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Study guide · Session 1

Ethical and Professional Standards

10-15% of the exam · session 1 · 10 learning modules

This topic covers how firms govern risk, why ethics underpins trust in the investment profession, and how the CFA Institute Code of Ethics and Standards of Professional Conduct (effective 1 January 2024) apply to everyday decisions. Level I questions are mostly short scenarios: you decide whether a person's conduct conforms to or violates a specific Standard, and what they should have done instead.

A study feature written by ExamDragon, not part of the real exam. Each heading is one of this topic's 10 learning modules in the 2027 curriculum, named in our own words.

At a glance

Session 1
10-15%

of the exam, as CFA Institute weights it for 2027

Weight
10-15%
Modules
10
Key terms
9

What this guide covers, module by module

  1. ETH.1Why ethics builds trust in finance
  2. ETH.2The Code, the Standards and enforcement
  3. ETH.3Law, independence, honesty and competence
  4. ETH.4Inside information and market manipulation
  5. ETH.5What members owe their clients
  6. ETH.6What members owe their employers
  7. ETH.7Research basis, client communication, records
  8. ETH.8Disclosing conflicts, trade priority, referrals
  9. ETH.9Candidate conduct and using the CFA name
  10. ETH.10Mixed ethics cases at Level I

ETH.1Why ethics builds trust in finance

  • Ethics is a set of moral principles and rules of conduct that guide behaviour when choices affect others; ethical conduct balances self-interest with the interests of others.
  • A code of ethics states a group's values and the minimum conduct expected of members, communicates them to the public and supports trust in the group.
  • A profession is marked by specialised knowledge, a commitment to serve clients, high entry standards, continuing education, self-regulation and an enforced code of conduct.
  • Investment management depends on trust because clients usually cannot observe the quality of advice or execution; misconduct harms clients, firms and the efficiency of capital markets.
  • Legal and ethical are not the same: some legal acts are unethical, and some acts that break a rule (for example civil disobedience) may be ethical; laws often lag new practices.
  • Challenges to ethical behaviour include overconfidence in one's own character, situational pressures (bonuses, peers, deadlines) and a focus on short-term results.
  • A simple decision framework: identify the facts, duties and conflicts; consider the situational influences and alternatives; decide and act; then reflect on the outcome.
  1. The situationAn analyst can earn a larger bonus by rating a stock 'buy' before a deal closes, and nothing in local law forbids the rating.
  2. Step 1Identify: the duty is to clients relying on objective research; the conflict is the bonus.
  3. Step 2Consider: the pressure is situational, and the legality of the act does not settle whether it is ethical.
  4. Step 3Decide and act: issue the rating the research supports, then reflect on whether the bonus structure needs to change.
  5. Where questions turnAssuming that compliance with the law is enough: an act can be legal and still unethical.
  6. The takeawayThe framework moves the decision from 'is it legal?' to 'who relies on me and what do I owe them?'.
Practise ETH.1

ETH.2The Code, the Standards and enforcement

  • Members and candidates must follow the Code and Standards and each year sign a statement disclosing matters such as complaints, litigation or investigations relating to their professional conduct.
  • The Professional Conduct Program enforces them under the Rules of Procedure; staff may open an inquiry after a self-disclosure, a written complaint, public information such as a media report, or a report of exam misconduct.
  • After an inquiry, staff may close the matter, issue a cautionary letter or propose a sanction; a member or candidate who rejects a proposed sanction can have the matter heard by a panel of the Disciplinary Review Committee.
  • Sanctions for members include public censure, suspension or revocation of membership and of the right to use the CFA designation; candidates can be suspended or barred from the CFA Program.
  • The Code has six components: act with integrity and competence; put the profession's integrity and clients' interests above one's own; use reasonable care and independent judgment; practise and encourage professional, ethical conduct; promote the integrity and viability of capital markets; maintain and improve competence.
  • The seven Standards: I Professionalism, II Integrity of Capital Markets, III Duties to Clients, IV Duties to Employers, V Investment Analysis, Recommendations, and Actions, VI Conflicts of Interest, VII Responsibilities as a CFA Institute Member or CFA Candidate.
  1. The situationA newspaper reports that a charterholder is under regulatory investigation for misleading marketing.
  2. Step 1Public information such as a media report can lead Professional Conduct staff to open an inquiry.
  3. Step 2Staff gather facts, often asking the member for an explanation and documents.
  4. Step 3If staff propose a sanction and the member rejects it, a hearing panel decides.
  5. Where questions turnMixing up the Code (six broad principles) with the Standards (seven numbered Standards with sub-sections), or thinking only a client complaint can start an inquiry.
  6. The takeawayEnforcement can start from many sources, not only formal complaints, and the member has a right to a hearing.
Practise ETH.2

