CFA ethics is one of the most important topic areas in the CFA program. It represents 15% in Level 1, and 10-15% in Level 2 and Level 3. A good performance in ethics can also earn you a pass in case you score at the borderline.
CFA Level 1 Ethics
The exam content includes the CFAI Professional Code Program and Global Investment Performance standards (GIPS). You are expected to know the codes and standards, as well as the enforcement, application and recommended procedures.
CFA Level 2 Ethics
The coverage is around 80% the same as Level 1. The difference is three extra short sessions: soft dollar standard, research standard, and prudent investment rules.
It represents 10-15% of the Level 2 exam, meaning you can expect to see 2-3 ethics questions.
In terms of format, the multiple choice should look very similar. They are however presented in item sets and can make for some confusing scenarios. Also, be prepared to differentiate between what is recommended and what is required.
CFA Level 3 Ethics
Again, the exam content is pretty much the same as those in Level 1 and 2, but questions are more complex. You could have the ethics book in front of you for the exam and there would still be some indecision on the correct answers.
Level 3 Ethics tends to focus more on procedures for avoiding breaches of ethics and for handling breaches of ethics. It also adds the Asset Manager’s Code of Conduct.
CFA Level 1 Ethics Tips
Ethics could be dry and boring, but it is tested in all 3 levels and too important to be ignored.
1. Prepare to Read Ethics Multiple Times
Ethics questions are subtle and ambiguous, and it takes a fair bit of time to get it locked down. The good news is that once you do, you get payback for it in Level 2 and Level 3. A lot of the ethics material is the same across levels.
Repetition will get you thinking about it the right way. Try doing some questions every day over many weeks instead of cramming it at the end.
2. Know the CFA Ethics Standards
Here are the 7 Standards of Conduct:
- Integrity of capital markets
- Duties to clients
- Duties to employers
- Investment analysis, recommendations, and actions
- Conflicts of interest
- Responsibilities as a CFA Institute member or CFA candidate
You are expected to know what the standards stand for, and be able to differentiate them. For example, there will likely be questions on “which standard is…” and you should be able to pick the correct one from the possible choices.
3. Differentiate the CFA Codes of Ethics from the Standards
In addition to the Standards, we have the following CFA Code of Ethics:
- Act with integrity, competence, diligence, respect
- Client interest first
- Use reasonable care and exercise independent professional judgment
- Practice and encourage others
- Promote integrity of capital markets
- Maintain and improve professional competence
Now, candidates start to get confused — which ones are the standards and which are the codes? Remember this:
The Standards tell you what to do, and the Code tells you how to do it.”
4. Don’t Blindly Memorize
CFA Level 1 ethics does require a little bit more memorization because there are some industry-specific situations (e.g. the Standards and Codes) that are hard to generalize.
Having said that, you definitely don’t need to remember things like the numbering (e.g. what is II(B) of the Code). You should figure out how the logic works, such as what is permitted and not permitted instead of memorizing a bunch of rules.
5. Read Examples to Develop Your “Ethics Intuition”
The best way to do this is to go through all examples. Each example is a scenario of an underlying standard. It is the best place to learn how to recognize if an action is in compliance or not with a certain standard.
Also, work on all the ethics questions you can find, then read the explanatory answers for both correct and incorrect answers. You will slowly but surely get the hang of it, developing your “ethics intuition” in the process.
6. Think like a Lawyer
I have two readers who find ethics really easy and score >70% in their exams. Both have training in law schools.
Law school students are taught how to understand the law and go through various mental tests to determine if there is a violation and more importantly, what specific action in the whole chain of events caused the line to be crossed.
This technique is known as the IRAC — issue, rule, application, conclusion. I believe it’s an excellent tool to solve ethics questions.
Bonus CFA Ethics Study Tips for Level 2 and 3
The tips above apply to all levels, but here are additional ones for L2 and L3:
1. Don’t Rush when Reading the Vignette
When you go through the examples and EOCs, read the vignette and questions very, very carefully, and take them slowly.
2. Mark Key Information
You should be able to identify key info, violations or questionable behaviors. Make a note on the side of the page of the violation, underline or put a question mark. This will help you find the paragraph fast when you go back to verify info with each question asked.
3. Pick the More Conservative Answer
When you really can’t figure out, go for the more conservative answer.
Best Materials for CFA Level 1 Ethics
For CFA level 1 ethics on the standards, there is no substitute for the original material from CFA Institute. The curriculum goes through more ethically ambiguous situation than the Schweser book does.
For GIPS, some readers find Schweser good enough but I might as well study the entire ethics section based on CFAI text. It takes longer but CFAI text is more thorough and uses the same terminologies as in the exam.
Once you are done with your initial reading from CFAI text, revisions using other third-party providers can be productive.
Wiley Elan’s audio and videos are great to clarify concepts. This is especially useful when you reach Level 2 and Level 3.
I recommend sticking with the CFAI EOC as your core set of questions. The Schweser Qbank tends to ask about your high level knowledge of the ethics, while CFAI EOC questions go much deeper.
The Ethics Adjustment
One big incentive to do well in this topic area is this rule known as the “Ethics Adjustment”. Quoting from the CFAI website:
The Board of Governors instituted a policy to place particular emphasis on ethics. Starting with the 1996 exams, the performance on the ethics section became a factor in the pass/fail decision for candidates whose total scores bordered the minimum passing score. The ethics adjustment can have a positive or negative impact on these candidates’ final results.”
While the Ethics Adjustment has a net positive effect on candidate scores in most exam sessions, it only applies to borderline candidates. For example, if you score <50% in most topic areas, a >70% in ethics won’t save you. At the same time, you can fail ethics and still pass if you do well in other topic areas.
The CFA ethics section does not build on other topics. Because of this, some candidates procrastinate till the very end. Don’t do that.
To make life easier for you, remember this:
- Remember the macro – the Standards, the Codes and what they stand for. Don’t bother to memorize the micro concepts.
- Once you know the Standards, Ethics is a very logical topic. Simply overlay the Standards over any problem and figure out which Standard is violated or not.
- Use the mental checklist: Are they really doing something wrong? if yes, what rule covers it? What does the rule say and how does it apply to this situation? Use the IRAC and develop your ethics intuition.
For Your Further Reading
- Should I study in the order of the CFA curriculum book (i.e. Ethics first?)
- CFA pubs on Code of Ethics and Standards of Professional Conduct
- Reddit discussion on CFA ethics in Level 1
Here are more tips on these topic areas: