Standard I(C) Misrepresentation

Trust is the foundation of the investment profession. Investors must be able to rely on the statements and information provided to them by those with whom the investors have trusted their financial well-being. Honest communication is critical for capital markets to work efficiently. Investment professionals who make false or misleading statements not only harm investors but also reduce the level of investor confidence in the investment profession and threaten the integrity of capital markets as a whole.

Members and candidates must not misrepresent any aspect of their professional activities or investment practice, including, but not limited to, their qualifications or credentials, the qualifications or services provided by their firm, their performance record and the record of their firm, and the characteristics of an investment. Any misrepresentation made by a member or candidate relating to the member’s or candidate’s professional activities is a breach of this standard.

When communicating information about their professional activities, members and candidates must provide information and make disclosures that are accurate, timely, complete, and in plain language. The term “plain language” means language that is clear and concise, uses common words, and is not dominated by technical or obscure wording or jargon. Accurate language is truthful, free from error, and precise and is not incomplete, vague, or misleading. Timely communication means the statements are made or given with sufficient notice to allow those receiving the material to act on the information. Complete communications contain all facts and elements necessary and customary to convey the information.

A misrepresentation is any untrue statement or omission of a fact or any statement that is otherwise false or misleading. A member or candidate must not knowingly omit or misrepresent information or give a false impression about their professional activities in any communication, whether in written, electronic, or verbal form. In this context, “knowingly” means that the member or candidate either knows or should have known that the misrepresentation was being made or that omitted information could alter the investment decision-making process.

Written materials include but are not limited to research reports, underwriting documents, company financial reports, advertising material, market letters, newspaper articles, and books. Electronic communications include emails, texts, and information posted on the internet. Members and candidates should regularly monitor materials posted on websites and social media to ensure the information complies with this standard.

Members and candidates rely on models to identify new investment opportunities, develop investment vehicles, and produce investment recommendations and ratings. Although not every model can test for every factor or outcome, members and candidates must ensure that their analyses incorporate a broad range of assumptions—from very positive scenarios to extremely negative scenarios. The omission from the analysis of potentially negative outcomes or of levels of risk outside the norm may misrepresent the true economic value of the investment.

Members and candidates must exercise care and diligence when incorporating third-party information into their own work. Misrepresentations that result from using materials produced by outside parties become the responsibility of members and candidates when they incorporate that material into or make it part of their work. When providing information to clients from third parties, members and candidates share a responsibility for the accuracy of the marketing and distribution materials that pertain to the third party’s capabilities, services, and products.

Members and candidates must disclose their intended use of external third parties and must not represent the work of others as their own. Although the level of involvement of external third parties may change over time, appropriate disclosures by members and candidates are important to avoiding misrepresentations.

Most investments contain some element of risk that makes their return inherently unpredictable. Standard I(C) prohibits members and candidates from stating or implying that clients will obtain or achieve a rate of return that was generated in the past. Guaranteeing either a particular rate of return or preservation of investment capital (e.g., “I can guarantee that you will earn 8% on equities this year” or “I can guarantee that you will not lose money on this investment”) is also misleading to investors and a violation of this standard. Standard I(C) does not prohibit members and candidates from providing clients with information on investment products that have guarantees built into the structure of the product itself or for which an institution has agreed to cover any losses.

The performance benchmark selection process is another area where misrepresentations may occur. Members and candidates may misrepresent the success of their performance record through presenting benchmarks that are not comparable to their strategies. Further, clients can be misled if the benchmark’s results are not reported on a basis comparable to that of the fund’s or client’s results. Best practice is selecting the most appropriate available benchmark from a universe of available options. The transparent presentation of appropriate performance benchmarks is an important aspect in providing clients with information that is useful in making investment decisions.

