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Guidance for Standards I-VII

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Volume 10, Topic 3: Guidance for Standards I-VII

Overview

This topic provides detailed guidance for the seven Standards of Professional Conduct. It is broken down into two main parts: one covering Standards I-III and the other covering Standards IV-VII. Each standard is explained with its key principles, application guidance, recommended compliance procedures, and practical examples that illustrate both conforming conduct and violations. This enhanced version integrates traditional finance (TradFi) concepts with decentralized finance (DeFi) applications to provide a modern, comprehensive understanding.

This is the most heavily tested topic in the Ethics section. Mastering the specific application guidance here — not just memorizing the Standard titles from Topic 2 — is what separates strong exam performance from mediocre. exam-focus

Learning Objectives

The candidate should be able to:

  • demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity.
  • recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
  • identify conduct that conforms to the Code and Standards and conduct that violates the Code and Standards.

Part 1: Guidance for Standards I, II, and III

Standard I: Professionalism standard-I

A. Knowledge of the Law

Standard I(A): Members and Candidates must understand and comply with all applicable laws, rules, and regulations (including the Finance Code of Ethics and Standards of Professional Conduct) of any government, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of conflict, Members and Candidates must comply with the more strict law, rule, or regulation. Members and Candidates must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations.

Core Concept: This is the foundational standard requiring adherence to the highest applicable legal or ethical requirement. Ignorance of the law is not an excuse. The “more strict” rule applies, meaning you must follow whichever rule imposes the highest burden or restriction. As explored in Topic 1, ethical standards often exceed legal requirements — this standard operationalizes that principle. exam-focus compliance

DeFi Application: defi-application

  • Smart Contract Audits & Legal Wrappers: A DeFi analyst recommending a protocol must be aware of the legal implications of its smart contracts. If a protocol uses a “legal wrapper” (e.g., a traditional legal agreement that references the smart contract), the analyst must understand the jurisdictions governing that agreement.
  • Sanctions & Compliance: With regulators like the OFAC sanctioning DeFi protocols (e.g., Tornado Cash), members must know which protocols are sanctioned and ensure their investment actions do not violate these restrictions. Using a sanctioned mixer, even for legitimate privacy reasons, could violate this standard. compliance
  • Securities Laws: An analyst must determine if a token could be considered a security under local regulations (e.g., the Howey Test in the US). Recommending an unregistered security token would be a violation.

Examples:

  1. Following the Highest Requirement: An analyst in a country with no insider trading laws must still abide by Standard II(A) Material Nonpublic Information, as it is stricter. exam-focus
  2. Dissociating from a Violation: An analyst discovers their firm is using promotional material with inflated, non-GIPS compliant performance data. They must report it to their supervisor and/or compliance. If the firm refuses to correct it, the analyst must dissociate, which may require refusing to use the material and potentially resigning.

Recommended Procedures for Compliance:

  • Stay Informed: Regularly review updates from regulatory bodies (e.g., SEC, ESMA) and subscribe to legal/compliance newsletters.
  • Establish a Code of Ethics: Encourage your firm to adopt a code of ethics.
  • Seek Legal Counsel: When in doubt, consult with the compliance department or external legal counsel.
  • Document Dissociation: If you must dissociate from a violation, keep a written record of the steps you took.

B. Independence and Objectivity standard-I

Standard I(B): Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.

Core Concept: Your work must be your own, uninfluenced by outside pressures. This includes pressure from employers, clients, and external parties. Even the appearance of a conflict can be a violation. This is one of the most frequently tested standards — the exam loves scenarios involving gifts, travel, and issuer pressure. exam-focus

DeFi Application:

  • Token Allocations (Airdrops): An analyst covering a new DeFi protocol is offered a large, private allocation of tokens before the public launch. Accepting this could compromise their objectivity when writing research reports. This is distinct from a widely distributed public airdrop.
  • “Pay-to-Play” Listings: A DeFi analyst working for an exchange cannot accept payment from a project to list its token. The decision to list must be based on objective criteria like security, utility, and user demand.
  • Sponsored Research: A research firm paid by a DAO to write a report on its protocol must explicitly disclose this fact. The compensation should be a flat fee, not contingent on the report’s conclusion or the token’s price performance.

