Study guide
2.5 Application of the Code and Standards: Level II Case Method
CFA Level 2 Chartered Financial Analyst
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1 Introduction & CFA Level II Exam Strategy
1.1 CFA Level II Exam Overview & Item-Set Vignette Strategy 1.2 2026 Curriculum Structure & 10 Topic Weight Bands 1.3 300-Hour Study Plan, Calculator Mastery & Practical Skills Modules (PSM)
2 Ethical and Professional Standards
2.1 Code of Ethics & The Seven Standards of Professional Conduct 2.2 Vignette Analysis: Conflicts of Interest & Disclosure (Standard VI) 2.3 Duties to Clients (Standard III) & Duties to Employers (Standard IV) 2.4 Standard V: Investment Analysis, Recommendations & Actions and Standard VII: Responsibilities as a CFA Member or Candidate 2.5 Application of the Code and Standards: Level II Case Method 2.6 Recommended Procedures: Compliance Programs, Supervisory Systems & Firm Policies
3 Quantitative Methods
3.1 Multiple Linear Regression, ANOVA & Hypothesis Testing 3.2 Regression Diagnostics: Multicollinearity, Heteroskedasticity & Serial Correlation 3.3 Time-Series Analysis: AR Models, Nonstationarity & Cointegration 3.4 Machine Learning, Deep Learning & Big Data Projects 3.5 Extensions of Multiple Regression: Influence Analysis, Qualitative Variables & Logistic Regression 3.6 Big Data Projects: Wrangling, Exploration, Feature Engineering & Model Training
4 Economics for Valuation
4.1 Foreign Exchange Parity Relations & Equilibrium Exchange Rates 4.2 Economic Growth Theories & Production Function Analysis 4.3 Forward Points, the Carry Trade & Policy Effects on Exchange Rates 4.4 Growth Determinants: Natural Resources, Demographics, Convergence & Trade Openness
5 Financial Statement Analysis
5.1 Intercorporate Investments: Equity Method & Business Combinations 5.2 Employee Compensation: Defined Benefit Pension Plans & Share-Based Payments 5.3 Multinational Operations: Current Rate vs Temporal Translation 5.4 Analysis of Financial Institutions & The CAMELS Framework 5.5 Evaluating the Quality of Financial Reports & Accounting Adjustments 5.6 Integration of Financial Statement Analysis Techniques
6 Corporate Issuers
6.1 Analysis of Dividends: Policy Theories, Signaling & Taxation Systems 6.2 Share Repurchases: Methods, EPS and Book Value Effects & Payout Sustainability 6.3 Cost of Capital: Advanced Topics 6.4 Corporate Governance, Board Oversight & ESG Integration 6.5 Corporate Restructuring: Types, Motivations, Evaluation & Valuation 6.6 Restructuring Financial Effects: EPS, Net Debt to EBITDA, WACC & Divestitures
7 Equity Valuation
7.1 Equity Valuation Framework & Required Rate of Return Estimation 7.2 Discounted Dividend Valuation: Gordon Growth, Multistage & The H-Model 7.3 Free Cash Flow Valuation: FCFF and FCFE Modeling 7.4 Market-Based Valuation: Price and Enterprise Value Multiples 7.5 Residual Income Valuation 7.6 Private Company Valuation: Income, Market & Asset-Based Approaches 7.7 Choosing and Combining Models: Definitions of Value, Sum-of-the-Parts & Cross-Border Comparability
8 Fixed Income Analysis
8.1 The Term Structure and Interest Rate Dynamics: Spot, Forward & Swap Curves 8.2 The Arbitrage-Free Valuation Framework & Binomial Interest Rate Trees 8.3 Valuation and Analysis of Bonds with Embedded Options: OAS & Duration 8.4 Credit Analysis Models: Structural vs Reduced-Form Approaches 8.5 Credit Default Swaps (CDS): Mechanics, Pricing & Trading Strategies 8.6 Managing Yield-Curve Risk: Key Rate Durations, One-Sided Durations & Yield Volatility Structure
9 Derivatives & Risk Management
9.1 Pricing and Valuation of Forward Commitments: Equity, Fixed Income & FX 9.2 Swap Pricing and Valuation: Interest Rate, Currency & Equity Swaps 9.3 Contingent Claims: Binomial Option Pricing Model & Arbitrage Replication 9.4 The Black-Scholes-Merton (BSM) Model, Option Greeks & Dynamic Hedging 9.5 Interest Rate Options, Swaptions & the Black Model
10 Alternative Investments
10.1 Commodities and Commodity Derivatives: Sectors, Participants, Futures Returns & Indexes 10.2 Private Real Estate Investments: Direct Capitalization, DCF & Cost Approach 10.3 Public Real Estate Investments: REIT Structures, NAV, FFO & AFFO 10.4 Hedge Fund Strategies: Classification, Implementation & Portfolio Role 10.5 Real Estate Investment Features, Due Diligence & Index Construction Biases
11 Portfolio Management
11.1 Using Multifactor Models: Macroeconomic, Fundamental & Statistical Risk 11.2 Measuring and Managing Market Risk: VaR, CVaR & Stress Testing 11.3 Economics & Investment Markets: Business Cycles, Term Structure & Asset Allocation 11.4 Analysis of Active Portfolio Management & The Fundamental Law 11.5 Exchange-Traded Funds (ETFs): Creation, Arbitrage, Tracking & Applications 11.6 Backtesting and Simulation: Procedures, Metrics, Biases & Scenario Analysis
2.5 Application of the Code and Standards: Level II Case Method
Key Takeaways Explain This Topic AI
The "Application of the Code and Standards: Level II" learning module is tested as a case: candidates evaluate practices, policies, and conduct and then explain how each does or does not violate the Code and Standards.
