Standard III(A): Loyalty, Prudence, and Care
Owe clients loyalty, prudence and care: act for their benefit and put their interests before your employer's and your own. Identify who the client really is (for a pension plan, the beneficiaries), use client brokerage only for the client's benefit, seek best execution, and vote proxies in the client's interests.
Before this: Standard II(B): Market Manipulation
On the exam
- Demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity
- Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct
- Identify conduct that conforms to the Code and Standards and conduct that violates the Code and Standards
Demonstrate III(A), recommend procedures and identify compliant conduct. Expect soft-dollar, proxy-voting and "who is the client?" items. The usual wrong answers treat the plan sponsor as the client, let client commissions pay for firm expenses, or demand that every proxy be voted.
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.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What does Standard III(A) require?
You owe every client a duty of loyalty : act for the client’s benefit and place the client’s interests before your employer’s and your own. You must also use prudence and care . Prudence means the caution, skill and diligence a reasonable person in your role would use, including following the client’s investment parameters and balancing risk and return. Care means acting in a prudent and judicious way to avoid harm to the client.
Memorize
The Standard is a floor that applies to every member, whatever the job title or local law. It does not make you a legal fiduciary. A fiduciary duty is imposed by law or regulation on someone charged with acting for another party, such as managing their assets, and it sits in an enhanced position of trust. If a stricter legal duty applies to you, Standard I(A) tells you to follow the stricter rule.
Even a professional who only executes trades must work in the client’s interest, which means getting the most favorable terms available within the client’s instructions.
Who is the client?
Identifying the client is the first step, because you cannot be loyal to someone you have not identified. For an individual’s personal assets the client is obvious. For a pension plan or a trust it is not: the party that hires you is not the client. The duty of loyalty runs to the ultimate beneficiaries.
- 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
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- 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
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If you run a fund to an index or a stated mandate, there is no single client profile. Your duty is to invest consistently with the mandate. The duty to judge whether the fund suits an individual investor falls on whoever advises that investor.
Other roles have clients too. For a research analyst, the client may be the investing public, and independence and objectivity of the research then matter more than loyalty to one organization.
How do you build the portfolio?
Follow the guidelines your client sets, including any limits on asset types or specific securities. Judge each decision in the context of the total portfolio, not security by security: its place in the whole, the risk of loss and chance of gain, taxes, diversification, liquidity, cash flow and return needs. Where you cannot avoid a conflict between the firm’s business and the client’s interests, give clear and factual disclosure.
If you have custody of client assets, a heightened responsibility applies. Manage them under the governing documents, such as the trust deed or the management agreement. Acting against those documents risks a III(A) violation.
What may client brokerage pay for?
Client brokerage means the commissions generated by trading a client’s account. They are an asset of the client. The practice of using those commissions to buy research or other services is called soft commissions (soft dollars).
- Violation: paying a higher commission than you normally would to obtain goods or services without a corresponding benefit to the client.
- Acceptable: buying research that you use in managing the accounts whose trades paid for it.
When a client tells you which broker to use, that is directed brokerage . It is the client’s choice and no breach of loyalty. You must still seek the best price and execution, and you should disclose that the client may not be getting best execution . Best execution means a trading process that seeks to maximize the value of the client’s portfolio within the client’s objectives and constraints. It does not mean the lowest commission.
How should you vote proxies?
Proxy voting is part of the duty. Proxies have economic value for clients, and you must vote in an informed and responsible way. Failing to vote, voting without considering the question, or voting blindly with management on non-routine governance matters (such as a change to the company’s capital structure) may violate the Standard.
A cost-benefit analysis may show that voting every proxy does not benefit the client, so you need not vote in every case. Disclose your voting policy to clients.
Where do the lines fall?
| Situation | Verdict |
|---|---|
| A manager uses client commissions to pay for the firm’s office software | Violation (client brokerage must benefit clients) |
| A pension manager invests in the sponsor’s struggling supplier because the sponsor’s finance director asked | Violation (the beneficiaries are the clients) |
| A manager routes trades to a slower, pricier broker who refers new clients to the firm | Violation (best execution and loyalty) |
| A manager skips a routine vote where cost outweighs any benefit, under a written, disclosed policy | Acceptable |
| A manager takes extra risk in a conservative client’s account to hit a personal bonus target | Violation |
Try this 0 of 3
- Find the client right first time in all three relationships
- Clear the commission budget right first time
- Get the skipped vote right first time
Case 1 of 5 The pension plan
Lena Brandt, CFA, manages the equity portfolio of the Corvane Tooling pension plan at Halden Asset Management. Corvane is the plan sponsor, and three Corvane executives sit as the plan's trustees. Corvane's CFO asks Lena to put 4% of the plan into the shares of Pellam Steel, a struggling supplier Corvane depends on, "to keep our supply chain alive". Lena's own analysis rates Pellam a sell. The plan exists to pay the pensions of Corvane's current and former employees.
