CFA Practice Question

CFA Practice Question

Kruskal Meriwether is a senior research analyst with Bellwether Advisors. He has been following Crystals & Candles a publicly traded firm which makes high-quality diamond jewelry. Kruskal, after extensive interviews with senior management at Crystals, has inferred that the firm is about to take over a diamond-mining firm in South Africa at a rock-bottom price. The Crystal management has refused to explicitly confirm or deny this but Kruskal firmly believes that such a deal is in the works. He has not used any inside information; just pieced together information from various avenues to come to this conclusion.

In his reports, he states, "All my research seems to indicate that Crystal & Candles is likely to buy a South African diamond producer at a bargain price. Clearly, now is the time to buy Crystal and Candles' stock." 2 weeks after his report is released, Crystal's management announces that it has no intentions of making any acquisitions in the near future. This leads to a 7% decline in Crystal's stock, causing a large decline in the account's of Kruskal's clients.

Kruskal has

A. violated Standard V (A) - Diligence and Reasonable Basis.
B. not violated any CFA Institute code in this incident.
C. violated Standard III (C) - Suitability.
Explanation: Kruskal's recommendations were not based on whim, unsubstantiated rumors or inside information. It is clear that he put in much research behind his recommendation. The fact that his recommendation turned out to an incorrect choice ex post does not mean he was negligent. An investment advisor cannot be expected to be correct 100% of the time. What is expected of them is professional competence and diligence. Nothing in this incident indicates that Kruskal lacked either of these.

User Contributed Comments 9

User Comment
heli Why not A, violation based on diligence? I thought the analyst's decision to recommend buy was too aggressive. It even mentioned "clearly, now it's time to buy".
psos "clearly, now is the time to buy" in reference to the fact that the probabality or expected value in acquiring the cheap diamond mine is not currently priced into the value of the the best time to act on this info is ASAP as you can't predict whether the market will pick up on the possibility as well and the actual share prices begins to merge closer to the potential price
sh21 I missed this question as well, because of the reasons heli mentioned
chantal I think A also. The text clearly states that the reseach from which he inferred that piece of info is LIMITED to management interviews. Once top management was questionned, it was not substantiated. I fail to see how discussion that are non public can be later refered to as reseach...
The nature of this info could only be found from his interviews as NO Financial analysis could possibly come up with what they MIGHT BUY one day.

Instaed the research report should have mentionned that although a good target exists which would enhance value , that based on discussions with management such had yet to confirmed... that way you let investors speculate...
bkballa why is suitability not violated? I figured that since this recommendation led to a subtantial decline in the client's portfolios, he did not consider the reccomendation in the overall context of the portfolio. Anyone made the same mistake?
soukhov yep
Mikehuynh I also picked A because of the word "infer".
GBolt93 It specifically states he pieced together the information from various avenues, and I assume infer was used to make it clearer that they didn't directly tell him, as that would be material non-public information. As for suitability, you can have risky portfolios that lose considerable amounts, doesn't necessarily mean they weren't suitable investments.
dbalakos He is an analyst and not a portfolio manager, so I think that just by mentioning risk characteristics of the security in his analysis he is covered in part of suitability. So, C is not correct
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