However, Standard I(C) does not require that a benchmark always be provided in order to comply. Some investment strategies may not lend themselves to displaying an appropriate benchmark because of the complexity or diversity of the investments included. Furthermore, some investment strategies may use reference indexes that do not reflect the opportunity set of the invested assets—for example, a hedge fund comparing its performance with a “cash plus” basis. When such a benchmark is used, members and candidates must make reasonable efforts to ensure that they disclose the reasons behind the use of this reference index to avoid misrepresentations of their performance. Members and candidates should discuss with clients on a continuous basis the appropriate benchmark to be used for performance evaluations and any related fee calculations.

Reporting misrepresentations may also occur when valuations for illiquid or nontraded securities are available from more than one source. When different options are available, members and candidates may be tempted to switch providers to obtain higher security valuations. The process of shopping for values may misrepresent a security’s worth, lead to misinformed decisions to sell or hold an investment, and result in overcharging clients for advisory fees.

Members and candidates must take reasonable steps to provide accurate and reliable security pricing information to clients on a consistent basis. Changing pricing providers must not be based solely on the justification that the new provider reports a higher current value of a security. Consistency in the valuation process will improve the value of the security pricing information. Clients will likely have additional confidence that they were able to make an informed decision about continuing to hold these securities in their portfolios.

Members and candidates must ensure that all communications on social media regarding their professional activities adhere to the requirements of the Code and Standards. The perceived anonymity granted through these platforms may entice individuals to misrepresent their qualifications or abilities or those of their employer. Actions undertaken through social media that knowingly misrepresent investment recommendations or professional activities are violations of Standard I(C).

The omission of a fact or outcome can be misleading, especially in the use of models and technical analysis processes. Members and candidates may rely on such models and processes to look for new investment opportunities, to develop investment vehicles, and to produce investment recommendations and ratings. When inputs are knowingly omitted, the resulting outcomes may provide misleading information to those who rely on information for making investment decisions. Additionally, the outcomes from models must not be presented as fact, because they represent the expected results based on the inputs and analysis process incorporated.

Omissions in the performance measurement and attribution process can also misrepresent a manager’s performance and skill. Members and candidates must not misrepresent performance history by engaging in practices that distort past investment performance (e.g., cherry-picking the highest-performing accounts and presenting them as representative of a strategy).

Standard I(C) also prohibits plagiarism in the preparation of material for distribution to employers, associates, clients, prospects, or the general public. Plagiarism is defined as copying or using in substantially the same form materials prepared by others without acknowledging the source of the material or identifying the author and publisher of such material. Members and candidates must not copy (or represent as their own) original ideas or material without permission and must acknowledge and identify the source of ideas or material that is not their own.

The investment profession uses a myriad of financial, economic, and statistical data in the investment decision-making process. Through various publications and presentations, the investment professional is constantly exposed to the work of others and to the temptation to use that work without proper acknowledgment.

Misrepresentation through plagiarism in investment management can take various forms. The simplest and most flagrant example is to take a research report or study done by another firm or person, change the names, and release the material as one’s own original analysis. This action is a clear violation of Standard I(C). Other practices include (1) using excerpts from articles or reports prepared by others either verbatim or with only slight changes in wording without acknowledgment, (2) citing specific quotations as attributable to “leading analysts” and “investment experts” without naming the specific references, (3) presenting statistical estimates of forecasts prepared by others and identifying the sources but without including the qualifying statements or caveats that may have been used, (4) using charts and graphs without stating their sources, and (5) copying proprietary spreadsheets or algorithms without seeking the cooperation or authorization of their creators.

In the case of distributing third-party, outsourced research, members and candidates may use and distribute these reports as long as they do not represent themselves as the authors of such reports. Indeed, the member or candidate may add value for the client by sifting through research and repackaging it for clients. In such cases, clients should be fully informed that they are paying for the ability of the member or candidate to find the best research from a wide variety of sources. Members and candidates must not misrepresent their abilities, the extent of their expertise, or the extent of their work in a way that would mislead their clients or prospective clients. Members and candidates should disclose whether the research being presented to clients comes from another source, from either within or outside the member’s or candidate’s firm. Such disclosure allows clients to understand who has the expertise behind the report or whether the work is being done by the analyst, other members of the firm, or an outside party.

