Don’t have the books but presumably based on what you mention, it has to do with obligation imposed by the standards. Standards do NOT impose any obligation on members to report any wrongdoing (they go on to say that it may be prudent to do so however).
If you encounter unethical actions inside the firm, your first move could be to tell the wrongdoer to inmediately terminate the action. It didn’t work, then the second move is to talk with your supervisor about the problem (if the wrongdoer is the supervisor, go directly to the compliance area). If the compliance area doesn’t do nothing or even looks like to be in colussion then report the problem to the appropiate regulator/authority. At this phase, is highly probable you want to separate from the firm.
About the question, all the answers are correct, but the least correct choice would be C because as I wrote above, reporting to regulatory authorities is the last resource.
Not sure at all whether it is PRUDENT for CMLSML to say what he already said.