Learning Module 5 of Ethical and Professional Standards 10–15% of the exam

Guidance for Standard III: Duties to Clients

5 lessons. About 30 minutes in cram mode, 150 minutes in full.

Start with lesson 1 Learn with Sensei Read the module summary Practice this module

Lessons

1
Standard III(A): Loyalty, Prudence, and Care
demonstrate 8 min cram, 36 min full
2
Standard III(B): Fair Dealing
demonstrate 6 min cram, 32 min full
3
Standard III(C): Suitability
demonstrate 6 min cram, 32 min full
4
Standard III(D): Performance Presentation
demonstrate 6 min cram, 26 min full
5
Standard III(E): Preservation of Confidentiality
demonstrate 4 min cram, 24 min full

What the exam expects you to do

Demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity.Standard III(A): Loyalty, Prudence, and Care
Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.Standard III(A): Loyalty, Prudence, and Care
Identify conduct that conforms to the Code and Standards and conduct that violates the Code and Standards.Standard III(A): Loyalty, Prudence, and Care

Module summary

The whole module on one sheet, organised by lesson: what to memorize, how the ideas fit together, the formulas and the key terms. No paragraphs, just what you need to revise.

Hide what I know

How deeply to learn each part

Know the idea: Understand it in general. It frames other topics, but you will not calculate with it.
Use it: Understand it well enough to solve a question with it. Recognize when it applies.
Memorize: Learn it by heart. The exam will not give it to you.

Standard III(A): Loyalty, Prudence, and Care

Known

MemorizeStandard III(A): what to know cold

Topic	The rule
Loyalty	Client interests before your employer's and your own
Prudence and care	The judgment and care a reasonable professional would use in managing and disposing of their own affairs
The client	Individual: the person. Pension plan or trust: the beneficiaries, not the sponsor or trustee. Fund run to a mandate: the mandate
Soft commissions	Client brokerage is the client's asset. Using it (or paying more) for goods or services that do not benefit the client is a violation
Directed brokerage	The client may direct it. Still seek best execution and disclose that the client may not be getting it
Proxies	Vote in an informed, responsible way. Skipping is fine if a cost-benefit analysis says voting will not help the client. Disclose the policy
Statements	At least quarterly; separate client assets from your own

Memory hook Whose money is it? Commissions, votes and portfolio decisions all belong to the client, so spend them only on the client.

Know it cold Find the real client first. Then ask whether each action helps that client, not the firm or you.

Key terms

duty of loyalty Memorize
prudence Memorize
care Use it
fiduciary duty Know the idea
identifying the client Memorize
client brokerage Memorize
soft commissions Memorize
directed brokerage Use it
best execution Memorize
proxy voting Use it

Who is the client?

Duty of loyalty, prudence and careowed to the real client

Individual account Memorize the person who owns the assets
Pension plan or trust Memorize not the party who hired you
- Beneficiaries owed the duty of loyalty
- Sponsor or trustee hires you but is not the client
Fund managed to a mandate Use it no single client profile
- The stated mandate invest consistently with it
- Adviser to the fund's investors carries the personal client duties

Standard III(B): Fair Dealing

Known

MemorizeStandard III(B): what to know cold

Topic	The rule
Fair, not equal	No discrimination. Clients cannot all be reached at the same instant
Recommendations	Give all clients a fair opportunity to act. Changes matter more than first calls. Warn clients who have acted on the old view
Oversubscribed issue	Pro rata on order size, same price, round lots. Do not buy for yourself or relatives unless their accounts are managed like clients'
Hot issues	Bona fide public distribution. Never held back or used as a reward
Levels of service	Allowed if disclosed, open to all who pay, and not disadvantaging others
Client consent	Cannot excuse a patently unfair allocation method

Memory hook Same chance, same price, not same size: fill ratio = shares received ÷ total ordered, applied to every order.

Know it cold Allocate pro rata, disseminate together, disclose the procedures.

Key terms

fair dealing Memorize
investment recommendation Use it
investment action Use it
oversubscribed issue Memorize
pro rata Memorize
hot issue Use it
block trade Use it
levels of service Memorize

Where Standard III(B) applies

Fair dealingfair, not equal

Investment recommendations Memorize opinions on buying, selling or holding
- Initial and changed recommendations a fair chance for all to act
- Reach clients who acted on the old view and warn anyone ordering against the new one
Investment action Memorize trades and allocations
- Block trades same price, same commission, pro rata fills
- Oversubscribed new issues pro rata, round lots
Levels of service Memorize allowed with conditions
- Disclosed to clients and prospects
- Open to all not offered selectively

Formulas

Pro rata allocation Use it

A = O \times \frac{S}{T}

Quick example

A firm receives 6,400 shares of an oversubscribed issue. Eligible clients ordered 10,000 shares in total, and one client ordered 4,000. Fill ratio 6,400 ÷ 10,000 = 64%, so that client receives 4,000 × 0.64 = 2,560 shares.

