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LM3 Application of the Code and Standards Level III 2024 Level III Notes © IFT. All rights reserved 1 LM3 Application of the Code and Standards Level III 1. Introduction........................................................................................................................................................2 2. Sovereign Investment Corporation ...........................................................................................................2 3. Castle Biotechnology Case: David Plume, PhD, CFA.........................................................................10 4. Castle Biotechnology Case: Sandra Benning, CFA and Claris Deacon .......................................11 5. Lionsgate Limited & Bank of Australia Case: Tony Hill and Team .............................................13 6. Lionsgate Limited & Bank of Australia Case: Rob Portman, CFA; Kirk Graeme, CFA; The Delaney’s; David Milgram ...............................................................................................................................15 7. Gabby Sim.........................................................................................................................................................17 This document should be read in conjunction with the corresponding reading in the 2024 Level III CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are copyright 2023, CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved. Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by IFT. CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute. Version 1.0
LM3 Application of the Code and Standards Level III 2024 Level III Notes © IFT. All rights reserved 2 1. Introduction This reading has five cases that demonstrate how to apply the Code and Standards in situations where professional and ethical judgment is required. Exhibit 1 from the curriculum provides a framework for ethical decision-making and applying the Code and Standards. A Framework for Ethical Decision Making • Identify: Relevant facts, stakeholders and duties owed, ethical principles, conflicts of interest • Consider: Situational influences, additional guidance, alternative actions • Decide and act • Reflect: Was the outcome as anticipated? Why or why not? The following cases must be read from the perspective of how applying the framework might have changed each individual’s decision-making process. We have covered the most important points of each case. We suggest that you read the cases given in the curriculum to get a thorough understanding of the material. 2. Sovereign Investment Corporation Anthony Corrales and Victoria Adebayo worked together at a UK hedge fund (HFI). Recently, Adebayo decided to return to her home country and accept a position as chief financial officer and chief investment officer at her country’s Sovereign Investment Corporation (SIC). SIC’s mandate is to benefit the country’s developing economy by financing local projects that generate positive investment returns and attract global partners to co-invest with SIC. A secondary goal for SIC is to develop the country’s capital markets by promoting more activity and growth in the local stock market. To achieve these objectives, SIC has an investment company called National Investments (NI). In exchange for investment proceeds, investors are issued shares in NI. Adebayo receives two project proposals: • A complex mining project in an underpopulated, remote area of the nation. This project was proposed by one of the country’s regional governors who also leads the country’s opposing political party. The project is expected to bring economic benefits to the governor’s region but requires a major capital commitment. • A moderately sized urban infrastructure project. This project was proposed by the country’s minister of Finance who hired Adebayo. The project is less capital intensive and is expected to create hundreds of jobs for supporters of the political party currently in power. Adebayo knows that although both projects are potentially important to the country, it would not be possible to invest in both simultaneously. She quickly decides that NI should invest in the urban infrastructure project before investing in the mining project. Adebayo
LM3 Application of the Code and Standards Level III 2024 Level III Notes © IFT. All rights reserved 3 believes that this sequencing benefits the current political party in power while deferring investment in the mining project until the opposition party gains control of the government in a future election. EXAMPLE (This is Example 1 of the curriculum reading) 1. Did Adebayo’s decision to invest in the urban infrastructure project rather than the mining project most likely violate the CFA Institute Code and Standards? Yes, Adebayo violated Standard V(A): Diligence and Reasonable Basis. Adebayo’s decision to invest “quickly” without apparent analysis is made based on political, not investment, considerations and violates her responsibilities to exercise diligence, independence, and thoroughness in analyzing investments and taking investment action. 2. Which of the following would most likely mitigate any political bias influencing Adebayo’s decisions regarding how to invest NI assets? A. Requiring all investments be approved by a higher governmental authority B. Developing a rigorous governance framework for investment decisions C. Requiring Adebayo to disclose conflicts of interest B is correct. NI should have a robust and rigorous governance framework for making investment decisions that supports an appropriate level of due diligence undertaken and facilitates Adebayo’s duty to make independent and objective investment decisions free of bias. EXAMPLE (This is Example 2 of the curriculum reading) 1. Which of the following would most likely mitigate any political bias influencing Adebayo’s decisions regarding how to invest NI assets? A. Requiring all investments be approved by a higher governmental authority B. Developing a rigorous governance framework for investment decisions C. Requiring Adebayo to disclose conflicts of interest B is correct. NI should have a robust and rigorous governance framework for making investment decisions that supports an appropriate level of due diligence undertaken and facilitates Adebayo’s duty to make independent and objective investment decisions free of bias, as required by Standard I(B): Independence and Objectivity. NI’s development orientation does not justify taking a less-than-rigorous investment approach. If NI is to originate
LM3 Application of the Code and Standards Level III 2024 Level III Notes © IFT. All rights reserved 4 deals locally and bring in co-investors, it must demonstrate that it is acting in investors’ best interests. Anthony Corrales, CFA, Partner, Hedge Fund Investors Anthony Corrales, CFA, Adebayo’s former colleague and partner at the hedge fund HFI, contacts Adebayo and expresses interest in making a significant investment in NI. To demonstrate his conviction and convince his hedge fund partners of the opportunity, Corrales immediately invests 25% of his personal portfolio into NI in return for shares. After several days of deliberation, the hedge fund partners decide to invest HFI assets in NI but seek assurances that NI will maintain its aggressive investment strategy and commitment to high returns. Adebayo assures Corrales and the other hedge fund partners that NI is committed to providing its investors with high rates of return. After the hedge fund’s investment with SIC is made public, shares in NI trade higher on the exchange. Corrales is also interested in making private market investments directly for HFI. To help in this endeavor, the hedge fund uses local sub-advisers. For their role, the sub-advisers are paid from assets of the hedge fund, and although they have minimal or no experience as financial consultants or advisers, all sub-advisers have close connections with local high- ranking government officials. Payments are made by the sub-advisers on behalf of the hedge fund to cover substantial “deal fees” and other expenses to facilitate governmental support for each investment. Corrales views these expenditures as necessary to the fund’s investment success and reports them as operating expenses to the fund’s investors. EXAMPLE (This is Example 3 of the curriculum reading) 1. Which of Adebayo’s interactions with Corrales most likely violates the CFA Institute Code and Standards? A. Sharing information about NI’s current investments and financial condition B. Promising to provide updates directly to Corrales and the hedge fund partners C. Committing that she will maximize return on investment for NI’s investors C is correct. Standard III(C): Suitability requires CFA Institute members responsible for managing assets to a specific mandate, strategy, or style to take only investment actions that are consistent with that mandate. In the case of NI, Adebayo has a dual mandate to invest in projects that have both a beneficial socioeconomic impact and a positive expected investment return. This dual mandate is in contrast to traditional investment mandates that focus only on ROI regardless of outside or other impact. NI’s investors are informed up front that investment return is not the single determining factor for NI’s investment decisions. Any assurances by Adebayo to the hedge fund or other investors that promise a set rate or return or prioritize return maximization would be contrary to NI’s mandate.