## **Learning Outcomes**

This article explains how to apply the CFA Institute Code of Ethics and Standards of Professional Conduct to realistic Level II scenario-based questions, including:

- identifying explicit and implicit violations in narrative cases that test suitability, disclosure, loyalty, and diligence;
- distinguishing compliant behavior from subtle misconduct when facts are incomplete or conflicting;
- evaluating whether investment recommendations satisfy Standard III(C) – Suitability across differing client objectives, constraints, and risk profiles;
- assessing the adequacy and timing of conflict-of-interest disclosures to clients and employers, particularly when personal holdings or incentives are involved;
- analyzing outside business activities for potential conflicts with the duty to employer and determining when prior written consent is required;
- determining whether a “reasonable basis” exists for new or complex products given the research undertaken, documented assumptions, and risk analysis;
- judging whether client treatment meets the fair dealing requirement when allocating limited opportunities or new recommendations;
- formulating appropriate corrective actions, disclosures, and documentation steps that restore compliance with the Code and Standards in exam-style scenarios.

## **CFA Level 2 Syllabus**

For the CFA Level 2 exam, you are expected to understand how to analyze scenarios involving the Code and Standards in practice, with a focus on the following syllabus points:

- Recognizing violations in scenario-based cases aligned with the Code and Standards.
- Evaluating recommended practices, policies, and conduct for compliance.
- Recommending corrective actions to align with ethical and professional obligations.
- Applying suitability and disclosure requirements in client and employer relationships.
- Assessing conflicts of interest and the necessity for employer notification when personal interests are involved.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. If an adviser recommends a high-risk product equally to all clients without assessing their individual risk profiles, what Standard is most likely violated?
2. An investment adviser holds a personal stake in an illiquid asset and recommends purchases to clients, fully disclosing this holding only after client orders are executed. Does this comply with the Code and Standards? Explain.
3. May a member begin an outside business activity that may compete with their employer, provided it occurs outside working hours and is unrelated to current job duties? What steps must be taken under the Standards?
4. What should a member do when pressured by their employer to recommend products without proper diligence or reasonable basis?

## **Introduction**

Ethics scenario analysis is a key part of CFA Level 2. Questions are often structured as practical cases, requiring you to judge conduct and recommend appropriate corrective action. Familiarity with scenario application helps you recognize and solve practical compliance dilemmas, safeguarding both your clients' interests and your professional reputation.

## Understanding Scenario Application

Scenario-based questions test your ability to apply the Code and Standards in real-world situations. These questions may present apparent ethical dilemmas, requiring you to decide if a Standard is violated, and if so, how to correct the issue. Typical areas of focus include duty of loyalty to clients and employers, suitability of recommendations, disclosure of conflicts, and proper notification before engaging in additional activities.

> **Key Term: suitability**
> The requirement that recommendations or actions must align with each client's personal profile, objectives, and constraints, judged in the context of their total portfolio.
>
> **Key Term: disclosure of conflicts**
> The obligation to inform clients and employers of any material conflicts of interest that could reasonably be expected to impair your objectivity or independence.
>
> **Key Term: duty to employer**
> The responsibility to act for the benefit of your employer, including notification and obtaining written consent for external or competing business activities.
>
> **Key Term: reasonable basis**
> The obligation to have adequate research and analysis supporting any investment action or recommendation made to a client or employer, factoring in risks and significant limitations.
>
> **Key Term: fair dealing**
> The principle of treating all clients equally in the distribution of investment recommendations and actions, unless a disclosed difference in service exists.

## Scenario Analysis – Key Considerations

### 1. Suitability and Individual Circumstances

Suitability assessment must be client-specific. Blanket recommendations or arbitrary allocations violate the duty to ensure recommendations are aligned to each client’s objectives, constraints, and risk tolerance.

### **Worked Example 1.1**

A portfolio manager recommends investing 5% of all clients' portfolios in an untested technology stock without evaluating their investment goals or risk profiles.

> **Answer:**  
> This is a breach of suitability. The recommendation ignores individual circumstances and may expose clients to unsuitable risk, violating Standard III(C) – Suitability.

### 2. Disclosure of Conflicts

Recommendations in products or securities in which you have a material personal interest must be timely disclosed to both clients and employers prior to the action. Disclosure after the fact is insufficient.

### **Worked Example 1.2**

An adviser recommends to clients the purchase of a thinly traded cryptocurrency in which they currently hold a large personal position. Disclosure of this holding is only made after execution of client transactions.

> **Answer:**  
> This conduct violates the Standard on disclosure of conflicts. Disclosure must occur before making recommendations so clients can judge your objectivity.

### 3. Duty to Employer and Outside Activities

Prior to engaging in outside business—including even small, apparently unrelated roles—a member must notify their employer, providing full details, and secure written consent if the activity could create a conflict with employer interests.

### **Worked Example 1.3**

A research analyst starts mining cryptocurrency at home after work without informing his employer (a bank that offers transaction services), believing it is a harmless side project.

> **Answer:**  
> This breaches the duty to employer. Even if unintentional, outside activity that possibly competes or conflicts with the employer’s business interests must be disclosed, and prior written consent obtained.

### 4. Reasonable Basis and Diligence

Recommendations must be backed by thorough research and analysis. Using clients as "test runs" for investments without diligence or documentation is not permitted.

### **Worked Example 1.4**

An adviser allocates client capital to a new investment product primarily to observe its results before recommending it to other clients, without prior research.

> **Answer:**  
> This fails the reasonable basis Standard. Client funds cannot be used for personal experimentation; actions must be supported by proper analysis and documentation.

### 5. Fair Dealing and Allocation

Recommendations or investment opportunities must be fairly offered to all relevant clients. Preferential access, or selling personal holdings to favored clients, constitutes unfair dealing and a breach of ethical responsibilities.

### **Exam Warning**

> When recommending new or complex products, always reassess suitability at the individual client level and document your rationale. Do not use a single blanket allocation or treat smaller clients as low-risk test cases.

### **Revision Tip**

> If uncertain whether a personal interest could be a conflict, disclose it fully and before any client action. When in doubt about outside business activities, always ask your employer for written approval.

## **Summary**

Scenario-based exam items test your ability to apply CFA Institute ethical standards in practice. Focus on determining suitability, disclosing conflicts proactively, notifying your employer before starting any outside venture, and maintaining a reasonable basis through thorough analysis. Always ensure clients are treated fairly.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Assess recommendations for individual suitability and avoid blanket product allocations.
- Disclose personal holdings or outside interests before recommending or acting for clients.
- Obtain prior written consent from your employer before external business roles or competing activity.
- Support all client actions with documented, thorough research (reasonable basis).
- Treat all clients fairly; do not offer preferential terms or act on client accounts for personal benefit.
- Address conflicts of interest promptly and document all disclosures.
- Recognize unfair dealing and avoid using certain client accounts as informal test subjects.

## **Key Terms and Concepts**

- suitability
- disclosure of conflicts
- duty to employer
- reasonable basis
- fair dealing

Application of the Code and Standards - Scenario analysis and guidance application