Level II Ethics answers require identifying the specific sub-standard (for example III(B) Fair Dealing rather than "Standard III"), because distractors are usually adjacent sub-standards.
A firm policy can itself be the violation: an inadequate allocation policy, supervisory system, or disclosure document violates the Standards even before any client is harmed.
Disclosure never cures a prohibited act — material nonpublic information cannot be traded on with disclosure, and a prohibited referral arrangement is not repaired by telling the client afterwards.
When two Standards both appear to fit, the narrower and more specific one is the intended answer; general Professionalism is the fallback, not the default.
Last updated: August 2026
2.5 Application of the Code and Standards: Level II Case Method
Blueprint note: the third Ethics learning module at Level II is explicitly an application module. Its two learning outcomes ask you to evaluate practices, policies, and conduct relative to the Code and Standards and to explain how they do or do not violate them. That wording tells you the question format: a multi-actor narrative with several embedded actions, followed by four questions that each isolate one action.
1. The Structure of a Level II Ethics Item Set
A Level II Ethics vignette is typically one to two pages containing:
Two or three actors with different roles — a portfolio manager, a compliance officer, a research analyst, a supervisor;
A firm artefact — an allocation policy, a compensation arrangement, a disclosure document, a compliance manual, or a marketing brochure;
Four to six discrete actions , only some of which are violations;
At least one deliberate red herring : an action that looks unethical but is permitted, or one that looks routine but is not.
The four questions are independent. A common design is: one question on an actor's conduct, one on the firm's policy, one asking which action is least likely to violate, and one asking for the correct remedy or recommended procedure.
2. A Four-Step Reading Procedure
Step 1 — Map actors to duties. Write the actor's role beside each name as you read. Role determines which Standards can even apply. A supervisor imports Standard IV(C). Someone in possession of an issuer's unreleased earnings imports II(A). Someone paid by a third party for client referrals imports VI(C).
Step 2 — Tag each action with a sub-standard, immediately. Do not wait for the questions. Write "III(B)" or "V(A)" in the margin as you read. Level II distractors are adjacent sub-standards within the same Standard, so a tag of "Standard III" is not precise enough to answer with.
Step 3 — Separate policy defects from conduct defects. A vignette often contains a defective policy alongside compliant conduct , or vice versa. The Standards bind both. An allocation policy that fills the largest accounts first violates III(B) Fair Dealing even if no small client complains. A compliance manual with no personal-trading pre-clearance requirement is a VI(B) and IV(C) weakness before anyone front-runs anything.
Step 4 — Ask what would fix it. The Standards of Practice guidance for every Standard includes recommended procedures for compliance . Level II frequently asks for the remedy rather than the label, and the remedy is almost always a written policy, a pre-clearance or approval step, a disclosure, a firewall, or a record.
3. Tie-Break Rules When Two Standards Both Fit
Situation Standards that both seem to fit Intended answer Reason
Analyst trades ahead of a client order VI(B) Priority of Transactions; III(A) Loyalty, Prudence, and Care VI(B) The narrow rule governing personal transactions displaces the general fiduciary duty
Firm allocates an oversubscribed IPO to its largest accounts III(B) Fair Dealing; III(A) III(B) Fair Dealing is the specific Standard on differential treatment among clients
Manager buys an emerging-market fund for a conservative retiree III(C) Suitability; V(A) Diligence III(C) The defect is the client fit, not the research quality
Analyst trades on an unreleased merger heard from a director II(A) Material Nonpublic Information; I(A) Knowledge of the Law II(A) I(A) is the fallback where no more specific Standard applies
Marketing shows only the firm's best composite III(D) Performance Presentation; I(C) Misrepresentation III(D) Performance-specific communications fall under III(D)
Analyst accepts a supplier's paid trip before publishing I(B) Independence and Objectivity; IV(B) Additional Compensation I(B) if the payer is an issuer or third party seeking favourable research; IV(B) if the payer is a client of the member's own employer offering performance-based compensation The identity of the payer and the purpose of the payment decide
The general principle: the most specific Standard wins. Standard I(A) Knowledge of the Law and I(D) Misconduct are catch-alls, and choosing them when a specific sub-standard applies is the single most common Level II Ethics error.
