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Carol Blackwell, CFA, has been hired to manage trust assets for Blanchard Investments. Blanchard's trust manager, Thaddeus Baldwin, CFA, has worked in the securities business for more than 50 years. On Blackwell's first day at the office, Baldwin gives her several instructions.
Instruction 1: Limit risk by avoiding stock options.
Instruction 2: Above all, ensure that our clients' capital is kept safe.
Instruction 3: We take pride in our low cost structure, so avoid unnecessary transactions.
Instruction 4: Remember that every investment must have the quality to stand on its own.
Baldwin realizes that many of the firm's practices and policies would benefit from a compliance check. Because Blackwell recently received her CFA charter, Baldwin tells her she is the 'perfect person to work with the compliance officer to update the policy on proxy voting and the procedures to comply with Standard VI(B) Priority of Transactions.' Baldwin also wants Blackwell to evaluate whether the firm wants to, or can, claim compliance with the soft dollar standards. Baldwin hands Blackwell a handwritten outline he created, which includes the following statements:
Statement 1: CFA Institute's soft-dollar rules are not mandatory. In any case, ' client brokerage can be used to pay for a portion of mixed-use research.
Statement 2: Investment firms can use client brokerage to purchase research that does not immediately benefit the client. Commissions generated by outside trades are considered soft dollars, but commissions from internal trading desks are not.
During a local society luncheon, Blackwell is seated next to CFA candidate Lucas Walters, who has been assigned the task of creating a compliance manual for Borchard & Sons, a small brokerage firm. Walters asks for her advice.
When Walters returns to work, he is apprised of the following situation: Borchard & Sons purchased 25,000 shares of CBX Corp. for equity manager Quintux Quantitative just minutes before the money manager called back and said it meant to buy 25,000 shares of CDX Corp. Borchard then purchased CDX shares for Quintux, but not before shares of CBX Corp. declined by 1.5%. The broker is holding the CBX shares in its own inventory.
Borchard proposes three methods for dealing with the trading error.
Method 1: Quintux directs additional trades to Borchard worth a dollar value equal to the amount of the trading loss.
Method 2: Borchard receives investment research from Quintux in exchange for Borchard covering the costs of the trading error.
Method 3: Borchard transfers the ordered CBX shares in its inventory to Quintux, which allocates them to all of its clients on a pro-rata basis.
When updating the proxy-voting policy to conform to CFA Institute recommendations, which of the following recommendations is least appropriate for Blanchard to adopt?

Yi Tang updates several economic parameters monthly for use by the analysts and the portfolio managers at her firm. If economic conditions warrant, she will update the parameters even more frequently. As a result of an economic slowdown, she is going through this process now.
The firm has been using an equity risk premium of 5.6%, found with historical estimates. Tang is going to use an estimate of the equity risk premium found with a macroeconomic model. By comparing the yields on nominal bonds and real bonds, she estimates the inflation rate to be 2.6%. She expects real domestic growth to be 3.0%. Tang does not expect a change in price/earnings ratios. The yield on the market index is 1.7% and the expected risk-free rate of return is 2.7%.
Elizabeth Trotter, one of the firm's portfolio Managers, asks Tang about the effects of survivorship bias on estimates of the equity risk premium. Trotter asks, 'Which method is most susceptible to this bias, historical estimates, Gordon growth model estimates, or survey estimates?'
Tang wishes to estimate the required rate of return for Northeast Electric (NE) using the Capital Asset Pricing Model (CAPM) and the Fama-French three factor model. She is using the following information to accomplish this:
* The risk-free rate of return is 2.7%.

The board members for Kazmaier Foods have gathered for their quarterly board of directors meeting. Presiding at the meeting is the Chairman and CEO for Kazmaier, Phil Hinesman. The other eight members of the board are also present, including Allen Kazmaier, the brother of Kazmaier's founder; Elaine Randall, Executive Vice President for Emerald Bank, which Kazmaier uses to obtain short-term financing; and Bill Schram, Kazmaier's President and Chief Operating Officer. Each of the directors was elected to serve on the board for a 4-year term. They were elected two at a time over the past three years. With the exception of Hinesman, Allen Kazmaier, Randall, and Schram, board members had no ties to Kazmaier prior to joining the board and had no personal relationships with management. In addition to the regular board meetings, the five independent board members get together annually, in a meeting separate from the regular board meetings, to discuss the company's operations.