Examples:

  1. Travel Funding: An analyst should not accept a trip to a crypto conference paid for by a project they cover. Best practice is for the analyst’s firm to pay for all travel and accommodation.
  2. Issuer Pressure: A ratings analyst is pressured by their manager to give a new stablecoin a higher rating because the issuer is a major client of the firm’s investment banking division. The analyst must resist this pressure and provide a rating based solely on their independent analysis of the stablecoin’s collateral and mechanism.

Recommended Procedures for Compliance:

  • Restricted List: Maintain a list of securities that employees are not allowed to trade personally due to the firm’s involvement with the issuer.
  • Gift Policy: Implement a strict, firm-wide policy limiting the value of gifts that can be accepted.
  • Firewalls: Separate research and investment banking departments to prevent undue influence.

C. Misrepresentation standard-I

Standard I(C): Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.

Core Concept: Do not lie, mislead, or plagiarize. This includes misrepresenting your credentials, your firm’s performance, or the nature of an investment. Omissions of critical facts can also be misrepresentations. Performance misrepresentation connects directly to GIPS compliance.

DeFi Application:

  • Plagiarizing Code: A developer building a DeFi protocol cannot copy significant portions of code from another open-source project without proper attribution (as required by the license, e.g., MIT, GPL).
  • Performance Reporting: A fund manager running a DeFi yield farming strategy cannot “cherry-pick” the best-performing wallets to show to prospective clients. The performance composite must be representative of the entire strategy.
  • Social Media Hype: An analyst cannot use anonymous social media accounts to spread false positive rumors about a token they hold to “pump” the price. This is also a violation of Standard II(B) Market Manipulation.

Examples:

  1. Guarantees: Promising a client that an investment in a volatile cryptocurrency is “guaranteed to double” is a misrepresentation.
  2. Credentials: A candidate who has passed the Level II exam cannot refer to themselves as “Finance Certification II”.” They are a “Level III candidate.”
  3. Using Third-Party Research: An analyst can incorporate research from a third-party provider but must cite the source. Presenting it as their own work is plagiarism.

Recommended Procedures for Compliance:

  • Maintain Records: Keep copies of all materials used to prepare research reports.
  • Attribute Sources: Clearly cite all sources of information, including direct quotes and paraphrased ideas.
  • Performance Verification: Encourage the firm to become GIPS compliant to ensure fair and accurate performance reporting.

D. Misconduct

Standard I(D): Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence.

Core Concept: This standard covers a broad range of behaviors, even outside of work, that could call your professional integrity into question. It’s about maintaining the public’s trust in the profession.

DeFi Application:

  • “Rug Pulls”: A developer who launches a project, attracts investor funds, and then abandons it, taking the funds, is engaging in fraud and deceit, a clear violation of this standard.
  • Personal Integrity: A portfolio manager convicted of tax evasion has committed an act that reflects adversely on their professional integrity, even if it’s unrelated to their job duties.
  • Competence: A financial advisor who recommends complex DeFi derivatives to clients without fully understanding the risks themselves is not acting with competence.

Examples:

  1. Drunk Driving: A conviction for driving under the influence could be a violation if it suggests a lack of judgment and respect for the law that could carry over into professional activities.
  2. Falsifying Documents: Submitting a fake MBA diploma to an employer is an act of dishonesty and a violation.

Recommended Procedures for Compliance:

  • Adopt a Code of Ethics: Ensure all employees understand that professional conduct extends beyond the office.
  • Background Checks: Conduct thorough background checks on potential new hires.

Standard II: Integrity of Capital Markets standard-II

A. Material Nonpublic Information

Standard II(A): Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.

