Duties to Clients

This reading covers Standard III, Duties to Clients: Loyalty, Prudence, and Care; Fair Dealing; Suitability; Performance Presentation; and Preservation of Confidentiality. A candidate must be able to apply each duty to a fact pattern, recommend procedures for compliance, and tell conduct that conforms from conduct that violates.

Standard III sets out what members and candidates owe the people whose money or information they handle. Five Standards sit under it: Standard III(A) Loyalty, Prudence, and Care, Standard III(B) Fair Dealing, Standard III(C) Suitability, Standard III(D) Performance Presentation, and Standard III(E) Preservation of Confidentiality. The three LOS cover applying them to fact patterns (97.a), recommending compliance procedures (97.b) and separating conduct that conforms from conduct that violates (97.c).

LOS 97.a — Applying the five duties to clients

III(A) Loyalty, Prudence, and Care

Members and candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and candidates must act for the benefit of their clients and place their clients' interests before their employer's or their own interests.

The Standard does not create a fiduciary duty where none already exists. It does require acting in the client's best interest and recommending products that suit the client's investment objectives and risk tolerance, with the prudence, care, skill and diligence that a person acting in a similar role and familiar with such matters would use under the circumstances.

• Governing documents and total portfolio. Manage pooled client assets according to the governing documents (trust documents, investment management agreements), and make decisions in the context of the total portfolio.
• Disclose limitations. Tell clients about any limits on the advisory relationship (e.g., an adviser who may recommend only her own firm's products).
• Identify the client. For a pension plan, the duty runs to the plan participants and beneficiaries. The sponsoring company, its management and its shareholders are not the client. In some roles the "client" is the investing public as a whole rather than a specific person. For a pooled fund, decisions serve the fund's investors as a whole, in line with the fund's mandate, rather than each investor's individual needs.
• Diversification. A prudent manager of retirement assets keeps the portfolio properly diversified. Holding some of the sponsor's own stock is not banned; concentrating the plan in it at management's request is imprudent.
• Client brokerage (the commissions generated by client trades, also called soft dollars or soft commissions) is an asset of the client, because the client's trades pay for it. It must be used to benefit the client, e.g., to buy research that assists the manager in managing client accounts, and the arrangement should be disclosed to the client. Using it for research relevant only to the manager's own holdings, or for personal benefits the member could not otherwise obtain, breaches the duty.
• Best execution: seek the most favorable terms reasonably available for each trade. A trader who only executes client orders may owe no fiduciary duty, but the Standard still applies: in that role, loyalty and care mean seeking best execution on each order.
• Trading a client's account more often than its objectives require, in order to generate commissions for the member or the firm, puts their interests ahead of the client's and violates the Standard.
• Directed brokerage: when a client instructs that its trades go to a particular broker, following the instruction is acceptable because the brokerage belongs to the client. The member should disclose that best execution may not be achieved.
• Proxy voting: proxies have economic value, so they must be voted in an informed, responsible way in the clients' interest. Management's wishes do not decide the vote. A cost-benefit analysis may show that voting a particular proxy is not worthwhile, so voting every proxy is not required.
• Trade errors: a broker that absorbs the cost of its own trading error, with no implied promise of future business, raises no issue.

III(B) Fair Dealing

Members and candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.

Fair treatment is not the same as equal treatment. Firms may offer different levels of service (e.g., a premium research tier for a fee) as long as the tiers are disclosed to all clients and prospects, are available to anyone willing to pay for them, and do not disadvantage any client. Differences in when e-mails or other messages happen to arrive are a normal part of business.