The preparation of research reports based on multiple sources of information without acknowledging the sources is a violation of this standard. Examples of information from such sources include ideas, statistical compilations, and forecasts combined to give the appearance of original work. Although there is no monopoly on ideas, members and candidates must give credit where it is clearly due. Sources must be revealed to bring the responsibility directly back to the author of the report or the firm involved.

In some situations, however, members or candidates may use research conducted or models developed by others within the same firm without committing a violation. The most common example relates to the situation in which one (or more) of the original analysts is no longer with the firm. Research and models developed while employed by a firm are the property of the firm. The firm retains the right to continue using the work completed after a member or candidate has left the organization. The firm may issue future reports without providing attribution to the prior analysts. A member or candidate must not, however, reissue a previously released report solely under his or her name.

Members and candidates can prevent unintentional misrepresentations of the qualifications or services they or their firms provide if each member and candidate understands the limit of the firm’s or individual’s capabilities and the need to be accurate and complete in presentations.

Whether or not their employer provides guidance, members and candidates must make certain that they understand the services the firm performs and its qualifications and disclose that information without misrepresentation. Each member and candidate should prepare a summary of his or her own qualifications and experience and a list of the services the member or candidate is capable of performing.

Members and candidates should regularly monitor materials and content posted online or through social media to ensure that they contain current information. Members and candidates who publish content through websites should also ensure that all reasonable precautions have been taken to protect the website’s integrity, confidentiality, and security and that the website does not misrepresent any information and provides full disclosure.

To avoid plagiarism in preparing research reports or conclusions of analysis, members and candidates should take the following steps:

• Maintain copies: Keep copies of all research reports, articles containing research ideas, material with new statistical methodologies, and other materials that were relied on in preparing the research report.
• Attribute quotations: Attribute to their sources any direct quotations, including projections, tables, statistics, model/product ideas, and new methodologies prepared by persons other than recognized financial and statistical reporting services or similar sources.
• Attribute summaries: Attribute to their sources any paraphrases or summaries of material prepared by others.

(Example 17 added January 2019)

Rogers is a partner at Rogers and Black, a small firm offering investment advisory services. She assures a prospective client who inherited a portfolio worth US$1 million that “we can perform all the financial and investment services you need.” Rogers and Black is well equipped to provide investment advice but, in fact, cannot provide a full array of financial and investment services, such as tax planning.

McGuire is an issuer-paid analyst hired by publicly traded companies to electronically promote their stocks. McGuire creates a website that promotes his research efforts as a seemingly independent analyst. McGuire posts a profile and a strong buy recommendation for each company on the website, indicating that the stock is expected to increase in value. He does not disclose the contractual relationships with the companies he covers on his website, in the research reports he issues, or in the statements he makes about the companies in internet chatrooms.

Yao is responsible for the creation and distribution of the marketing materials for his firm, which claims compliance with the GIPS standards. Yao creates and distributes a presentation of performance for the firm’s Asian Equity Composite that states the composite has ¥350 billion in assets. In fact, the composite has only ¥35 billion in assets, and the higher figure on the presentation is a result of a typographical error. Nevertheless, the erroneous material is distributed to a number of clients before Yao catches the mistake.

Muhammad is the president of an investment management firm. The promotional material for the firm, created by the firm’s marketing department, incorrectly claims that Muhammad has an advanced degree in finance from a prestigious business school in addition to the CFA designation. Although Muhammad attended the school for a short period of time, he did not receive a degree. Over the years, Muhammad and others in the firm have distributed this material to numerous prospective clients and consultants.

Grant, a research analyst for a Canadian brokerage firm, has specialized in the Canadian mining industry for the past 10 years. She recently read an extensive research report on Jefferson Mining, Ltd., by Barton, an analyst at a different firm. Barton provided extensive statistics on the mineral reserves, production capacity, selling rates, and marketing factors affecting Jefferson’s operations. He also noted that initial drilling results on a new ore body, which had not been made public, might show the existence of mineral zones that could increase the life of Jefferson’s main mines, but Barton cited no specific data as to the initial drilling results. Grant called an officer of Jefferson, who gave her the initial drilling results over the telephone. The data indicated that the expected life of the main mines would be tripled. Grant added these statistics to Barton’s report and circulated it as her own report within her firm.

