Guidance for Standards I–VII

CFA Level II · CFA · 7 min read

Welcome to Ethics: Your Secret Weapon for Level II!

Hello there! If you’ve made it to CFA Level II, you already know that Ethics is a huge part of the exam. While the Standards are the same as Level I, the questions at Level II are Vignette-based, meaning they are longer stories where you have to spot the violations. Don't worry if this seems tricky at first; we are going to break these down into simple, real-world rules that will help you navigate even the toughest scenarios.

Standard I: Professionalism

This is the foundation. It’s all about keeping your "professional house" in order.

I(A) Knowledge of the Law

The Rule: You must follow the stricter law. If the CFA Institute rules are stricter than your local law, follow the CFA rules. If the local law is stricter, follow that.
• Common Mistake: Thinking you must report every violation to the government. Usually, you should first report it to your supervisor or compliance officer.
• Quick Tip: If you find out about a violation at your firm, you must dissociate (step away) from it. If you can't stop it, you might even have to resign.

I(B) Independence and Objectivity

The Rule: Don't let gifts, money, or pressure influence your professional judgment.
• Analogy: Imagine a restaurant critic getting a free $1,000 meal from a chef. Can they really give an honest review after that? Probably not!
• The "Modest" Gift Rule: Small gifts (like a cheap pen or a standard business lunch) are okay, but anything lavish must be disclosed to your employer before you accept it if it comes from a client, and you must have permission if it’s from a third party seeking to influence you.

I(C) Misrepresentation

The Rule: No lying, no "cherry-picking" data, and absolutely no plagiarism.
• Key Point: You must credit the source if you use someone else's research. You don't need to credit "recognized financial services" (like Bloomberg or the S&P 500) for basic data, but you do need to credit their specific analyses.

I(D) Misconduct

The Rule: Don't do anything that reflects poorly on your honesty or integrity.
• Did you know? This Standard covers your personal life too, but only if it affects your professional reputation. Getting a speeding ticket? Usually okay. Committing fraud? Definitely a violation.

Summary: Professionalism is about "The Stricter Rule," "No Bribes," "Give Credit," and "Stay Honest."

Standard II: Integrity of Capital Markets

This is about making sure the "game" is fair for everyone.

II(A) Material Nonpublic Information (MNPI)

The Rule: If you have "inside info" that could move a stock price, you cannot trade on it or cause others to trade on it.
• The Mosaic Theory: This is your best friend! You can use non-material, non-public info combined with public info to reach a conclusion. This is just good research!
• Step-by-step: 1. Is the info "Material" (would a reasonable investor want to know it)? 2. Is it "Nonpublic"? If the answer to both is YES, you must wait until it is public before trading.

II(B) Market Manipulation

The Rule: Don't distort prices or volume to deceive others.
• Example: Spreading false rumors on a message board to make a stock price go up so you can sell yours (a "Pump and Dump").

Summary: Don't cheat using inside info and don't try to "rig" the market.

Standard III: Duties to Clients

In the CFA world, the Client always comes first—even before your employer!

III(A) Loyalty, Prudence, and Care

The Rule: Act with the same care you would use for your own money. The client's interest is the top priority.
• Soft Dollars: If you use client commissions to buy research, that research must benefit the client. Using "soft dollars" to buy office furniture is a huge violation!

III(B) Fair Dealing

The Rule: Treat all clients fairly. This does not mean "equally" (you can give different levels of service for different fees), but you cannot favor one client over another when a new "Buy" recommendation comes out.
• Quick Tip: Send the recommendation email to everyone at the same time.

III(C) Suitability

The Rule: Before you invest, you must know your client. You need an IPS (Investment Policy Statement).
• Common Mistake: Investing in a high-risk tech stock for a 90-year-old grandmother who needs stable income. Even if the stock is "good," it’s not suitable for her.

III(D) Performance Presentation

The Rule: Don't mislead clients about your past performance. Don't show only your best years (cherry-picking).

III(E) Preservation of Confidentiality

The Rule: Keep client info secret unless: 1. It involves illegal activity. 2. Disclosure is required by law. 3. The client gives permission.

Summary: Put the client first, be fair to everyone, make sure the investment fits the person, and keep their secrets.

Standard IV: Duties to Employers

IV(A) Loyalty

The Rule: Don't hurt your firm.
• Leaving a firm: You can prepare to leave (like renting an office), but you can't start soliciting your current firm's clients until you have actually left. You cannot take files or client lists with you unless you have permission.

IV(B) Additional Compensation Arrangements

The Rule: You cannot accept a "bonus" from a client for good performance unless you get written permission from your employer first.

IV(C) Responsibilities of Supervisors

The Rule: If you manage people, you must make sure they follow the rules. If you find a violation, you must investigate and stop it. Simply saying "I didn't know they were doing that" is not an excuse!

