2.3 Duties to Clients (Standard III) & Duties to Employers (Standard IV)

Duties to Clients (Standard III) & Duties to Employers (Standard IV)

Executive Summary: Standards III, IV, V, and VII govern the core day-to-day operational relationships in the investment industry. Level II vignettes test fiduciary obligations, soft dollar boundaries, fair dealing in trade allocation, client confidentiality exceptions, non-compete boundaries during employment transitions, supervisory delegation responsibilities, 7-year record retention rules, and proper usage of the CFA designation.

---

Standard III: Duties to Clients in Depth

Standard 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. They must act for the benefit of their clients and place their clients' interests before their employer's or their own interests.

• Identifying the Ultimate Client: Fiduciary duty is owed to the ultimate beneficial owner of the assets, not the corporate entity or plan sponsor hiring the manager. For defined benefit pension plans, the duty is owed to the plan participants and retirees, not the corporate CFO or pension trustees.
• Best Execution: Managers must seek the most favorable terms for client transactions under the circumstances, evaluating price, speed, execution certainty, and total transaction costs.
• Soft Dollar Standards: Brokerage commissions paid by client accounts belong exclusively to the clients. Soft dollar credits generated from client commissions may ONLY be used to acquire investment research and direct analytical tools that provide direct assistance in the investment decision-making process.
  • Allowable: Research reports, economic data feeds, financial modeling software, industry seminar registrations directly related to portfolio securities.
  • Prohibited: Office rent, administrative salaries, computer hardware, marketing expenses, travel accommodations, client entertainment.
  • Mixed-Use Items: If a service has both research and administrative utility (e.g., an enterprise accounting and equity valuation platform), the firm must make a reasonable pro-rata allocation and pay for the administrative portion using firm "hard dollars."
• Proxy Voting: Proxies have economic value. Managers must establish formal voting guidelines and vote proxies in the best economic interest of clients, unless the client expressly retains voting rights in writing.

Standard 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 vs. Equal Treatment: Fair dealing does not require identical service to every client. Firms may offer tiered service levels (e.g., premium institutional advisory vs. mass retail digital execution) provided that the different service levels are disclosed, available to all clients who meet objective criteria, and do not disadvantage other clients.
• Simultaneous Dissemination: New recommendations or revisions must be disseminated simultaneously to all eligible clients. Analysts must not give select institutional clients early notice prior to general distribution.
• Trade Allocation: Partial executions of block trades must be allocated on a pro-rata basis across all participating client accounts. Personal or firm accounts must not receive preferential allocation.

Standard III(C): Suitability

When members and candidates are in an investment advisory relationship with a client, they must:

1. Formulate an Investment Policy Statement (IPS) covering return objectives, risk tolerance, and investment constraints (liquidity, time horizon, tax, legal/regulatory, unique circumstances).
2. Update the IPS at least annually or immediately upon a material life event.
3. Evaluate securities strictly in the context of the total portfolio, assessing correlation and diversification benefits rather than evaluating individual asset risk in isolation.

Standard III(D): Performance Presentation

Members must ensure that investment performance information is fair, accurate, and complete. Avoid cherry-picking historical time periods, omitting terminated strategies, or presenting simulated backtests without prominent disclosure.

Standard 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 by the client.
2. Disclosure is required by applicable law or a valid court subpoena.
3. The client or prospective client permits disclosure in writing.

---

Standard IV: Duties to Employers in Depth

Standard IV(A): Loyalty

In matters related to their employment, members and candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.

• Independent Practice / Moonlighting: Undertaking independent consulting or outside business activities that compete with the employer is permissible ONLY if the employee receives prior written consent from the employer.
• Preparing to Leave vs. Solicitation:
  • Permissible Preparation: While still employed, an analyst may incorporate a future company, lease future office space, and make non-competitive administrative arrangements on personal time.
  • Prohibited Conduct: An employee must NOT solicit current clients, solicit colleagues to defect, take proprietary financial models, or misappropriate client contact lists prior to formal termination of employment.
• Whistleblowing: If an employer is engaged in persistent illegal activity or gross ethical violations that compromise market integrity or client assets, protecting clients overrides loyalty to the employer.

Standard IV(B): Additional Compensation Arrangements

Members and candidates must not accept any gifts, benefits, compensation, or consideration that competes with or creates a conflict of interest with their employer's interest unless they obtain prior written consent from all parties involved (both the employer and the outside paying party).

Standard IV(C): Responsibilities of Supervisors

Members and candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.

• Supervisory Systems: Supervisors must establish, maintain, and enforce an effective compliance program with written policies, periodic training, and detection mechanisms.
• Delegation without Abdication: Supervisors may delegate administrative monitoring tasks to compliance staff, but remain ultimately accountable for supervisory failure.
• Inadequate Compliance Program: If a firm's compliance system is fundamentally deficient and senior leadership refuses remediation, the supervisor must decline the supervisory assignment in writing.

---

Standards V & VII: Professional Integrity Overview

• Standard V(A) Diligence & Reasonable Basis: Recommendations and actions must be supported by thorough, independent research. Relying on third-party models requires independent due diligence into model assumptions.
• Standard V(B) Communication with Clients: Distinguish clearly between factual historical data and forward-looking opinions/estimates in all research.
• Standard V(C) Record Retention: Maintain all research notes, IPS documents, and trade records supporting recommendations. CFA Institute recommends a minimum retention period of 7 years unless local law specifies otherwise.
• Standard VII(A) Conduct in CFA Program: Candidates must maintain absolute confidentiality of exam content and must not share exam questions, formulas, or grading details.
• Standard VII(B) Designation Usage: "CFA" and "Chartered Financial Analyst" must be used strictly as adjectives modifying a noun (e.g., "CFA charterholder"), never as a standalone noun or verb. Candidates must never imply that the charter guarantees superior returns.

---

Scenario Comparison Table