Core Concept: Do not trade or help others trade on “inside information.” Information is “material” if it would affect a security’s price or a reasonable investor’s decision. It’s “nonpublic” until it has been made available to the general market. This is consistently one of the top three most tested standards on the Finance Certification 1 exam. exam-focus

DeFi Application:

  • DAO Governance Votes: A member of a large DAO’s core team knows that a major proposal to change the tokenomics will be announced next week. This is material nonpublic information. They cannot trade on this information or share it with others.
  • Protocol Exploits: A white-hat hacker discovers a critical vulnerability in a major lending protocol. This information is material and nonpublic. They must report it to the protocol’s team and cannot short the token before the vulnerability is disclosed and patched.
  • Mosaic Theory in DeFi: An analyst combines public information (e.g., on-chain transaction data, Discord chat logs, governance forum discussions) with non-material nonpublic information (e.g., a private conversation with a developer about their general workload). If this combination leads them to a material conclusion (e.g., a major product launch is delayed), they can act on it. This is the “mosaic theory” and is not a violation.

Examples:

  1. Tender Offer: An executive at a company knows it is about to be acquired at a premium. They tell their friend, who buys the stock. Both the executive (tipper) and the friend (tippee) have violated this standard.
  2. Analyst Reports: A well-respected analyst is about to downgrade a widely held stock. This information is considered material. If they tell a client before the report is released, it is a violation.

Recommended Procedures for Compliance:

  • Firewalls: Create information barriers between departments that may possess inside information (like M&A) and the trading department.
  • Restricted Lists: Prohibit trading in securities of companies where the firm has material nonpublic information.
  • Encourage Public Dissemination: Urge companies to release material information to the public in a fair and timely manner.

B. Market Manipulation standard-II

Standard II(B): Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.

Core Concept: Don’t intentionally distort market prices or trading volumes. This standard covers both transaction-based manipulation (e.g., wash trading) and information-based manipulation (e.g., spreading false rumors).

DeFi Application:

  • Wash Trading: A trader simultaneously buys and sells the same NFT across different wallets they control to create the illusion of high demand and trading volume, hoping to lure in other buyers at an inflated price.
  • “Pump and Dump” Schemes: A group of traders coordinates to buy a low-cap token, promote it heavily on social media with misleading information (“This is the next 100x coin!”), and then sell their holdings as new investors buy in, causing the price to crash.
  • Oracle Manipulation: A trader takes out a large flash loan to manipulate the price of an asset on a specific decentralized exchange (DEX) that a lending protocol’s oracle uses as its price feed. This allows them to borrow assets from the lending protocol at an unfair valuation.

Examples:

  1. Marking the Close: A trader executes a large buy order for a stock just before the market closes to drive up the closing price, which may affect the valuation of portfolios.
  2. Spreading False Rumors: An investor shorts a stock and then posts false, negative information about the company on an online forum to drive the price down.

Recommended Procedures for Compliance:

  • Firm Policies: Establish clear, written policies prohibiting market manipulation.
  • Education: Train employees on what constitutes manipulation.
  • Monitoring: Monitor trading activity for suspicious patterns.

Standard III: Duties to Clients standard-III fiduciary

A. Loyalty, Prudence, and Care

Standard III(A): Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.

Core Concept: Your clients’ interests come first — before your own and before your employer’s. You must act with the skill and diligence of a competent professional. This fiduciary duty is the ethical foundation of portfolio management and connects to the prudent investor concept. fiduciary exam-focus

DeFi Application:

  • Identifying the Client: When managing a DAO’s treasury, the “client” is the DAO’s token holders, not the core development team that hired the manager. All decisions must be for the benefit of the token holders.
  • Prudent Judgment with New Technology: Recommending that a conservative, risk-averse client put a large portion of their portfolio into a new, unaudited, and highly speculative yield farm would violate the duties of prudence and care.
  • Soft Dollars: A manager cannot direct client trades to a high-cost DEX simply because that DEX provides the manager with free access to a premium analytics tool. The research/service obtained through “soft dollars” must directly benefit the clients whose trades are generating the commissions.

Examples:

  1. Best Execution: A manager must seek the best possible execution for client trades. This doesn’t just mean the lowest commission; it means the best overall result (price, speed, likelihood of execution).
  2. Proxy Voting: A portfolio manager has a duty to vote on corporate proxies. These votes must be cast in the best long-term interest of the client, not to support company management with whom the manager has a friendly relationship.