On your calculator

6400÷10000×4000= 2560

6400ENTER10000÷4000× 2560

ENTER enter (on the HP, puts the number on the stack)

Standard III(C): Suitability

Known

MemorizeStandard III(C): what to know cold

Situation	What you must do
Advisory relationship	Reasonable inquiry into experience, risk and return objectives and constraints before advising or acting. Put it in a written investment policy statement (IPS). It may include environmental, social and governance (ESG) preferences as a constraint
Updating	IPS reviewed at least annually and before material changes to recommendations or decisions. ESG concerns may grow over time: update the IPS
Judging fit	Each investment against the client's needs, the investment's characteristics and the total portfolio, not alone
Unsolicited, unsuitable, small impact	Discuss, educate. Client acknowledges the discussion, including that it is against your advice. Follow firm policy, then you may proceed
Unsolicited, unsuitable, material impact	Use it to update the IPS. If the client refuses: separate account if the firm allows, else decide whether to continue the relationship
Fund run to a mandate	Stay inside the stated objectives and constraints. Suitability for each investor is the adviser's job

Memory hook Know, fit, update: know the client, fit the whole portfolio, update every year.

Know it cold Advisory duty runs to the client's IPS. Mandate duty runs to the fund's stated mandate.

Key terms

suitability Memorize
advisory relationship Memorize
investment policy statement Memorize
risk profile Use it
total portfolio context Memorize
unsolicited trade request Memorize
managing to a mandate Memorize
ESG preferences Use it

A client asks for a trade the adviser thinks is unsuitable

Unsolicited, unsuitable requestpause and discuss before trading

Small impact on the portfolio Memorize size or risk change is limited
- Educate the client show how it departs from the IPS
- Client acknowledges the discussion including that it is against the adviser's advice; then follow firm policy and proceed
Material impact Memorize portfolio risk or return shifts
- Update the IPS the client sees the effect on goals
- Client refuses to update options depend on the firm
  - Separate accountif firm policy allows
  - Reconsider the relationshipif no alternative exists

Standard III(D): Performance Presentation

Known

MemorizeStandard III(D): what to know cold

Topic	The rule
Test	Reasonable efforts to make performance fair, accurate and complete
Scope	Past performance and reasonably expected performance. Whole firm, one member, written or oral
Do not	Cherry-pick accounts or periods; drop terminated accounts; imply past returns will repeat
Must label	Simulated or model results; a prior firm's record; gross, net or after-tax basis
Brief presentation	Allowed. Supporting detail must be available on request. Best practice notes that it is limited
Best method	Comply with the GIPS standards. Otherwise use composites of similar portfolios and keep records

Memory hook Whole record, honest label: every account, every period, and a tag on anything that is not real, gross or borrowed.

Know it cold Ask three questions of any figure: is it fair, is it accurate, is it complete?

Key terms

fair, accurate and complete Memorize
composite Use it
terminated accounts Memorize
simulated results Memorize
prior-firm record Use it
brief presentation Use it
GIPS standards Know the idea

What a performance figure must be, and how to keep it so

Performance communicationfair, accurate and complete

Avoid Memorize practices that mislead
- Cherry-picking best accounts or best periods only
- Dropping terminated accounts survivors-only record
- Unlabeled simulations model results shown as actual
Disclose Memorize so the audience is not misled
- Simulated or model results say so
- A prior entity's record where and how it was earned
- Gross, net or after-tax which basis applies
Method Use it compliance practices
- GIPS compliance the best method
- Weighted composites of similar portfolios, not one star account
- Keep supporting records the data behind each figure

Standard III(E): Preservation of Confidentiality

Known

MemorizeStandard III(E): what to know cold

Topic	The rule
Who is covered	Current, former and prospective clients
Exception 1	The information concerns illegal activity by the client
Exception 2	Disclosure is required by law
Exception 3	The client or prospect permits it
CFA Institute PCP	Providing client information for an investigation into your own conduct is not a breach
Safest practice	Share only with colleagues who also work for the client. If in doubt, ask compliance or legal counsel
Vulnerable investor	Set up a secondary contact (trusted family member, legal adviser) at account opening. Limited disclosure may be allowed where legally permissible; document it

Memory hook Three gates, and they are all open or shut for a reason: crime, court, consent. No gate, no sharing (apart from limited, documented disclosure about a vulnerable client).

Know it cold Does an exception apply? If none does, keep it confidential, whatever the client's status.

Key terms

client confidentiality Memorize
former and prospective clients Memorize
illegal activity exception Memorize
disclosure required by law Memorize
client permission Memorize
Professional Conduct Program investigation Use it
information security Use it
vulnerable investor Use it
secondary contact Use it

May client information be disclosed?

Information about a clientdefault: keep it confidential

Who is covered Memorize status does not matter
- Current clients
- Former clients the duty survives the relationship
- Prospective clients including those who never signed
Three exceptions Memorize any one is enough
- Illegal activity by the client may need to report to the authorities
- Required by law for example a court order
- Client or prospect permits it express authorization
Not a breach Use it PCP investigations
- CFA Institute Professional Conduct Program treat it as an extension of yourself

Vulnerable investors under III(E)

A client who may lack capacity or be exploiteddiminished capacity or financial exploitation

Watch for red flags Use it signs of diminished capacity or financial exploitation
Best practice: a secondary contact Memorize trusted family member or legal adviser, set up at account opening
Limited disclosure may be allowed Memorize where legally permissible; it does not violate III(E)
Document the conversation Memorize record what was said and to whom