When Marks sells mortgage-backed derivatives called “interest-only strips” (IOs) to public pension plan clients, she describes them as “guaranteed by the US government.” Purchasers of the IOs are entitled only to the interest stream generated by the mortgages, however, not the notional principal itself. One particular municipality’s investment policies and local law require that securities purchased by its public pension plans be guaranteed by the US government. Although the underlying mortgages are guaranteed, neither the investor’s investment nor the interest stream on the IOs is guaranteed. When interest rates decline, causing an increase in prepayment of mortgages, interest payments to the IOs’ investors decline, and these investors lose a portion of their investment.

Abdrabbo manages the investments of several high-net-worth individuals in the United States who are approaching retirement. Abdrabbo advises these individuals that a portion of their investments should be moved from equity to bank-sponsored certificates of deposit and money market accounts so that the principal will be “guaranteed” up to a certain amount. The interest is not guaranteed.

Swanson is a senior analyst in the investment research department of Ballard and Company. Apex Corporation has asked Ballard to assist in acquiring the majority ownership of stock in the Campbell Company, a financial consulting firm, and to prepare a report recommending that stockholders of Campbell agree to the acquisition. Another investment firm, Davis and Company, had already prepared a report for Apex analyzing both Apex and Campbell and recommending an exchange ratio. Apex has given the Davis report to Ballard officers, who have passed it on to Swanson. Swanson reviews the Davis report and other available material on Apex and Campbell. From his analysis, he concludes that the common stocks of Campbell and Apex represent good value at their current prices; he believes, however, that the Davis report does not consider all the factors a Campbell stockholder would need to know to make a decision. Swanson reports his conclusions to the partner in charge, who tells him to “use the Davis report, change a few words, sign your name, and get it out.”

Browning, a quantitative analyst for Double Alpha, Inc., is excited after returning from a seminar. In that seminar, Jorrely, a well-publicized quantitative analyst at a national brokerage firm, discussed one of his new models in great detail, and Browning is intrigued by the new concepts. He proceeds to test the model, making some minor changes but retaining the concepts, until he produces some very positive results. Browning quickly announces to his supervisors at Double Alpha that he has discovered a new model and that clients and prospective clients should be informed of this positive finding as ongoing proof of Double Alpha’s continuing innovation and ability to add value.

Zubia would like to include in his firm’s marketing materials some “plain-language” descriptions of various concepts, such as the price-to-earnings (P/E) multiple and why standard deviation is used as a measure of risk. The descriptions come from other sources, but Zubia wishes to use them without reference to the original authors.

Through a mainstream media outlet, Schneider learns about a study that she would like to cite in her research. She questions whether she should cite both the mainstream intermediary source and the author of the study itself when using that information.

Ostrowski runs a two-person investment management firm. His firm subscribes to a service from a large investment research firm that provides research reports that can be repackaged by smaller firms for those firms’ clients. Ostrowski’s firm distributes these reports to clients as its own work.

Stafford is part of a team at Appleton Investment Management responsible for managing a pool of assets for Open Air Bank, which distributes structured securities to offshore clients. He becomes aware that Open Air is promoting the structured securities as a much less risky investment than the investment management policy followed by himself and the team to manage the original pool of assets. Also, Open Air has procured an independent rating for the pool that significantly overstates the quality of the investments. Stafford communicates his concerns to his supervisor, who responds that Open Air owns the product and is responsible for all marketing and distribution. Stafford’s supervisor goes on to say that the product is outside the US regulatory regime that Appleton follows and that all risks of the product are disclosed at the bottom of page 184 of the prospectus.

