Introduction to Standard III: Duties to Clients

Welcome to one of the most critical parts of the CFA Level II Ethics curriculum! If Standard I and II were about the profession and the markets, Standard III is about the "heart" of your work: the relationship between you and your clients. At Level II, you aren't just memorizing definitions; you are learning to spot subtle violations in complex stories (vignettes) and recommending how to fix them.

Think of Standard III as the "Client-First" rulebook. It ensures that the person who trusts you with their money is the one who benefits most from your actions. Let’s break down the five sub-sections of this Standard.

III(A): Loyalty, Prudence, and Care

This is the "Fiduciary" standard (though the CFA Institute uses the phrase "fiduciary-like" to apply globally). It means you have a legal and ethical obligation to act in the client's best interest.

Key Concepts:

  • Loyalty: Place the client's interests before your firm's or your own.
  • Prudence: Act with the caution and discretion that a "prudent" person would use.
  • Care: Act with the diligence and competence required for the task.

Common Exam Scenarios to Watch For:

1. Soft Dollar/Soft Commission Policies: This occurs when a manager uses brokerage commissions (which belong to the client) to "buy" research or services from a broker. This is only allowed if the research directly benefits the client. If you use soft dollars to pay for your firm’s office rent or new computers, you have violated this Standard.

2. Voting Proxies: You don't have to vote every single minor proxy, but you must have a policy. You must vote on material issues in the best interest of the client. Tip: Blindly voting with management without doing research is usually a violation.

3. Choice of Broker: You must seek "best execution" for client trades. You shouldn't direct trades to your brother-in-law’s brokerage if his fees are higher and his execution is slower.

Key Takeaway: Always ask, "Is this action benefiting the client more than anyone else?"

III(B): Fair Dealing

Important Distinction: "Fairly" does not mean "Equally." You do not have to give every client the exact same service, but you must not disadvantage any client.

Key Rules:

  • Disseminating Recommendations: When you change a rating (e.g., from Buy to Sell), all clients must have a fair opportunity to act on it. You cannot call your "favorite" clients in the morning and wait until the afternoon to email the others.
  • Trade Allocation: When an oversubscribed IPO comes in, you must allocate it pro-rata (proportionally) across all suitable accounts. You cannot give the "hot" shares to your biggest clients first.
  • Different Service Levels: It is okay to have "Premium" and "Standard" service levels (where Premium gets faster access), but these levels must be disclosed to everyone and be available for anyone to join (for a higher fee).

Quick Review: Fairness is about the process of distributing information and trades.

III(C): Suitability

This is about making sure the "shoe fits." Even a "great" investment is a bad choice if it doesn't fit the client's needs.

The Process:

1. The IPS: Before taking action, you must develop an Investment Policy Statement (IPS) for the client. This includes their return objectives and risk constraints (liquidity, legal, time horizon, etc.).

2. Annual Review: You must update the IPS at least annually, or whenever there is a major life change (like a client getting married or losing their job).

3. The Portfolio Context: Evaluate an investment based on the entire portfolio, not in isolation. A high-risk derivative might be "suitable" if it hedges a specific risk in a large portfolio.

Specific Situations:

If a client asks you to buy a stock that you know is unsuitable for their IPS:

  • First, educate the client on why it doesn't fit.
  • If they insist, and it has a minimal impact, follow your firm’s policy.
  • If it has a material impact, you may need to update the IPS or, in extreme cases, decline the trade or stop managing that account.

Note: For managers who follow a specific mandate (like an Index Fund), suitability means staying true to the mandate, not the individual needs of the fund's investors.

III(D): Performance Presentation

You must ensure that your performance reports are fair, accurate, and relevant.

Avoid These Common Traps:

  • Cherry-Picking: Showing only your best-performing accounts while hiding the ones that lost money.
  • Survivorship Bias: Presenting history that only includes funds that are still active today (ignoring the ones that failed).
  • Comparing Apples to Oranges: Comparing a high-risk equity fund to a low-risk bond index as a benchmark.

Did you know? While GIPS (Global Investment Performance Standards) is a great way to comply with this, the Code and Standards do not require you to be GIPS-compliant. They just require you not to be misleading.

III(E): Preservation of Confidentiality

You must keep information about current, former, and prospective clients secret.

The Three Exceptions:

You can (and sometimes must) break confidentiality if:

1. Illegal Activity: The information concerns illegal activity on the part of the client.

2. The Law: Disclosure is required by law (e.g., a court order).

3. The PCP: The CFA Institute Professional Conduct Program is investigating your conduct and asks for info.

Common Mistake: If a client is doing something unethical but not illegal, you generally still have to maintain confidentiality, though you should seek legal counsel and consider resigning from the account.

Summary Checklist for the Exam

  • Standard III(A): Client interests first? Best execution? Soft dollars benefit the client?
  • Standard III(B): All clients told at the same time? Pro-rata allocation?
  • Standard III(C): Is there an IPS? Was it updated this year? Does the trade fit the total portfolio?
  • Standard III(D): Is the performance data misleading? Is the benchmark appropriate?
  • Standard III(E): Is the client info being kept private? If not, is there a legal/CFA requirement to share?

Don't worry if these seem overlapping! Level II vignettes will often give you a specific clue—like a list of clients receiving different emails—to point you directly toward the right sub-standard (in that case, Fair Dealing).

Cross-Reference: For more on your responsibilities to your firm, see Guidance for Standard IV: Duties to Employers.