ETH.3Law, independence, honesty and competence

  • I(A) Knowledge of the Law: follow the stricter of applicable law and the Code and Standards; do not knowingly participate in or assist violations, and dissociate from them, which may mean refusing work or leaving the firm.
  • I(B) Independence and Objectivity: use reasonable care to keep independence and objectivity; do not offer, solicit or accept gifts or benefits that could reasonably be expected to compromise them. Modest token gifts are acceptable; paying one's own travel to an issuer visit is best practice.
  • I(C) Misrepresentation: do not knowingly misrepresent analysis, recommendations, qualifications or services; this covers plagiarism, guaranteeing returns on risky investments and using others' work without credit.
  • I(D) Misconduct: do not engage in professional conduct involving dishonesty, fraud or deceit, or any act that reflects adversely on professional reputation, integrity or competence.
  • I(E) Competence: act with and maintain the competence needed to fulfil professional responsibilities, and do not take on work you are not able to do properly without getting the expertise required.
  • Factual statements are allowed: citing a government bond's guaranteed coupon, or quoting a published source with credit, is not misrepresentation.
  1. The situationA member works in a country whose law allows managers to accept unlimited gifts from brokers; the Code and Standards are stricter.
  2. Step 1Compare: local law is less strict than the Standards on gifts.
  3. Step 2Apply I(A): the stricter rule governs, so I(B) limits on gifts apply.
  4. Step 3The member may accept only modest gifts that could not reasonably compromise objectivity, and should follow firm disclosure policy.
  5. Where questions turnThinking that following local law is always enough, or that a 'guaranteed' statement is always misrepresentation even when the instrument really is guaranteed.
  6. The takeawayWhen law and the Standards differ, the stricter one wins, whichever it is.
Practise ETH.3

ETH.4Inside information and market manipulation

  • II(A) Material Nonpublic Information: members who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on it.
  • Information is material if a reasonable investor would want it or its release would likely move the price; it is nonpublic until it has been disseminated to the market at large.
  • Mosaic theory: an analyst may combine public information with nonmaterial nonpublic information to reach a conclusion that would be material, and act on it.
  • Firms prevent misuse with information barriers (firewalls), restricted and watch lists and review of employee trading.
  • II(B) Market Manipulation: do not engage in practices that distort prices or artificially inflate trading volume to mislead market participants, such as spreading false rumours or pump-and-dump schemes.
  • Legitimate strategies that exploit real inefficiencies, or large trades made for genuine reasons, are not manipulation.
  1. The situationAn analyst counts delivery trucks at a factory, talks to suppliers about general demand and reads public filings, and concludes earnings will beat forecasts.
  2. Step 1Each piece on its own is public or nonmaterial.
  3. Step 2Combining them into a material conclusion is the mosaic theory.
  4. Step 3The analyst may publish the recommendation and act on it, keeping records of the research.
  5. Where questions turnTreating any nonpublic fact as forbidden: the test needs information that is both material and nonpublic.
  6. The takeawayDiligent analysis of public and nonmaterial information is rewarded, not prohibited.
Practise ETH.4

ETH.5What members owe their clients

  • III(A) Loyalty, Prudence, and Care: act for the benefit of clients and put their interests before the employer's and one's own; for a pension plan the beneficiaries are the clients. Voting proxies and directing brokerage (soft dollars) must serve clients.
  • III(B) Fair Dealing: deal fairly and objectively with all clients when giving recommendations or taking investment action; fair does not mean identical service levels, but disclosed levels must be available to all and allocations such as hot issues must be fair, often pro rata.
  • III(C) Suitability: in advisory relationships, learn the client's objectives, constraints and experience, keep them current (review at least annually) and judge suitability for the whole portfolio; a fund manager must stay within the stated mandate.
  • III(D) Performance Presentation: make reasonable efforts to ensure performance information is fair, accurate and complete; GIPS compliance is one way but is not required.
  • III(E) Preservation of Confidentiality: keep information about current, former and prospective clients confidential unless it concerns illegal activity, disclosure is required by law, or the client permits it.
  1. The situationAn oversubscribed new issue reaches a manager who wants to allocate it to her best-performing accounts and her spouse's fee-paying account.
  2. Step 1III(B) requires a fair allocation among all clients for whom the issue is suitable, typically pro rata.
  3. Step 2Her spouse's account is a client account but may not receive preference over other clients.
  4. Step 3If the allocation is too small to share, the procedure must still be set in advance and applied consistently.
  5. Where questions turnBelieving fair dealing requires every client to receive the same service, or that the plan sponsor rather than the beneficiaries is the client of a pension manager.
  6. The takeawayFair dealing is about a consistent, disclosed process that does not favour any client.
Practise ETH.5