Recommended Procedures for Compliance:

  • Disclose Conflicts: Clearly disclose all potential conflicts of interest to clients.
  • Regular Statements: Provide clients with regular, itemized account statements.
  • Fair Dealing: Treat all clients fairly when taking investment action.

B. Fair Dealing

Standard III(B): Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.

Core Concept: Treat all clients fairly. You cannot discriminate against any client. This doesn’t mean everyone gets the exact same treatment (clients paying for premium services can receive more attention), but no client should be disadvantaged.

DeFi Application:

  • Airdrop/Token Allocations: When a new token is launched (an IPO equivalent), a manager cannot allocate all the shares to their largest or favorite clients. A fair allocation system, such as pro-rata based on account size or indication of interest, must be developed and followed.
  • Disseminating Recommendations: An analyst cannot email a “buy” recommendation for a new token to their institutional clients and then wait several hours before releasing it to their retail clients. All clients must have a fair opportunity to act on the recommendation.

Examples:

  1. Block Trades: When executing a large block trade, a manager must allocate the shares and the execution price fairly among all participating client accounts.
  2. Time Stamping: Firms should time-stamp the receipt and dissemination of research to document that all clients were treated fairly.

Recommended Procedures for Compliance:

  • Develop a Dissemination Policy: Formalize the process for how recommendations are sent to clients to ensure fairness.
  • Objective Allocation Procedures: Create and disclose the firm’s trade allocation policies to all clients.

C. Suitability standard-III

Standard III(C): When Members and Candidates are in an advisory relationship with a client, they must: a. Make a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action and must reassess and update this information regularly. b. Determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints. c. Judge the suitability of investments in the context of the client’s total portfolio.

Core Concept: Know your client. Recommendations must be suitable for the client’s specific situation, objectives, and risk tolerance, and must be judged within the context of their entire portfolio. This standard connects directly to the Investment Policy Statement (IPS) process covered in Portfolio Planning and Construction. exam-focus

DeFi Application:

  • Developing an IPS for DeFi: An advisor must create a detailed Investment Policy Statement (IPS) for a client before recommending any DeFi strategies. This IPS should explicitly address the client’s understanding of and tolerance for risks unique to DeFi, such as smart contract risk, regulatory risk, and custody risk.
  • Portfolio Context: A highly speculative, “degen” yield farm might be a suitable investment for an aggressive investor with a high-risk tolerance, but only if it represents a very small, appropriate portion of their overall well-diversified portfolio.
  • Unsolicited Requests: A client asks their advisor to invest in a meme coin that the advisor knows is unsuitable. The advisor must explain the risks and why it’s unsuitable. If the client insists, the advisor may need to document that the trade was unsolicited and unsuitable, or even consider terminating the advisory relationship if the trade would materially impact the portfolio’s risk profile.

Examples:

  1. Updating the IPS: A client’s financial situation changes after they receive a large inheritance. The advisor must update the IPS to reflect this before making new recommendations.
  2. Fund Mandate: A manager of a “Global Large-Cap Equity Fund” cannot invest in illiquid, private DeFi startups, as this would violate the fund’s stated mandate.

Recommended Procedures for Compliance:

  • Investment Policy Statement (IPS): Create a written IPS for every advisory client.
  • Regular Updates: Review and update the IPS with the client at least annually.
  • Portfolio-Level Suitability: Always consider the impact of a new investment on the client’s total portfolio.

D. Performance Presentation standard-III

Standard III(D): When communicating investment performance information, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.

Core Concept: Don’t misrepresent performance. Presentations must be honest and complete. Complying with the Global Investment Performance Standards (GIPS) is the best way to meet this standard.

DeFi Application:

  • On-Chain vs. Off-Chain Data: When presenting the performance of a DeFi strategy, clearly state which data is sourced directly from the blockchain and which is from off-chain sources. Do not present simulated or back-tested results as actual performance without clear disclosure.
  • Composite Construction: A firm managing multiple yield farming strategies cannot create a composite that only includes the best-performing strategies or terminated (unsuccessful) accounts. The composite must be representative of the firm’s overall skill.

