Ethical and Professional Standards
Reading 3. Guidance for Standards I-VII
Learning Outcome Statements
a. demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity;
b. distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards;
c. recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.
CFA Curriculum, 2020, Volume 1
Subject 7. Standard III (A) Loyalty, Prudence, and Care
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.
This standard relates principally to members who have discretionary authority over the management of client's assets.
Fiduciary duty refers to the obligations of loyalty and care in regard to the responsibility of managing someone else's assets. A fiduciary duty is a position of trust.
- A fiduciary is someone with the duty of acting for the benefit of another party.
- Loyalty is owed to clients and prospects.
- Clients' interests come before yours.
- A heightened level of fiduciary duty arises if the fiduciary has "custody" or effective control of the client's assets.
- Governing documents (e.g., trust documents and investment management agreements) are primary determinants of a fiduciary's powers and duties.
Fiduciary standards apply to a large number of persons in varying capacities, but exact duties may differ in many respects, depending on the nature of the relationship with the client or the type of account under which the assets are managed. The first step in fulfilling a fiduciary duty is to determine what the responsibility is and the identity of the "client" to whom the fiduciary duty is owed.
- When managing personal assets of an individual, the investment manager owes loyalty to that individual (i.e., the client).
- When managing the portfolios of a pension plan or trust, the investment manager owes loyalty to beneficiaries of the plan or trust (i.e., the "client"), not the person who hires the manager.
A fiduciary must make investment decisions in the context of the portfolio as a whole rather than by individual investments within the portfolio. The fiduciary should thoroughly consider the risk of loss, potential gains, diversification, liquidity and returns.
Often a manager may direct clients' trades through a particular broker because an investment manager often has discretion over the selection of brokers. The broker may provide research services that provide a broad benefit to the manager. The manager has thus used "soft dollars" to purchase beneficial services through brokerage, which is an asset to the manager's clients. Since the manager would expect to purchase research services anyway, the soft dollar arrangement is not necessarily inappropriate. The manager must seek the best price and execution, and disclose any soft dollar arrangements.
Procedures for compliance
- Follow all the applicable laws and rules.
- Establish the investment objectives of the client, taking into account:
- The client's needs and circumstances.
- The investment's basic characteristics.
- Diversification. All portfolios should be adequately diversified, unless the plan guidelines state otherwise.
- Deal fairly with all clients.
- Conflicts of interest. All conflicts must be disclosed.
- Disclose compensation agreements.
- Proxy solicitations. Proxies must be voted in the best interest of the beneficiaries.
- Confidentiality. Members must maintain the confidentiality of their dealings at all times.
- Best execution. The best execution that is reasonably available should be provided to all clients.
- Loyalty - members must always act in the best interest of their clients.
A client anxiously tells you that he needs to liquidate a bond portfolio immediately because he needs funds to pay for an operation for a relative. The bonds are highly liquid, but you and a colleague purchase the securities for about 75% of their market value. This is a clear violation of your fiduciary duty to the client. You have violated your position of trust. Furthermore, you have engaged in a deceitful action, which dishonors the CFA designation.
A portfolio manager benefits a pension plan's sponsor rather than its beneficiaries by acquiring the sponsoring company's stock with the pension fund, to support its stock price, and voting proxies in support of the management, which is not in the best interest of the beneficiaries. He violates the standard because he should have made investment decisions solely in the interest of the beneficiaries of the pension plan, regardless of the sponsor's benefits.
A portfolio manager directs trades to a brokerage firm. In return, he gets favorable treatment on his personal transactions. He violates the standard because he breaches his fiduciary duty to clients. He should have hired a brokerage firm that offers the best execution for the client.
A portfolio manager receives research from a brokerage firm that does not directly benefit the accounts being traded. He does not violate the standard as long as he gets the best execution for his clients and discloses the soft dollar arrangement to them.
An investment firm uses a large brokerage house, ABC. ABC's research is average, but provides asset allocation studies to make up for the large commission charged. The firm is also very friendly with ABC senior management. The standard has been violated, since soft dollars have been paid, but not for research activities.
User Contributed Comments 9You need to log in first to add your comment.
Is obtaining non reserach service from a brokerage firm doing a firms pension trading with the knowledge of the client. WOuld that be a violation?
This doesn't appear to be in violation of any standard.
I think it is a violation ONLY if you pay for it by brokerage.
Prudent man rule : preserve capital amd avoid risk.
Prudent investor rule :manage as if managing own capital , preserve capital , cost concious, diversified portfolio
Shingle theory : if u r advertising as a investment professional ur subject to follow strict standards
Why is buying research with soft dollars ok (Example 4), but not "asset allocation studies" (Example 5). It seems that asset allocation studies are a form of research.
To Slothrop -> because of the brokerage firm in example 5 provides "asset allocation studies" in lieu of "large commision charged" which is not in the benefit for the CLIENT.
Remember, loyalty is to the beneficiary of the portfolio who is not necessarily the same as the client.
Are the procedures for compliance to be memorized?
@Slothrop: i think it is because Asset allocation study doesn't benefit the client directly but to the manager's benefit (just think of it as an educational gift). The manager uses client's asset to his/her benefit with a charge(commission) on the client. Research is more direct link to client's interest.