senior portfolio manager for ZZYY Capital Management who oversees a team of investment professionals who manage labor union pension funds. A few years ago, ZZYY sought to win a competitive asset manager search to manage a significant allocation of the pension fund of the United Doughnut and Pretzel Bakers Union (UDPBU). UDPBU’s investment board is chaired by Gomez, a recognized key decision maker and long-time leader of the union. To improve ZZYY’s chances of winning the competition, Mandel made significant monetary contributions to Gomez’s union reelection campaign fund. Even after ZZYY was hired as a primary manager of the pension fund, Mandel believed that his firm’s position was not secure. Mandel continued to contribute to Gomez’s reelection campaign fund and lavishly entertained the union leader and his family at top restaurants on a regular basis. All of Mandel’s outlays were routinely handled as marketing expenses reimbursed by ZZYY’s expense accounts and were disclosed to his senior management as being instrumental in maintaining a strong close relationship with an important client.
Comment: Mandel not only offered but actually gave monetary gifts, benefits, and other considerations that reasonably could be expected to compromise Gomez’s objectivity. Therefore, Mandel was in violation of Standard I(B).
Example 12 (Fund Manager Relationships)
Scott is a performance analyst who is responsible for analyzing the performance of external managers for her firm. While completing her quarterly analysis, Scott notices a change in one manager’s reported composite construction. The change concealed the bad performance of a particularly large account by placing that account into a new residual composite. This change allowed the manager to remain at the top of the list of manager performance. Scott knows her firm has a large allocation to this manager, and the fund’s manager is a close personal friend of the CEO. She needs to deliver her final report but is concerned about pointing out the composite change.
Comment: Scott would be in violation of Standard I(B) if she did not disclose the change in her final report. The analysis of managers’ performance must not be influenced by personal relationships or the size of the allocation to the outside managers. By not including the change, Scott would not be providing an independent analysis of the performance metrics for her firm.
See also Standard V(A)–Diligence and Reasonable Basis.
Example 13 (Intrafirm Pressure)
Stein is head of performance measurement for her firm. During the last quarter, many members of the organization’s research department were removed because of the poor quality of their recommendations. The subpar research caused one larger account holder to experience significant underperformance, which resulted in the client withdrawing his money after the end of the quarter. The head of sales requests that Stein remove this account from the firm’s performance composite because the performance decline can be attributed to the departed research team and not the client’s adviser.
Comment: Pressure from other internal departments can create situations that cause a member or candidate to violate the Code and Standards. Stein must maintain her independence and objectivity and refuse to exclude specific accounts from the firm’s performance composites to which they belong. As long as the client invested under a strategy similar to that of the defined composite, it cannot be excluded because of the poor stock selections that led to the underperformance and asset withdrawal.
About the Author(s)
CFA InstituteCFA Institute is the global association of investment professionals that sets the standard for professional excellence and credentials. The organization is a champion of ethical behavior in investment markets and a respected source of knowledge in the global financial community. Our aim is to create an environment where investors’ interests come first, markets function at their best, and economies grow.
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