III. DUTIES TO CLIENTS

C. Suitability.

1. When Members and Candidates are in an advisory relationship with a client, they must:
a. Make a reasonable inquiry into a client 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 re-assess and update this information regularly.
b. Determine that an investment is suitable to the client's financial situation and consistent with the client's written objectives, mandates, and constraints prior to making an investment recommendation or taking investment action.
c. Judge the suitability of investments in the context of the client's total portfolio.

2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must only make investment recommendations or take investment actions that are consistent with the stated objectives and constraints of the portfolio.

Members must always consider the appropriateness and suitability of the client's investment action and match this up against the needs and circumstances of the particular client in order to determine the suitability of the investment for the client.

In the event that a new client is obtained or an existing client's previous investment matures, the member need not immediately obtain client information if he or she first re-invests these funds in some form of cash equivalent. The member will then obtain the client's investment preferences. He or she will need to determine from the client the level of risk that the client is prepared to accept (in other words, the client's risk tolerance level). This needs to be ascertained before any investment action is taken.

You are required to:

• Know the type and nature of your clients'.
• Know the return objectives and risk tolerance of your clients.
• Know the liquidity needs, expected cash flows, investable funds, time horizon, tax considerations, regulatory and legal circumstances, and other constraints of your clients.

You are NOT required to change an existing client portfolio as soon as it comes under your discretion; it is best to take a bit of time, plan and implement actions in an organized way.

Procedures for compliance

A written investment policy statement should be developed.

• Client identification: Identify the type and nature of clients, and the existence of separate beneficiaries.
• Investor objectives:
  • Return objectives (income, growth in principal, maintenance of purchase power).
  • Risk tolerance (suitability and stability of values).

• Investor constraints: Liquidity needs, expected cash flows (patterns of additions and/or withdrawals), investable funds (assets and liabilities or other commitments), time horizon, tax considerations, regulatory and legal circumstances, investor preferences, circumstances, unique needs, and proxy voting responsibilities and guidance.
• Performance measurement benchmarks.

The investor's objectives and constraints should be maintained and reviewed periodically to reflect any changes in the client's circumstances. Annual review is reasonable unless business or other reasons dictate more or less frequent review.

Example 1

After a five-minute interview, you advise a client how to invest a substantial proportion of her wealth. You have violated the "Know your customer" rule. You do not have adequate basis to make a detailed recommendation.

Example 2

An analyst tells a client about the upside potential, without discussing the downside risks. He violates the standard because he should discuss the downside risks as well.

Example 3

When recommending an investment to a client, an analyst mainly focuses on the characteristics of the specific investment. He violates the standard because the primary focus for determining the suitability of an investment should be on the characteristics of the entire portfolio.

Example 4

Should a firm move from a fundamental approach to selecting stocks to a more technically-based model, it would need to communicate this change to all of its current and prospective clients. Clients must always be made aware of the risk of investing as well as possible downside risks. The portfolio must always be looked at as a whole.

Example 5

The portfolio managers at DD Investing sit down with Danielle to analyze her needs and circumstances. While discussing her position with her, they find out that a wealthy cousin left her $500,000 as part of her inheritance. This triples the size of her current portfolio. As a result of the increased funds, Danielle's willingness to assume risk has increased; she can now bear more risk. Therefore, the portfolio managers should now invest more funds in the equity side of her portfolio, to increase risk and potential returns.

Example 6

A client requests to change his investment strategy from investing in North-American blue chips to emphasizing countries with high economic growth rates. The portfolio manager should explain the potential risks and returns to the client, and ask him to consider them before changing the investment strategy.

Example 7

An investment manager uses the proceeds of some high yielding securities to invest 20% of the client's portfolio in a high-risk stock, because he believes that a merger is in place and will push the price of the stock up. He will then sell the stock and repurchase other high-yielding securities. The client depends on the portfolio for her support. The manager has violated this standard, since he has not considered the effects of each transaction within the context of the entire portfolio.