Level II Version 2_v11 2013 Sample ExamClick
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1Jacob Kostecka Case Scenario
Jacob Kostecka, CFA, is a portfolio manager at Forkson Investment Management (FIM), an asset
management and research focused organization. After obtaining his CFA charter last month, Kostecka was
transferred to the private wealth management group.
One of Kostecka’s clients, Dharshi Bope, was involved in a major motorcycle accident and is in critical
condition fighting for his life. Bope is a single parent with a daughter in her mid-twenties, Praveen Nathoo.
Since the accident, Nathoo has managed her father’s affairs paying all expenses, including investment
advisory fees. In several conversations with Nathoo, Kostecka highlighted Bope’s low risk tolerance and
investment goal of capital preservation. Nathoo has indicated her interest in managing the account more
aggressively and possibly moving it to another management firm. Nathoo recently petitioned the court to
appoint her full power of attorney to legally manage Bope’s affairs. Prior to the court decision, Nathoo asks
Kostecka to invest her father’s account in the initial public offering (IPO) of Chatterbox, a highly sought-
after social media company that has yet to generate a profit.
The following week, the court approves Nathoo’s request to act on behalf of her father. Going through
records in her father’s home, Nathoo discovers documents showing Bope embezzled several million dollars
from his employer, a real estate development company. Most of these funds were placed directly into Bope’s
personal account for which Nathoo is now responsible. Nathoo informs Kostecka about her discovery;
however, Kostecka does not act on this information given that this is a large account for FIM.
A month later, Kostecka joins Chatterbox’s board. Based on his knowledge of the company, Kostecka
believes the stock is a good investment, even though Chatterbox is not yet profitable. Buoyed by his faith in
Chatterbox, Kostecka ultimately purchases shares of the company’s IPO for Nathoo’s account, as well as for
all clients he currently manages. When Kostecka informs Nathoo about the purchase, she shares her concern
about her legal responsibilities and lack of accounting knowledge in overseeing the account. Kostecka
provides Nathoo a list of recommended professionals he has worked with in the past, including attorneys
and accountants. When he was in college ten years earlier, Kostecka was engaged to one of the attorneys
but broke off the relationship before their wedding, while one of the accountants was Kostecka’s college
roommate. Since then, Kostecka has not had any contact with the lawyer and the accountant.
The Chatterbox investment is profitable on the first day of trading, as the shares double from their opening
price. Kostecka tells his clients the multifactor valuation model used by FIM shows Chatterbox stock is
still undervalued and FIM’s research report, due out the next day, will recommend investors hold their
Chatterbox shares. However, Kostecka also tells his clients they should sell their shares because he believes
Chatterbox is overvalued and the stock price will fall soon. Kostecka notes he has followed through on this
belief by selling his personal holdings of Chatterbox shares. Nathoo ignores Kostecka’s recommendation to
sell Chatterbox. Over the next week, the stock declines 75%.
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1Jacob Kostecka Case Scenario (continued)
Watching Chatterbox’s severe share price decline, Nathoo becomes furious with Kostecka because he
did not sell shares of Chatterbox in Bope’s account. She files a complaint with Kostecka’s supervisor,
Sally Fang, CFA, claiming she was misled on the value of the IPO in the days immediately after the stock
started trading. Kostecka responds to the complaint by telling Fang, “the analyst who wrote the hold
recommendation on Chatterbox has only passed his CFA Level II examination. As a charterholder, I have
earned the right to use the CFA designation, so I am more qualified to manage clients’ investments.”
In order to build his client base, Kostecka prepares performance information that he plans to show
prospective clients. He includes the firm’s composite performance based on similar client portfolios that
meet the CFA Institute GIPS Standards. In addition, Kostecka prepares his own composite performance,
including all accounts he manages. This presentation includes Nathoo’s account assuming she had sold
her shares of Chatterbox. Along with his performance record, Kostecka provides a footnote disclosing the
following language: “If your account is managed on a discretionary basis, you might expect results similar
to those shown above.”
Question
Regarding the investment request made by Nathoo to invest in Chatterbox, Kostecka should most likely:
Feedback
“Guidance for Standards I–VII,” CFA Institute
2013 Modular Level II, Vol. 1, Reading 2, Standard III (A) Loyalty, Prudence, and Care, Guidance; Standard
III (C) Suitability, Guidance
Study Session 1-2-b
Recommend practices and procedures designed to prevent violations of the CFA Institute Code of Ethics and
Standards of Professional Conduct.
C is correct because the account should be managed according to the client’s investment goal of capital
preservation and a low risk tolerance. An investment in the IPO of an unprofitable social networking
company most likely does not meet Bope’s investment goal. The account should be managed as Bope
requested because he is still the client. The adviser must know whom his fiduciary responsibility is owed
to, in this case the father, and not who is currently paying his fee, the daughter. Under Standard III (A)
Loyalty, Prudence, and Care, the first step for Members and Candidates in fulfilling their duty of loyalty
to clients is to determine the identity of the “client” to whom the duty of loyalty is owed. Only when the
daughter is granted legal responsibility over her father’s affairs by the court does she become the client.
See also Standard III (C) Suitability, which requires that when Members and Candidates are in an advisory
relationship with a client, they must 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. This
Standard also requires Members and Candidates to determine that an investment is suitable to the client’s
financial situation and consistent with the client’s written objectives, mandates, and constraints before
making an investment recommendation or taking investment action.
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