Standard III(C): Suitability

What does Standard III(C) require?

When you are in an advisory relationship with a client, you must weigh the client’s needs, circumstances and objectives when deciding whether an investment or action is appropriate. That test is suitability . A correct suitability decision does not guarantee profit, because suitable investments can still lose value.

Memorize

• Before acting, make a reasonable inquiry into the client’s investment experience, risk and return objectives and financial constraints, and keep it up to date.
• When acting, make sure each investment fits the client’s written objectives and constraints.
• Whatever you buy, judge it in the context of the whole portfolio, not on its own.
• If you manage a fund to a stated strategy or mandate, keep to it.

The duty to gather information and judge suitability falls on members who give advice in an advisory relationship. Someone who only executes a retail client’s specific instructions, or a sell-side analyst, may have no chance to judge suitability for the end client.

What goes into the policy statement?

At the start of an advisory relationship, collect the client’s financial circumstances, relevant personal data, attitude to risk and objectives. Record them in a written investment policy statement (IPS) covering risk tolerance, return requirements and all constraints (time horizon, liquidity, tax, legal and regulatory factors, unique circumstances). The IPS also sets out each party’s role and a schedule for review.

The Handbook notes that an IPS may include ESG preferences (environmental, social and governance) as a client constraint. These concerns may grow over the relationship, which is a reason to update the IPS.

A client’s risk profile is the single most important input to suitability. Pay particular attention to leverage and limited liquidity in derivatives and synthetic products, which bear directly on whether they suit the client.

Review the IPS at least annually, and before any material change to recommendations or decisions. Changes that matter include the number of dependents, tax status, health, liquidity needs and risk tolerance. An institution’s changes might be unfunded pension liabilities or a foundation’s distribution requirements. If a client withholds information about assets you do not manage, your analysis can only rest on what you were given.

What does total portfolio context mean?

Total portfolio context means you judge an investment by its place in the whole portfolio: its effect on diversification, its risk against the client’s tolerance, and its fit with the required strategy. A high-risk security alone can be a suitable holding as a small part of a diversified portfolio, or when the client’s objectives contemplate speculative investments.

What if the client asks for an unsuitable trade?

An unsolicited trade request that you know is unsuitable should wait until you have talked it through. What happens next depends on the size of the effect.

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

What if you run a fund to a mandate?

Managing to a mandate means managing a pooled fund or index strategy to a stated objective. Your duty is to invest consistently with that mandate, so the manager of an inflation-linked government bond fund who buys equities to chase returns is out of line. You are not responsible for judging whether the fund suits each person who buys it. Only a member with an advisory relationship takes on that responsibility.

Where do the lines fall?

Situation	Verdict
An adviser puts a retiree who needs income into a leveraged fund without reviewing the IPS	Violation
An emerging-market small-cap fund is 5% of a diversified, growth-oriented portfolio	Suitable in total portfolio context
A European utilities fund manager moves a fifth of the fund into Asian chip makers	Violation (mandate)
A client insists on a small speculative trade; the adviser explains the risk and documents the discussion	Acceptable
An IPS was written six years ago and never revisited despite the client’s divorce	Violation (must update)

Compliance practices

• Keep a written IPS for every advisory client, covering client identification, return and risk objectives, constraints (liquidity, cash flows, investable funds, time horizon, tax, legal and regulatory, preferences including ESG, proxy voting) and performance benchmarks.
• Regular updates. Review the IPS at least annually and after major events. Document any attempt to review that circumstances prevented.
• Suitability test policies. Encourage firm-level suitability tests that look beyond expected return: the effect on diversification, the investment’s risks against the client’s risk tolerance, and its fit with the required strategy.

Go deeper Why one security can look wrong and be right

Risk in a portfolio comes from how holdings move together, not from each holding’s volatility alone. A volatile asset that moves differently from the rest can lower the risk of the whole, or add a small amount of risk for a worthwhile return. That is why Standard III(C) says to judge the investment’s place in the total portfolio. The same logic returns in the portfolio management topic.

Go deeper The client who insists on a material unsuitable trade

If the effect is material and the client will not update the IPS, you do not simply place the trade. Some firms let the client place it in a separate unmanaged account, so it sits outside your advice. If no alternative exists, you weigh whether to continue the advisory arrangement. The decisive facts in a question are the size of the effect and whether the client was told and agreed.