Item 1 on the board meeting agenda is a discussion about the importance of corporate governance and how Kazmaier can improve its corporate governance system. Hinesman begins the discussion by saying, 'A strong system of corporate governance is important to our shareholders. Studies have shown that, on average, companies with strong corporate governance systems have higher measures of profitability than companies with weak corporate governance systems.' Randall adds her comment to the discussion: 'The lack of an effective corporate governance system increases risk for our investors. If we do not have the appropriate checks and balances in place, our investors may be exposed to the risk that information used to make decisions about our firm is misleading or incomplete, as well as the risk that mergers or acquisitions the firm enters into will benefit management at the expense of shareholders.'
After a lengthy discussion, the board agrees on five separate recommendations that will enhance its current system of corporate governance. One of these recommendations is to change the function and structure of the board's audit committee. Currently the audit committee consists of Matthew Bortz, David Smith, and Ann Williams---three independent directors who each have backgrounds in finance and accounting. The board agrees that one more member should be added to the committee and that the committee should expand its list of responsibilities.
Item 2 on the agenda for the board of directors' meeting is a report from Kazmaicr's Chief Financial Officer, Doug Layman. The following information was included in the material that was distributed to each board member before the meeting:
Current share price: $40.00
Shares outstanding: 56, 250,000
Estimated earnings: $112.5 million
Planned capital spending: $150 million
Target debt-to-equity ratio 1 to I
Cost of equity: 8.0%
Constant growth rate: 5.2%
Layman tells the board that his analysis indicates that, based on a constant-growth dividend discount model, the initiation of an $0.80 per share dividend would reduce the cost of equity by 1.2% and increase the value of the firm's stock, assuming that earnings, the cost of debt, and the constant growth rate don't change.
Item 3 on the agenda is the sale of Kazmaier's condiment packaging division to Sautter Packaging and Supply Company. Layman believes the sale will net the company $50 million, payable in cash. After discussing the pros and cons of selling the division, the directors agree that the sale is in the best interests of the company and its shareholders. The directors then move to a vote, and the sale of the condiment packaging division is approved unanimously. The committee then moves on to discuss what to do with the proceeds from the sale. Williams suggests that paying out the $50 million to shareholders as a special dividend would continue to give the firm flexibility in how it uses its excess cash. Smith tells the board that a share repurchase can be thought of as an alternative to a cash dividend, and that if the tax treatment between the two alternatives is the same, investors should be indifferent between the two. After debating the merits of special dividends and stock repurchases, Kazmaier's board authorizes the proceeds from the sale of the condiment packaging division to be used for the purchase of $50 million worth of outstanding shares.
An external agency recently included Kazmaier in a review of corporate governance systems to determine whether or not the structure of the board of directors was consistent with corporate governance best practices. The agency scored companies based on the following criteria:
Criterion 1: Composition of the board of directors.
Criterion 2: Chairman of the board of directors.
Criterion 3; Method of electing the board.
Criterion 4: Frequency of separate sessions for independent directors.
Each of the four criteria was weighted equally, with the firm receiving a positive mark for being in compliance with corporate governance best practice.
A month after the board meeting, the price of Kazmaier stock is still at $40 per share, and the sale of Kazmaier's condiment packaging division does not go through. In order to finance the approved share repurchase, Kazmaier is forced to borrow funds. Schram states, 'I am concerned that the cost of the debt used to repurchase shares may cause a reduction in earnings per share.'
Jennifer Nagy, a vice president in Kazmaier's finance division, tells Schram not to be concerned about using debt to finance the share repurchase because the rationale behind the repurchase is sound. Nagy then writes down some of the common rationales for share repurchases and hands them to Schram.
Rationale 1: Repurchasing shares can prevent the EPS dilution that comes from the exercise of employee stock options.
Rationale 2: Management can use a share repurchase to alter the company's capital structure by decreasing the percentage of equity.
Rationale 3: Like a dividend increase, a share repurchase is a way to send a signal to investors that Kazmaier's management believes the outlook for the company's future is strong.
Are the comments made by Hinesman and Randall about corporate governance systems correct?