Summary: Don't compete with your boss while you work there, get permission for outside bonuses, and watch over your team.

Standard V: Investment Analysis, Recommendations, and Actions

V(A) Diligence and Reasonable Basis

The Rule: Do your homework. You must have a "reasonable and adequate basis" for any recommendation.
• Analogy: You wouldn't buy a house just because the front door looks pretty. You'd check the plumbing, the roof, and the neighborhood. Do the same for stocks!

V(B) Communication with Clients

The Rule: Distinguish between Fact and Opinion.
• Fact: "The company grew earnings by 5% last year."
• Opinion: "We expect the company to grow by 10% next year."
• Crucial: Always tell clients about the basic format and general principles of your investment process.

V(C) Record Retention

The Rule: Keep your files! CFA Institute recommends keeping records for at least 7 years.

Summary: Do your research, explain it clearly (facts vs. opinions), and keep your notes for 7 years.

Standard VI: Conflicts of Interest

VI(A) Disclosure of Conflicts

The Rule: If you have a conflict (like owning the stock you are recommending), you must tell your clients and employer. Transparency is the best medicine.

VI(B) Priority of Transactions

The Rule: The "Order of Eating" is: 1. Clients, 2. Employer, 3. You.
• Never trade for your own account before the client has had a chance to act on a recommendation.

VI(C) Referral Fees

The Rule: If you get paid to refer a client to someone else (or vice-versa), you must tell the client before they sign up.

Summary: Tell everyone about your conflicts, let the client trade first, and disclose referral fees.

Standard VII: Responsibilities as a CFA Member or Candidate

VII(A) Conduct as Participants in CFA Institute Programs

The Rule: Don't cheat. Don't share specific exam questions. Don't do anything that compromises the integrity of the exam.

VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program

The Rule: Don't exaggerate what the designation means. You aren't "smarter" or "guaranteed to get better returns" just because you have the CFA charter.
• Grammar Tip: "CFA" is an adjective, not a noun.
• Correct: "I am a CFA charterholder."
• Incorrect: "I am a CFA."

Summary: Respect the exam and use the letters correctly!

Final Quick Review Box

• Stricter Law: Always follow it.
• Client Priority: Client > Employer > You.
• Gifts: Disclose to employer; get permission if it's for future work.
• Research: Must have a "reasonable basis."
• Inside Info: Material + Nonpublic = Do not trade!
• The Goal: Ethics is about integrity. When in doubt, ask: "Is this fair to the client and the market?"

Keep practicing those vignettes! You've got this!

Quick check

Can you answer these now?

Open each question to check the key ideas from this chapter.

When local law and the CFA Code and Standards conflict, which rule must a member follow?

A member must follow the stricter of the two rules.

What is the concept of dissociation when a violation is discovered?

Dissociation means stepping away from or refusing to participate in an activity that violates the Standards.

What are the disclosure requirements for gifts received from clients versus third parties?

Client gifts must be disclosed to the employer; third-party gifts intended to influence judgment require written permission BEFORE acceptance.

When is it NOT necessary to cite a source for data under Standard I(C)?

Credit is not required when using factual data from recognized financial services like Bloomberg or S&P.

What constitutes Material Nonpublic Information (MNPI)?

Information is material if a reasonable investor would want it to make a decision; it is nonpublic if it hasn't been disseminated to the general market.

What is the "Mosaic Theory" in the context of investment research?

Mosaic Theory allows analysts to reach conclusions by combining public information with non-material, non-public information.

What is the requirement for using client "soft dollars"?

Soft dollars (client commissions) must be used to purchase research or services that directly benefit the client.

Does Standard III(B) Fair Dealing require members to treat all clients equally?

No; it requires that clients be treated fairly, though different service levels are permitted if they don't disadvantage others.

What is the purpose of an Investment Policy Statement (IPS) under Standard III(C)?

The IPS documents a client's objectives and constraints to ensure all investment recommendations are suitable.

What actions are permitted versus prohibited when a member is preparing to leave their firm?

Members can make administrative preparations to leave, but they cannot solicit clients or take company property until after they have resigned.

What are the responsibilities of a supervisor under Standard IV(C)?

Supervisors must establish and enforce compliance systems to ensure subordinates follow the law and Standards.

What is the difference between facts and opinions in client communication?

Facts are historical or verifiable data; opinions are projections or expectations that must be clearly labeled as such.

What is the recommended record retention period for investment research and data?

The CFA Institute recommends keeping records for at least seven years.

What is the "Order of Priority" for trade execution under Standard VI(B)?

The priority order is: 1. Clients, 2. Employer, 3. The Member (Personal Accounts).

What are the restrictions on using the "CFA" designation letters?

The letters "CFA" must be used as an adjective, not a noun, and cannot imply superior performance.

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