Examples:

  1. Brief Presentations: If providing a brief performance summary, you must make detailed information available upon request.
  2. Simulated Data: Clearly label any performance data that is based on a model or back-test as “simulated” and explain the methodology.

Recommended Procedures for Compliance:

  • GIPS Compliance: Encourage your firm to adopt the GIPS standards.
  • Provide Full Disclosure: Disclose whether performance is gross or net of fees, the benchmark used, and any other relevant information.

E. Preservation of Confidentiality

Standard III(E): Members and Candidates must keep information about current, former, and prospective clients confidential unless: a. The information concerns illegal activities on the part of the client. b. Disclosure is required by law. c. The client or prospective client permits disclosure of the information.

Core Concept: Client information is private. Protect it. This duty extends even to former and prospective clients.

DeFi Application:

  • Blockchain Privacy: While wallet addresses are public, the identity of the person who owns the wallet is confidential client information. An advisor cannot reveal that “wallet 0x123…” belongs to their client, John Doe.
  • Data Security: Client information stored electronically (e.g., in a CRM) must be secured against hacks. Using unencrypted email to send sensitive client data would be a violation of the duty of care.
  • Illegal Activities: If an advisor knows a client is using DeFi protocols to launder money, they may be required by law to report this to the authorities. In this case, the duty to uphold the law supersedes the duty of confidentiality.

Examples:

  1. Charity Donation: An advisor cannot share a client’s name and financial details with a local charity for a fundraising campaign without the client’s explicit permission.
  2. Cooperating with Finance: This standard does not prevent a member from providing confidential client information to Finance for the purposes of a Professional Conduct investigation.

Recommended Procedures for Compliance:

  • Secure Storage: Ensure that all client records, both physical and electronic, are stored securely.
  • Firm Policies: Understand and follow your firm’s policies on data privacy and security.

Part 2: Guidance for Standards IV, V, VI, and VII

Standard IV: Duties to Employers standard-IV

A. Loyalty

Standard IV(A): In matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.

Core Concept: Be a loyal employee. You cannot compete with your employer, steal trade secrets, or solicit clients for a new venture while still employed. However, this duty is subordinate to the duty to clients and to market integrity — a critical distinction that comes up in whistleblowing scenarios. See Ethics Application for worked examples. exam-focus

DeFi Application:

  • Independent Practice: A developer working for a DeFi protocol firm cannot use their work hours or company resources to build their own, separate DeFi project for personal profit without written consent from their employer.
  • Leaving an Employer: An analyst planning to leave their firm to start a competing DeFi research boutique cannot download the firm’s client list or proprietary research models before they resign. They can use publicly available information to contact former clients after they have left.
  • Social Media: An employee cannot use their firm-branded social media account to promote their personal side projects or solicit clients for a future business.

Examples:

  1. Soliciting Clients: Before resigning, a portfolio manager asks their largest clients to move with them to their new firm. This is a violation.
  2. Whistleblowing: An employee discovers their firm is engaged in illegal activity. Reporting this to the authorities is not a violation of loyalty, as the duty to protect the integrity of capital markets comes first.

Recommended Procedures for Compliance:

  • Written Consent: Obtain written permission from your employer before engaging in any independent practice for compensation.
  • Non-Compete Agreements: Understand and abide by the terms of any non-compete agreement you have signed.

B. Additional Compensation Arrangements

Standard IV(B): Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved.

Core Concept: You cannot accept side deals or compensation that could create a conflict with your employer’s interests without getting written permission from your employer first.

DeFi Application:

  • Advisory Tokens: An analyst is offered an “advisor” role with a new DeFi project, which includes a grant of tokens. This arrangement must be disclosed in writing to their employer, and they must receive written consent before accepting, as it could compete with their employer’s interests (e.g., if the employer also provides research or advisory services).

Examples:

  1. Client Bonus: A client offers a portfolio manager a personal bonus for achieving a 20% return. The manager must get written consent from their employer before accepting.
  2. Board Service: An analyst is offered a paid position on the board of directors of a company they cover. This must be disclosed to and approved by their employer.