ETH.6What members owe their employers

  • IV(A) Loyalty: in matters related to employment, act for the employer's benefit and do not deprive it of skills, divulge confidential information or otherwise cause harm.
  • Preparing to leave (for example arranging a new job) is allowed, but before leaving a member must not solicit the employer's clients or take client lists or records; afterwards, memory and public sources may be used unless a non-compete agreement applies.
  • Starting independent practice that competes with the employer requires the employer's consent; whistleblowing to protect clients or market integrity can be consistent with the Standard.
  • IV(B) Additional Compensation Arrangements: do not accept gifts, benefits or compensation that compete with or might reasonably create a conflict with the employer's interest unless written consent is obtained from all parties involved.
  • IV(C) Responsibilities of Supervisors: make reasonable efforts to ensure that anyone under one's supervision complies with laws, rules and the Code and Standards; a supervisor who finds the compliance system inadequate should decline supervisory responsibility in writing until it is improved.
  1. The situationA client offers a portfolio manager a bonus of EUR 5,000 if the account beats its benchmark by 3% this year.
  2. Step 1The bonus could create a conflict by encouraging favouritism toward that client.
  3. Step 2IV(B) requires written consent from all parties involved, here the employer.
  4. Step 3The manager discloses the terms in writing and accepts only after consent.
  5. Where questions turnThinking that a member who has not yet resigned may contact clients 'just to let them know', or that a verbal okay is enough under IV(B).
  6. The takeawayOutside compensation tied to the job needs written consent, not just verbal notice.
Practise ETH.6

ETH.7Research basis, client communication, records

  • V(A) Diligence and Reasonable Basis: exercise diligence, independence and thoroughness in analysis and have a reasonable and adequate basis, supported by research, for any recommendation or action.
  • Relying on third-party or group research is allowed after reasonable checks of its soundness; a member may put their name on a group report they personally disagree with if the process was sound and the view is reasonable.
  • V(B) Communication with Clients and Prospective Clients: disclose the basic format and general principles of the investment process and any significant change to it; disclose significant limitations and risks; distinguish fact from opinion.
  • V(C) Record Retention: develop and keep appropriate records supporting analysis and recommendations; records belong to the firm, and without a regulatory rule seven years is the recommended minimum.
  • Quantitative models need understanding of their assumptions and limits; using a model without testing it can fail V(A).
  1. The situationA manager switches a fund's process from fundamental stock picking to a quantitative model.
  2. Step 1The change is significant to how the fund is run.
  3. Step 2V(B) requires telling clients promptly about the change and its risks.
  4. Step 3V(A) requires that the manager understands and has tested the model, and V(C) that the testing is documented.
  5. Where questions turnPresenting a forecast as fact (an opinion such as an earnings estimate must be identified as an opinion), or thinking records leave with the analyst.
  6. The takeawayChanging the process triggers diligence, disclosure and record-keeping duties together.
Practise ETH.7

ETH.8Disclosing conflicts, trade priority, referrals

  • VI(A) Disclosure of Conflicts: make full and fair disclosure of all matters that could reasonably impair independence and objectivity or interfere with duties to clients, prospective clients and the employer; disclosure must be prominent, delivered in plain language and communicate the information effectively.
  • Typical conflicts: owning shares one recommends, directorships, investment banking relationships and compensation linked to recommendations.
  • VI(B) Priority of Transactions: client and employer transactions come before transactions in which a member is a beneficial owner; members must not front-run client trades.
  • Family accounts that pay normal fees are treated as client accounts: neither favoured nor disadvantaged.
  • VI(C) Referral Fees: disclose to the employer, clients and prospective clients any compensation, consideration or benefit received or paid for recommending products or services, before the engagement and including its nature and value.
  1. The situationAn adviser receives GBP 200 from an accountant for each client referred and plans to mention it only if a client asks.
  2. Step 1The payment is consideration for a referral.
  3. Step 2VI(C) requires disclosure to clients and prospects before they engage, and to the employer.
  4. Step 3Disclosing only on request does not meet the Standard.
  5. Where questions turnBelieving a fee-paying family member's account must wait until all other clients trade, or that a conflict disclosed in fine print is enough.
  6. The takeawayReferral arrangements must be disclosed in advance, with their nature and value, without waiting for a question.
Practise ETH.8