• Do not discriminate among clients when disseminating recommendations. Delivery channels may differ: e-mail to clients who supplied an address and same-day post to the rest is fair. The duty is owed to clients, so a firm may keep its research for its clients and need not release it to the public.
• Give every client a fair opportunity to act on each recommendation. A client unaware of a changed recommendation should be told of the change before an order for that security is accepted.
• Treat individual and institutional clients fairly and impartially. A member must not exploit his or her position in the industry at clients' expense (e.g., by taking shares of an oversubscribed IPO for personal accounts).
• Clients may not be ranked by account size, fees or trading volume for the order in which they hear of recommendation changes or receive fills.
• Trade allocation: when an order is only partly filled or filled in blocks at different prices, allocate pro rata (in proportion to each account's order size) across all accounts for which the trade is suitable, at the same average price. Allocation by alphabet, fee level or other arbitrary rule is unfair. So is waiting to see which fills have gained before deciding which accounts get them.
• Tipping portfolio managers of discretionary accounts before the report reaches other clients favors some clients over others. Acting on the tip is also a violation.

III(C) Suitability

• The financial constraints cover liquidity needs, expected cash flows, time horizon, tax, and legal and regulatory circumstances. The information is usually documented in an investment policy statement (IPS) gathered at the start of the relationship, and it is reassessed regularly and whenever circumstances change.
• Consider whether the use of leverage is suitable for the client.
• Because suitability is judged for the portfolio as a whole, a volatile holding can suit a moderate-risk client if it lowers the risk of the total portfolio.

Under part 2, a fund whose mandate admits only dividend-paying stocks may not buy a non-dividend growth stock, however attractive. The manager of such a fund judges investments against the fund's mandate. Whether the fund suits an individual investor is the concern of the adviser who recommends it.

Unsolicited trade requests that look unsuitable: the member does not execute the trade until he or she has discussed with the client why it does not fit the IPS. If the effect on the total portfolio's risk/return profile is minimal, the member may then follow the firm's policy on unsuitable trades; the client must acknowledge the discussion and why the trade is unsuitable. If the effect is material, the client may agree to revise the IPS and accept the changed risk profile. If the client will not, firm policy may allow the trade in a separate client-directed account. Failing other options, the member may need to reconsider the relationship.

III(D) Performance Presentation

When communicating investment performance information, members and candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.

• The Standard covers oral as well as written performance communications.
• The same facts often breach Standard I(C) Misrepresentation too, which counts selective performance data and results that omit accounts among its violations. Standard III(D) is the Standard aimed specifically at performance communications.
• Do not present a new fund's "history" built from the past returns of assets it now holds, or from other accounts, as if the fund itself had earned it.
• Do not cherry-pick. A list of winning picks misrepresents results unless it is the complete list, however accurate each return on it is.
• A firm's stated rules on which accounts enter a composite, and from what date, apply to every account alike; bringing an account in early or leaving one out because of its results misstates performance.
• Adhering to the Global Investment Performance Standards (GIPS) is voluntary, but a claim of GIPS compliance that the firm's calculations do not support misleads clients and prospects about its performance and violates the Standard.
• Do not turn a single fund's or single period's result into a claim about the firm's typical results. Never guarantee future returns, and never suggest, directly or by implication, that past returns can be repeated.
• Stating accurate past results is acceptable. Brief presentations are allowed if detailed information is available on request and the presentation indicates that it offers only limited information.

III(E) Preservation of Confidentiality

Members and candidates must keep information about current, former, and prospective clients confidential unless: 1. The information concerns illegal activities on the part of the client, 2. Disclosure is required by law, or 3. The client or prospective client permits disclosure of the information.

Information may be shared with the CFA Institute Professional Conduct Program in an investigation, because the program keeps it confidential. No family tie or private agreement lets a member withhold it. Inside the firm, share client information only with colleagues who work on the client's account. Illegal activity by a client may create an obligation to report it to the authorities.

When unsure whether an exception applies, the member consults compliance or legal counsel. Client data must also be protected: storing identifiable client records on unsecured personal devices or networks is a failure to preserve confidentiality. When a client reveals her own information in an online group or chat the member runs, the disclosure is the client's, not the member's; the member's duty is to take reasonable precautions, such as warning users that posts are visible to all and removing such a post promptly.

LOS 97.b — Recommended procedures for compliance

LOS 97.c — Violation or not? Quick reference