Recommended Procedures for Compliance:

  • Immediate Written Report: Report any proposed additional compensation to your supervisor and compliance department in writing.

C. Responsibilities of Supervisors

Standard IV(C): Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.

Core Concept: If you are a supervisor, you are responsible for preventing and detecting violations by those you supervise. This requires establishing and enforcing adequate compliance procedures.

DeFi Application:

  • Inadequate Procedures: A supervisor at a crypto hedge fund knows their traders are using anonymous social media to promote the fund’s positions but does nothing to stop it. The supervisor has violated this standard by failing to prevent market manipulation.
  • Education: A supervisor must ensure their team is educated on the latest regulations affecting DeFi. Simply telling them to “follow the law” is not enough.

Examples:

  1. Detecting Violations: A supervisor notices that one of their analysts has a suspiciously high trading return in their personal account and investigates. They discover the analyst is front-running client trades. The supervisor has fulfilled their duty.
  2. Declining Responsibility: If a firm’s compliance procedures are inadequate, a supervisor should decline in writing to accept supervisory responsibility until the procedures are improved.

Recommended Procedures for Compliance:

  • Adequate Compliance System: Implement a system with written procedures, regular training, and a designated compliance officer.
  • Enforcement: Once a violation is discovered, a supervisor must promptly investigate and take steps to ensure it is not repeated.

Standard V: Investment Analysis, Recommendations, and Actions standard-V

A. Diligence and Reasonable Basis

Standard V(A): Members and Candidates must: a. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions. b. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.

Core Concept: Do your homework. Your recommendations must be based on thorough and independent research.

DeFi Application:

  • Smart Contract Diligence: Before recommending a DeFi protocol, an analyst must have a reasonable basis for their recommendation. This should include reviewing the smart contract audits, understanding the protocol’s economic model, and assessing the development team’s experience. Simply relying on a high APY is not sufficient diligence.
  • Third-Party Research: An analyst can use research from a third-party crypto analytics firm, but they must first perform due diligence to ensure the provider’s research process is sound.

Examples:

  1. Quantitative Models: If using a quantitative model, you must understand its assumptions and limitations.
  2. Group Research: If you are part of a research team, you do not have to agree with the team’s consensus opinion, but you must believe the team’s research process had a reasonable and adequate basis.

Recommended Procedures for Compliance:

  • Written Guidance: Develop written procedures for what constitutes adequate due diligence for different types of investments.
  • Review of Providers: Establish a process for reviewing and approving third-party research providers.

B. Communication with Clients and Prospective Clients

Standard V(B): Members and Candidates must: a. Disclose to clients and prospective clients the basic format and general principles of the investment processes they use. b. Promptly disclose any changes that might materially affect those processes. c. Use reasonable judgment in identifying which factors are important to their investment analyses and include those factors in communications. d. Distinguish between fact and opinion in the presentation of investment analysis and recommendations.

Core Concept: Communicate clearly and honestly with clients. They need to understand your investment process, its risks, and its limitations. Always distinguish between facts and your opinions.

DeFi Application:

  • Process Disclosure: An advisor using a complex, multi-step yield farming strategy must explain the general principles of this strategy to clients, including the types of protocols used, the risks of each step (e.g., smart contract risk, impermanent loss), and how assets are moved between protocols.
  • Fact vs. Opinion: An analyst’s report should state facts, such as “The protocol’s Total Value Locked (TVL) is $500 million.” It should state opinions as opinions, such as “In my opinion, the protocol’s token is currently undervalued.”

Examples:

  1. Change in Process: A firm decides to replace its proprietary stock-picking model with a new one. This is a material change that must be communicated to all clients.
  2. Risk Disclosure: When recommending a leveraged investment, the risks of leverage must be clearly explained.

Recommended Procedures for ‘Compliance:

  • Regular Updates: Keep clients informed of any material changes to your investment philosophy or process.
  • Clear Communication: Ensure all client communications are clear, concise, and easy to understand.