ETH.9Candidate conduct and using the CFA name

  • VII(A) Conduct as Participants in CFA Institute Programs: do not engage in conduct that compromises the reputation or integrity of CFA Institute, the CFA designation or the integrity, validity or security of CFA Institute programs.
  • Exam security: candidates must not share specific questions or topics tested, or say which topics were or were not on the exam; general comments on difficulty are acceptable, and members may publicly criticise CFA Institute policies.
  • VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program: do not misrepresent or exaggerate the meaning or implications of membership, the designation or candidacy.
  • Only members in good standing who have been awarded the charter may use the designation; they must pay dues and file the annual professional conduct statement. 'CFA' is used as an adjective (CFA charterholder), never as a noun, and there is no partial designation such as 'CFA Level II'.
  • A candidate may state facts such as passing levels on the first attempt, but must not claim superior ability or imply that passing predicts better investment results.
  1. The situationA candidate's profile reads: 'CFA Level II, expected charter 2028.'
  2. Step 1'CFA Level II' implies a partial designation, which does not exist.
  3. Step 2'Expected charter 2028' implies an outcome that is not certain.
  4. Step 3Acceptable wording: 'Candidate in the CFA Program, passed Level I.'
  5. Where questions turnThinking any discussion of the exam is a breach: general remarks are fine, specific questions and topic content are not.
  6. The takeawayReference the program factually: candidacy and passed levels, never a partial or promised designation.
Practise ETH.9

ETH.10Mixed ethics cases at Level I

  • Start every case by naming who is owed a duty: clients first, then the employer, then the member's own interest.
  • Ask which Standard is engaged: information (II), clients (III), employer (IV), analysis and communication (V), conflicts (VI), or program conduct (VII); one act can engage several.
  • Look for the remedy the Standards prefer: disclosure, written consent, documented policy, or declining the work.
  • Firm policies that are stricter than the Standards should be followed; firm policies that are weaker do not excuse a violation.
  • Watch the timing: disclosure before engagement, consent before acceptance, client orders before personal orders.
  1. The situationA research analyst buys a stock for her own account the day before her firm publishes her buy recommendation on it.
  2. Step 1Duty: clients should have the chance to act on the recommendation first.
  3. Step 2VI(B) is violated because she traded ahead of the clients' opportunity to act.
  4. Step 3Remedy: follow blackout periods and pre-clear personal trades; disclose the holding under VI(A).
  5. Where questions turnStopping at the first Standard you spot when the facts also breach another.
  6. The takeawayIn mixed cases, identify the duty, the Standard and the timing, then the remedy.
Practise ETH.10

Key terms

Risk tolerance
The amount of risk an organisation or investor is willing to accept to reach its goals.
Risk budgeting
Allocating a total risk limit across activities, managers or asset classes.
Mosaic theory
Reaching a material conclusion from public and nonmaterial nonpublic information, which is permitted.
Material information
Information a reasonable investor would want, or that would likely move the price if released.
Fair dealing
Treating all clients fairly and objectively; not necessarily identically.
Soft dollars
Using client brokerage commissions to buy research or services, which must benefit the clients.
Dissociate
To separate oneself from a violation, for example by refusing to take part or leaving the firm.
Professional Conduct Program
CFA Institute's process for investigating and sanctioning breaches of the Code and Standards.
Beneficial owner
A person who benefits from or controls an account's investments, such as one's own or a spouse's account.

After this guide: After this guide you should be able to name the Standard a scenario engages, decide whether the conduct conforms or violates it, and state the remedy the Standards expect.

Practise Ethical and Professional Standards

Built to the topics and weights CFA Institute publishes for the 2027 Level I curriculum, and its Code of Ethics and Standards of Professional Conduct (effective 1 January 2024). The module names, explanations, worked examples and traps are ExamDragon's own. Every source this path is built on.