Step 1 of 5 Who is the client?
Three parties stand around the plan. To whom does Lena owe her duty of loyalty?
Read the case, then answer each step. 5 cases.
What procedures help?
- Send each client an itemized statement at least quarterly, tell them where assets are held, and keep client assets separate from your own.
- If unsure, ask what you would expect if you were the client. If still in doubt, disclose the matter in writing and get the client’s approval.
- Push the firm to adopt written policies covering: following applicable rules, setting the client’s objectives, considering suitability against the whole portfolio, regular client communication, disclosure of conflicts and fees, best execution, proxy voting and confidentiality.
Go deeper Fiduciary duty in law versus III(A)
The Code and Standards do not impose a legal fiduciary duty and do not require every member to be a fiduciary. They set one benchmark of loyalty, prudence and care for everyone. Where the law does impose a fiduciary duty, you must meet it too, and the stricter requirement governs. On the exam, if an answer says the Standard “makes the member a fiduciary”, be suspicious. If the question describes a legal duty, apply the stricter rule.
Go deeper Best execution is not the cheapest broker
A low commission can come with poor prices, slow fills or leaked orders. Best execution is judged by the overall value to the client: the total cost, the price achieved, speed and certainty of execution. A manager who picks the broker for personal or firm benefit, such as referrals or free services, is not seeking best execution even if the commission looks low.
Memorize this
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.
- 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
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- 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
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How it is asked
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Who is the client?
A manager runs a corporate pension plan and the sponsor's chief financial officer (CFO) asks for a purchase that helps the sponsor. Violation?
Yes, III(A). The beneficiaries are the clients. Trap: "the sponsor hired the manager".
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What can client commissions buy?
Which use of soft dollars is most consistent with the Standards?
Research used in managing the accounts that paid the commissions. Trap: office costs, marketing, anything for the firm generally.
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Must every proxy be voted?
A written policy skips a routine vote where the cost outweighs the benefit. Violation?
No. Voting is part of the duty, but cost-benefit and a disclosed policy are allowed. Trap: "all proxies must be voted".
Exam traps
- Treating the plan sponsor, its executives or the trustees as the client. For a pension plan or trust the duty runs to the beneficiaries.
- Using soft dollars for anything that helps the firm in general (rent, salaries, marketing). Client brokerage may buy only what benefits the clients who paid.
- Thinking directed brokerage is a violation. It is the client's choice, but you must still seek best execution and disclose the possible cost.
- Insisting every proxy must be voted. A cost-benefit analysis can justify not voting, but blind votes with management on non-routine matters can violate the Standard.
Checkpoint
3 exam-style questions. About 90 seconds each.
1The chief executive of a company asks the manager of the company's pension plan to build a large position in the company's own shares, saying it would "show the market that employees back us". The manager thinks the shares are overvalued but buys them for the plan to keep the relationship. Did the manager violate the Standards?
2Which use of client brokerage commissions (soft dollars) is most consistent with Standard III(A)?
3A manager's written, disclosed policy is to vote proxies unless the cost clearly outweighs the benefit to clients. Applying it, the manager does not vote on a routine resolution at a tiny foreign holding. Did the manager violate the Standards?
Key takeaways
- Clients first, with reasonable care and prudent judgment.
- Identify the real client: the beneficiaries of a plan or trust, the mandate of a fund.
- Client brokerage belongs to the client. Seek best execution, which is not the same as the lowest commission.
- Vote proxies in the client's interests, under a disclosed policy.
All Ethical and Professional Standards formulas, every lesson
Practice exam-style questions on Guidance for Standard III: Duties to Clients
Questions about this lesson?
Where this comes back
- Standard III(B): Fair Dealing Guidance for Standard III: Duties to Clients
Questions candidates ask
What does loyalty, prudence and care mean for a CFA member?
Put clients' interests before your employer's and your own, and use the care and judgment a reasonable professional would. The Standard applies whatever your job title, and it does not replace any stricter legal fiduciary duty.
What are soft dollars and how can they be used?
Soft dollars are client brokerage commissions used to pay for research or other services. They may be used only for goods and services that benefit the clients whose trades generated them. Paying more commission for firm benefits violates the duty of loyalty.
Who is the client in a pension plan?
The plan's beneficiaries, not the sponsor or trustees who hired the manager. The manager's duty of loyalty, prudence and care runs to the beneficiaries, so the sponsor's wishes cannot override their interests.
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