C. Record Retention

Standard V(C): Members and Candidates must develop and maintain appropriate records to support their investment analyses, recommendations, actions, and other investment-related communications with clients and prospective clients.

Core Concept: Keep good records. You need to be able to support your work and show your reasoning.

DeFi Application:

  • On-Chain and Off-Chain Records: An analyst’s research records for a DeFi protocol should include not only their own notes and models but also links to relevant on-chain transactions, governance proposals, Discord discussions, and smart contract audit reports.
  • Social Media: If an analyst uses Twitter to communicate with clients, those communications must be archived in accordance with firm and regulatory policy.

Examples:

  1. Leaving a Firm: The records you create as an employee belong to your employer. You cannot take them with you to a new firm without permission.
  2. Retention Period: In the absence of specific regulatory guidance, Finance recommends retaining records for at least seven years.

Recommended Procedures for Compliance:

  • Firm Policy: Understand and follow your firm’s record retention policy, whether for physical or electronic records.
  • Archiving: Ensure all client communications, including emails and social media, are properly archived.

Standard VI: Conflicts of Interest standard-VI

A. Disclosure of Conflicts

Standard VI(A): Members and Candidates must make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer. Disclosures must be prominent, in plain language, and communicate the relevant information effectively.

Core Concept: Disclose all actual and potential conflicts of interest. This allows clients and employers to judge your objectivity for themselves. The 2023 revision to Standard VI(A) renamed this “Avoid or Disclose Conflicts,” emphasizing that avoidance is preferred when possible. exam-focus compliance

DeFi Application:

  • Personal Token Holdings: An analyst writing a research report on a token must disclose if they personally own that token.
  • DAO Relationships: A consultant advising a DAO on its treasury management must disclose if they are also an advisor to a protocol that the DAO is considering investing in.
  • Referral Fees: A crypto exchange that pays influencers to refer new users must ensure that the influencers disclose this referral arrangement to their audience.

Examples:

  1. Board Membership: An analyst who sits on the board of directors of a company must disclose this in any research report they write about that company.
  2. Broker-Dealer Relationships: A brokerage firm that makes a market in a stock must disclose this to clients who buy or sell that stock.

Recommended Procedures for Compliance:

  • Prominent Disclosure: Make disclosures in a way that is easy for clients to see and understand, not buried in legal boilerplate.
  • Update Disclosures: Update disclosures whenever new conflicts arise or existing ones change.

B. Priority of Transactions

Standard VI(B): Investment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner.

Core Concept: Clients and employers trade first. You cannot act on investment information for your personal benefit before your clients have had the opportunity to do so.

DeFi Application:

  • Front-Running: An analyst at a crypto research firm is about to publish a “strong buy” recommendation for a small-cap token. They cannot buy the token for their personal account just before the report is released. This is front-running.
  • Family Accounts: This standard applies to accounts you have a “beneficial interest” in, which includes accounts of your spouse and children. You cannot trade in their accounts before your clients’ trades are executed.

Examples:

  1. IPO Allocations: If an IPO is oversubscribed, a manager cannot allocate shares to their personal account while their clients’ orders go unfilled.
  2. Personal Liquidity Needs: If you need to sell a stock for personal reasons (e.g., a down payment on a house) at the same time your firm is recommending clients buy it, you must still prioritize client transactions.

Recommended Procedures for Compliance:

  • Blackout/Restricted Periods: Prohibit personal trading before and immediately after client trades.
  • Preclearance: Require employees to get pre-approval for all personal trades.

C. Referral Fees

Standard VI(C): Members and Candidates must disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.

Core Concept: Disclose any fees you receive for referring clients or that you pay for being referred clients. This allows all parties to understand the full cost of the services and any potential biases.

DeFi Application:

  • Affiliate Links: An influencer who posts an “affiliate link” to a new DeFi platform (where they get a percentage of the trading fees from anyone who signs up through their link) must clearly disclose this arrangement.
  • Interdepartmental Referrals: A private banker who gets a bonus for referring a client to the bank’s crypto asset management division must disclose this fee to the client at the time of the referral.