4. Rules That Disclosure Does Not Cure
Candidates over-generalise "disclose and proceed". Disclosure is the remedy for conflicts, not for prohibitions.
Material nonpublic information cannot be acted on, disclosed selectively, or "neutralised" by telling the client. The only compliant responses are to encourage public dissemination by the issuer and to refrain from acting or causing others to act. A firewall prevents contamination; it does not launder information already held.
Market manipulation under II(B) is prohibited outright. Disclosing an intent to create artificial volume does not make it permissible.
Plagiarism under I(C) is not cured by a general statement that the firm uses outside research; attribution must be specific, with the exception of factual data from recognised statistical sources.
Referral arrangements under VI(C) must be disclosed before the client engages the member, not after the referral fee is earned, and must state the nature and value of the consideration.
Trading ahead of a recommendation is not cured by disclosing personal ownership; the transaction priority rule still binds.
Where disclosure is the remedy: VI(A) conflicts such as beneficial ownership, board seats, investment-banking relationships, and referral compensation; V(B) process limitations; and IV(B) additional compensation arrangements, which additionally require written consent from all parties .
5. Worked Case: One Vignette, Five Actions
Narrative. Meridian Asset Management runs a concentrated small-cap strategy. Its written allocation policy states that partial fills of block trades are distributed "at the portfolio manager's discretion, having regard to account size". Portfolio manager Daniel Achebe supervises two junior analysts. During the quarter:
Achebe receives a partial fill on an illiquid position and allocates the full amount to the firm's three largest separately managed accounts, citing the policy.
Analyst Priya Raman, preparing an initiation report, is told by the issuer's chief financial officer at a private dinner that next quarter's revenue will miss guidance by 15%. She does not trade, but she cuts her forecast and publishes a downgrade the next morning.
Achebe reviews Raman's downgrade note but does not ask where the revenue view came from, and approves publication.
Meridian's brochure states that its small-cap composite returned 21% last year; the composite excludes two accounts closed mid-year after losses.
Raman accepts a €200 restaurant meal from a broker who executes Meridian's small-cap trades and reports it to compliance the same week under the firm's gift-log policy.
Analysis.
Action Sub-standard Verdict and reasoning
1 III(B) Fair Dealing Violation, and the policy itself is defective. Allocating partial fills by account size disadvantages smaller clients. A compliant policy uses pro-rata allocation by order size at an average execution price.
2 II(A) Material Nonpublic Information Violation. Acting includes publishing a recommendation derived from the information, not only trading. Refraining from trading is not a defence, and the mosaic theory does not apply because the input was a single item of material nonpublic information rather than non-material pieces combined with public data.
3 IV(C) Responsibilities of Supervisors Violation. A supervisor must make reasonable efforts to detect violations; approving a sharp forecast revision with no inquiry into its source is not reasonable effort. Note this is a separate violation from Raman's II(A) breach.
4 III(D) Performance Presentation Violation. Excluding terminated accounts creates survivorship bias and makes the presentation misleading, whether or not the firm claims compliance with any performance standard.
5 I(B) Independence and Objectivity Not a violation. A modest meal from a broker, disclosed to the employer under a gift policy, is a customary business courtesy of token value. Lavish travel or entertainment conditioned on order flow would change the answer.
Action 5 is the deliberate red herring. Level II Ethics almost always includes exactly one permitted action that pattern-matches to a violation, because the "least likely to violate" question requires it.
Remedies the case would support
Rewrite the allocation policy to require pro-rata allocation at an average price , with documented exceptions.
Add a research-source attestation to the note-approval workflow, so a supervisor sees where a non-public-looking input came from.
Maintain a restricted list and watch list with a firewall procedure, and require escalation when an employee receives issuer information outside a public setting.
Present composite performance that includes terminated accounts for the periods in which they were managed.
Keep the gift log and set a stated monetary threshold above which pre-approval is required.
Scoring your own answers
When you review a practice Ethics item set, do not record only right or wrong. Record whether you failed at Step 2 (wrong sub-standard), Step 3 (missed a policy defect), or the disclosure rule. Nearly all repeat Ethics errors at Level II fall into one of those three buckets, and each has a different fix.