Learning Outcomes
After reading this article, you will be able to identify how CFA ethical and professional standards apply to real portfolio management scenarios, with emphasis on the duties owed to clients in investment recommendations, suitable portfolio communication requirements, and the importance of maintaining fairness, objectivity, and transparency in all client communications relating to portfolio advice and action.
CFA Level 3 Syllabus
For CFA Level 3, you are required to understand the practical application of the CFA Institute Code of Ethics and Standards of Professional Conduct in portfolio management. In particular, your revision should focus on the following points:
- Recognize and apply the CFA Standards on Duties to Clients in a portfolio context
- Evaluate the appropriateness and requirements for fair and objective communication in portfolio and investment recommendations
- Assess portfolio recommendations for suitability, fair dealing, and adequate disclosure
- Identify risks and consequences when ethical standards are not upheld in portfolio advice
- Analyze and improve investment communication and recommendations for clarity, objectivity, and transparency
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Which CFA Standard explicitly requires that portfolio managers make recommendations suitable to each client's financial situation?
- Why is it important for communications with clients to be fair and objective when proposing changes to their portfolio?
- If an advisor recommends a high-turnover strategy that generates higher fees but does not disclose this risk, which Duty to Client might they be failing?
- What should be included in client communications to ensure recommendations are both appropriate and comply with CFA Standards?
Introduction
Ethical and professional standards provide a basis for portfolio management practices. Advisers and managers must balance portfolio decisions with their duties to each client. This article focuses on applying the CFA standards on Duties to Clients and on communication when making portfolio recommendations. Adherence to these standards helps maintain client trust and protects both the firm and the adviser from reputational and legal risk.
Key Term: Duties to Clients
The set of obligations CFA charterholders owe to their clients under the CFA Code and Standards, including loyalty, prudence, care, and suitability.
THE CORE CLIENT DUTIES IN PORTFOLIO RECOMMENDATIONS
Fair Dealing and Priority of Transactions
Portfolio managers must treat all clients equally and prioritize client interests above their own or their firm's. Fair dealing demands that no client receives preferential access to investment opportunities, research, or changes in strategy. All recommendations, regardless of client size or relationship, must be distributed using a fair process.
Key Term: Fair Dealing
The requirement to offer each client the same degree of care and opportunity in investment recommendations and actions.
Suitability and Know Your Client (KYC)
Each recommendation must be suitable to the client's profile. This requires an up-to-date understanding of client goals, risk tolerance, time horizon, constraints, and preferences. The suitability test should be applied at both the portfolio and individual trade levels.
Key Term: Suitability
The obligation to ensure each recommendation or action is appropriate to a client's objectives, financial situation, and needs.
Objectivity and Transparency in Communication
Clients deserve clear, objective communications regarding all recommendations and decisions made for their portfolios. Portfolio managers must disclose all relevant information for a decision, including material risks, costs, conflicts of interest, and the rationale for a recommendation. This transparency is required even if the news or recommendation may be unwelcome or reflect poorly on the adviser.
Key Term: Communication with Clients
The expectation that all portfolio recommendations and updates be presented factually, impartially, and with sufficient relevant disclosure to enable informed decisions.
Implementation: Practical Application of Standards
A portfolio manager must demonstrate the following in client communications and recommendations:
- Provide a detailed rationale for each portfolio change or recommendation
- Clearly articulate the benefits, drawbacks, and potential risks
- Disclose costs, liquidity constraints, and any impact on overall portfolio risk
- Update clients about material changes in market conditions that could affect objectives or suitability
Worked Example 1.1
A manager is rebalancing a client's portfolio to add alternative assets and increase long-term return potential. The manager emails a one-line notice: "We are reallocating 15% of your equity into private equity for enhanced returns." Does this meet CFA Standards?
Answer:
No. The manager must explain the reason for the recommendation, suitability for this client's objectives, potential liquidity impacts, structural risks of alternatives, and relevant fees. Minimal communication fails the transparency and suitability requirements under Duties to Clients.
Worked Example 1.2
A client requests a "yield-maximizing" portfolio. The manager proposes high-yield bonds without discussing increased default risk or volatility, focusing only on higher returns. Is this appropriate?
Answer:
No. All material risks must be disclosed. Omitting discussion of credit risk and volatility breaches both the suitability requirement and the obligation to communicate fairly and objectively.
Exam Warning
Before making changes to a client's portfolio, do more than just issue a generic notice or rely on standard templates. Clients must receive specific, relevant explanations in plain language about how each recommendation aligns with their goals and what risks/costs may be involved.
Summary
Upholding CFA Standards when making portfolio recommendations is more than a formality. Suitability, fair dealing, and transparent client communication together build the trust that is essential for long-term client relationships and successful practice. Each client must be treated as a unique principal, with recommendations and explanations suited to their circumstances. Every communication regarding portfolio decisions should be factual, impartial, and disclose all material facts and risks.
Key Point Checklist
This article has covered the following key knowledge points:
- The Duties to Clients require loyalty, prudence, care, and prioritizing client interests in all actions
- Suitability requires a thorough up-to-date understanding of client objectives and needs before making portfolio recommendations
- All portfolio recommendation communications must be fair, objective, and transparent, with clear explanations of risks, benefits, and costs
- Fair dealing demands equal treatment and opportunity for all clients in access to information and recommendations
- Failing in any of these duties increases not only regulatory and legal risk, but undermines client confidence and can lead to professional sanction
Key Terms and Concepts
- Duties to Clients
- Fair Dealing
- Suitability
- Communication with Clients