Palmer is head of performance for an investment manager. When asked to provide performance numbers to databases, he avoids disclosing that the firm excludes from composites accounts that have underperformed their benchmark. The composite returns reported to the databases, although accurate for the accounts that have not underperformed their benchmark, do not present a true representation of the investment manager’s track record.

Finch is a sales director at a commercial bank, where he directs the bank’s client advisers in the sale of third-party mutual funds. Each quarter, he holds a division-wide training session where he provides fact sheets on investment funds the bank is allowed to offer to clients. These fact sheets, which can be redistributed to clients, are created by the mutual fund firms and contain information about the funds, including investment strategy and target distribution rates. Finch knows that some of the fact sheets are out of date; for example, one long-only fund approved the use of significant leverage last quarter as a method to enhance returns. He continues to provide the sheets to the sales team without updates because the bank has no control over the marketing material released by the mutual fund firms.

Lowery manages the Majesty Fund, which was established in 2018 and has become one of the leading Asian environmental, social, and governance (ESG) funds. The fund’s mandate is to seek sustainable wealth creation. Lowery uses ESG scores provided by third-party rating organizations to assess potential investments for the fund. The fund declares in promotional material and client agreements that it engages in proactive engagement and proxy voting for companies owned by the fund to create sustainable growth. However, Lowery has done neither of these activities. As a result, the fund has never published its detailed engagement reports that include its engagement strategy and its outcomes. Moreover, there has been no clear communication by the fund regarding its proxy voting and its consequences.

For many years, Stafford was a partner at Lionsgate LLP, a large, full-service accounting firm that provides audit and other services, primarily in the area of investment performance. She leaves Lionsgate, with a junior associate, to form her own firm, Angelwood Analytics. Angelwood’s website, social media, and print marketing heavily emphasize Stafford’s expertise and experience and state that Stafford will be personally involved in all client work. Angelwood’s clients are small at first, but eventually Stafford attracts several large clients. To service these larger clients, she transitions to an oversight role and hires new staff to work with her longtime clients. Business becomes so successful that Stafford resorts to hiring third-party contractors that eventually provide support for over 50% of Angelwood’s work. The staff she uses are qualified, industry practice allows use of third-party contractors for the work, and Angelwood’s client agreement states that staffing decisions for each client are discretionary for the firm.

For the past two decades, Huggins has managed an investment advisory firm catering to retail clients and high-net-worth individuals. Overall, the investment performance history of the firm for the past five years has been satisfactory, but since the onset of the global pandemic, performance has dropped appreciably. On the firm’s website, Huggins provides the five-year performance history of the fund as a way to convince potential clients to hire his firm for advisory services. He does not update the information on the website to clarify that the performance history since the beginning of the pandemic has been less than stellar, even though that information is available.

Hamilton is a research analyst for a private equity fund focused on impact investing in the ESG space. Hamilton creates several research reports to distribute to potential investors that generally demonstrate and describe the process the fund goes through when choosing ESG investments. The reports for potential investors are not as detailed as the research reports provided to investors once they commit to investing in the fund. After committing US$50 million to the fund, one investor, a charitable foundation, receives the more detailed reports. The chief investment officer of the foundation is unhappy that the private equity fund seems overweighted in developing technology and therefore represents a riskier investment than was indicated by the more general information initially provided by Hamilton.

The sovereign wealth fund of a developing country is seeking an investment manager to manage a portion of the fund’s assets. The fund’s directors want to take advantage of the efficiencies, innovation, and increased profitability they believe are available through the use of artificial intelligence (AI) tools in the investment process. As such, they include several questions on the use of artificial intelligence on the request for proposal (RFP) sent out to potential managers. Al-Wazir, CEO of AWZ Investment Advisers, is intent on being competitive in the fund’s manager search, even though his firm is just beginning to explore AI to enhance investment performance. Wanting to provide a seemingly thorough and knowledgeable answer, he uses ChatGPT to complete the portion of the RFP asking for a narrative of how each responding manager incorporates AI in its investment process.