Examples:

  1. Nature of Compensation: The disclosure must include the nature of the fee (e.g., flat fee, percentage of assets) and its estimated value.
  2. Timing: Disclosure must be made before the client enters into a formal agreement.

Recommended Procedures for Compliance:

  • Employer Approval: Encourage your firm to develop procedures for approving referral fee arrangements.
  • Client Notification: Provide clients with written notification of any approved referral fee programs.

Standard VII: Responsibilities as a Finance Member or Candidate standard-VII

A. Conduct as Participants in Finance Certifications

Standard VII(A): Members and Candidates must not engage in any conduct that compromises the reputation or integrity of Finance or the finance designation or the integrity, validity, or security of Finance programs.

Core Concept: Don’t cheat or do anything else that would damage the integrity of the Finance Certification.

Examples:

  1. Sharing Exam Questions: You cannot share what was on the exam with anyone. This includes specific questions or even broad topic areas that were heavily tested.
  2. Violating Rules: Bringing a non-approved calculator into the exam room is a violation.
  3. Volunteer Conduct: Using your volunteer position at a local finance society to promote your own business over others is a violation.

B. Reference to Finance, the finance designation, and the Finance Certification

Standard VII(B): When referring to Finance, Finance membership, the finance designation, or candidacy in the Finance Certification, Members and Candidates must not misrepresent or exaggerate the meaning or implications of membership in Finance, holding the finance designation, or candidacy in the Finance Certification.

Core Concept: Be truthful and accurate when referring to your status as a member or candidate.

Examples:

  1. Partial Designation: You cannot claim to have a “partial finance” or be a “Finance Certification II”.” If you have passed all three exams but have not yet met the work experience requirement, you can state that fact, but you cannot use the finance designation.
  2. Implying Superior Performance: You cannot state or imply that finance certificationholders achieve superior investment returns. You can state that the program enhances your skills.
  3. Candidacy: You are only a “candidate” if you are registered to sit for a specific upcoming exam. If you passed Level I but are not registered for Level II, you are not currently a candidate.

Practice Problems & Mini-Cases exam-focus

These scenarios test your ability to identify the applicable Standard and determine proper conduct. For additional practice, see Topic 5.

  1. Scenario: An analyst at a crypto research firm is offered a significant allocation of a new, unreleased token from a project they cover. The project team says it’s a “thank you” for their fair coverage. What standard is most at risk, and what should the analyst do?

    • Answer: Standard I(B) Independence and Objectivity. Accepting the tokens could compromise, or appear to compromise, the analyst’s objectivity. The analyst should decline the allocation. If their firm has a gift policy, they should consult it, but a significant private allocation would almost certainly violate it.

  2. Scenario: A portfolio manager discovers a new DeFi protocol that offers an extremely high, but risky, APY. They invest a small portion of their most aggressive client’s portfolio into the protocol, consistent with the client’s high-risk tolerance. They do not, however, invest any funds from their retired, risk-averse clients. Has the manager violated any standards?

    • Answer: The manager has likely acted in accordance with Standard III(C) Suitability. They considered the specific risk tolerance and objectives of each client. The investment was suitable for the aggressive client but not for the risk-averse clients. Judging the investment in the context of the total portfolio and the client’s specific needs is key.

  3. Scenario: A developer leaves her job at a major DeFi protocol (Firm A) to join a competitor (Firm B). Before leaving, she copies the code for a proprietary analytics tool she built while at Firm A. She believes this is acceptable because she wrote the code herself. Is she in violation of the standards?

    • Answer: Yes, she has violated Standard IV(A) Loyalty. The code she wrote as an employee of Firm A is the property of Firm A. Taking it to a new employer without permission is misappropriation of her former employer’s property.

  4. Scenario: An analyst posts on a public forum: “Just finished my research on XYZ token. My model shows it’s going to $5, a 3x from here. This is a fact.” Which standard has the analyst violated?

    • Answer: Standard V(B) Communication with Clients and Prospective Clients. The analyst has failed to distinguish between fact and opinion. The output of their model is an opinion or projection, not a fact.

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