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Scott LaRue is a portfolio manager for Washington Advisors. Washington has developed a
proprietary model that has been thoroughly researched and is known throughout the
industry as the Washington model. The model is purely quantitative and screens stocks into
buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to
clients. The director of research frequently alters the model based on rigorous research—an
aspect that is well explained to clients, although the specific alterations are not continually
disclosed. Portfolio managers then make specific sector and security holding decisions,
purchasing only securities that are indicated as "buys" by the model. La Rue feels the model
would be improved by adding some factors but he has not fully tested this new version of
the model. LaRue discloses his model to his own clients but not to his supervisor. LaRue is:
A)
violating the Standards by not having a reasonable and adequate basis for his
investment recommendation.
B) not violating the Standards.
C)
violating the Standards by not considering the appropriateness of the
recommendations to clients.
LMS Securities is a boutique broker-dealer specializing in private placements for technology
companies. The firm also provides aftermarket support for the companies that go public
after private rounds of financing. This support includes market making and research
coverage.
Susan Jones, CFA, is an analyst at LMS Securities. She is responsible for a subset of the
companies for which LMS offers research coverage. She recently received her annual CFA
Institute Professional Conduct statement, but has not yet filled it out and turned it in. Steve
Brown is an analyst who directs the due diligence process for LMS Securities' private
placements. Brown passed the Level II exam five years ago, and has registered for the Level
III exam every year since then, but has never taken it. He is registered for the Level III CFA
exam next June, but nobody at the office believes he will actually take the test.
Sunrise Technologies is a longtime client of LMS Securities. LMS arranged four levels of
private financing, for Sunrise, providing in-depth business consulting as well as handling all
of the private placements. Sunrise went public 90 days ago and is currently trading at $14
per share.
Kenneth Karloff, CEO of LMS Securities, instructed Jones to write a favorable research report
on Sunrise Technologies right before the company went public, setting a price target of at
least $30 per share. Jones has developed a number of alternative cash flow projections for
Sunrise Technologies. She picks an optimistic scenario to justify a $30 price target and issues
a positive report using those projections.
After Sunrise Technologies has gone public, Karloff decides to help Jones to write a more-
detailed research report on the company. Karloff provides Jones with information about the
product pipeline and sensitive patent litigation that was given to him in confidence by
Sunrise executives while the company was private. Given the product pipeline and legal
outlook, Jones revises her cash flow models to reflect greater growth, then writes a positive
report and advises LMS's clients to buy the stock.