ETH 5 Guidance for Standard III: Duties to Clients

Standard III gathers the obligations that a member or candidate owes directly to clients into five lettered parts, III(A) through III(E). One idea runs through all of them, easy to state and demanding to apply: the client comes first, ahead of the professional’s employer and ahead of the professional’s own interests. For each part the reading gives the plain requirement, guidance that interprets it, procedures a firm can adopt to stay on the right side of the line, and a run of short cases that label conduct as either compliant or a breach. The sections below follow that same order for every subpart.

A recurring theme is that these duties set a floor, not a ceiling. They bind every member and candidate regardless of job title, local law, or whether a formal fiduciary relationship exists, and they never replace a stricter legal or regulatory obligation that also applies. Before working through the parts one by one, it helps to see them side by side.

Each part is examined in its own section. The worked cases are applied judgement scenarios: read the facts, decide whether the conduct meets the standard, and check your reasoning against the solution.

Standard III(A) holds that members and candidates owe their clients loyalty, must act with reasonable care and prudent judgment, and must place the client’s interest ahead of the employer’s and their own.

The single standard and what prudence means

Client interests are paramount. Every investment action should be taken purely for the client’s benefit and in whatever way the professional genuinely believes serves that client best, given the known facts. Prudence sets the quality bar: bring the diligence, skill, and care that a sensible professional in a comparable role, versed in such matters, would apply. In portfolio work that means respecting the parameters the client has set and balancing risk against return, while taking care to avoid foreseeable harm.

One purpose of a single global standard is to remove the confusion investors face when duties shift with job function, jurisdiction, or the exact nature of the advice. Anyone hiring a member or candidate can rely on loyalty, prudence, and care being present regardless of local rules. The standard does not override legal duties, however. As Standard I(A) Knowledge of the Law makes clear, the strictest applicable requirement wins, including any fiduciary duty imposed by law. Professionals who hold custody or effective control of client assets, and any access to client funds, whether direct or indirect, counts, carry a heightened responsibility and must manage those assets according to the governing documents such as trust deeds and management agreements.

Meeting Standard III(A) does not turn every professional into a fiduciary. Whether fiduciary status applies depends on the type of client, whether advice is being given, and the surrounding facts. What the standard does require, in every role, is work in the client’s best interest. A professional who only executes trades and gives no advice still owes prudence and care: there the duty centers on obtaining the most favorable terms achievable and staying within the client’s instructions. In a blended arrangement, where the professional executes trades and also advises on a limited menu of products, the limits should be set out in the client agreement at the outset, for instance that recommendations cover only the firm’s own products, so clients know they may look elsewhere for a wider selection.

Identifying the client

Loyalty cannot be delivered until the professional is clear about who the client actually is. A client is any person or organization the professional serves in a way normally offered for a fee; a prospective client is one who has shown interest, or is being solicited, and could become a client. Usually the identity is obvious, as with an adviser serving individual investors, or a company executive whose clients are the firm’s public shareholders. For a pension plan or a trust, though, the client is not whoever hired the manager but the plan or trust beneficiaries, and loyalty runs to them. For a fund tracking an index or mandate there may be no individual client at all, so the duty is to invest consistently with the stated mandate; the advisory relationship with each fund investor belongs to whoever advises that investor.

Building and guiding the portfolio

Because the manager usually knows far more than the client, the client is in a vulnerable, trust-based position. The manager should confirm that the client’s goals and expectations are realistic and appropriate to the client’s situation, and that the level of risk is right. The professional must watch for places where the firm’s incentives, from selling products to generating transactions, could collide with the client’s interests, and where a conflict cannot be avoided it must be disclosed clearly and factually, as covered in Standard VI(A) Disclosure of Conflicts. Client guidelines bind: some clients, such as charities or those investing on environmental, social, and governance (ESG) criteria, restrict which securities are allowed, while others set limits by overall portfolio risk and return. Suitability of any single holding is judged by its place in the whole portfolio, once the manager has weighed the position’s risk and return, tax effects, and the portfolio’s diversification, liquidity, cash flow, and return needs.

Soft commissions and directed brokerage

Managers often choose the brokers who execute trades, which opens the door to conflicts. Paying an inflated commission to buy research or other goods, with no matching benefit to the client, breaks the duty of loyalty; this practice is known as soft dollars or soft commissions. Unless a client directs otherwise, the professional must pursue best price and best execution, where best execution means a trading process that seeks to lift the value of the client’s portfolio as far as possible within the objectives and constraints the client has set. When a client instead directs trades to a named broker, a practice called directed brokerage, the arrangement does not break loyalty, because commissions are the client’s asset used for the client’s benefit; even so, the professional should confirm with the client that whatever the brokerage provides will help the account, and should warn the client that best execution may be lost.

Voting proxies

Proxies carry economic value, so voting them thoughtfully is part of loyalty. Failing to vote, voting without weighing the issue, or reflexively siding with management on a significant governance matter such as a change in capitalization can each breach the standard. That said, a cost-benefit test may show that voting every proxy is not worth the effort, so voting all of them is not always required. Proxy voting policies should be disclosed to clients.

Recommended procedures

• Send clients with managed assets an itemized statement at least quarterly, disclose where assets are held and when they move, and keep client assets separate from everyone else’s.
• When in doubt, ask what you would want if you were the client, and put questionable matters in writing for client approval.
• Follow all applicable laws and Code provisions, and establish the client’s objectives and constraints at the outset.
• Weigh each action against the client’s needs, the investment’s own characteristics, and the whole portfolio, and diversify unless the mandate forbids it.
• Review accounts on a schedule, deal fairly across clients, and avoid or disclose conflicts of interest.
• Disclose how the manager is paid, vote proxies in the client’s interest, preserve confidentiality, and seek best execution.

Standard III(B) directs members and candidates to deal fairly and objectively with every client when they analyze investments, make recommendations, take investment action, or carry out other professional work.

Fair does not mean identical

The word in the standard is fairly, not equally. No professional can reach every client at the same instant, and clients differ in needs, criteria, and objectives, so the same opportunity is not right for all of them. Charging more for deeper or more personal service is allowed, provided the extra service does not disadvantage other clients, the different tiers are disclosed, and they are open to anyone rather than handed out selectively. What the standard forbids is discriminating against clients, in either the timing or the quality of what they receive.

Disseminating recommendations and changes

An investment recommendation is any opinion to buy, sell, or hold a security or other investment, delivered by full report, brief update, a change to a recommended list, or even a spoken word; anything sent outside the firm counts as general distribution. The professional must get recommendations out so that every client has a fair chance to act. Because timing and communication methods vary across client types, an equitable system is needed to prevent selective disclosure, and clients should be told what kinds of communication to expect. Changes matter as much as first recommendations: a material change must reach all current clients, with special care for those known to have acted on the earlier advice. A client about to place an order that runs against a just-changed recommendation should be told of the change before the order is accepted.

Investment action and allocating new issues

Taking action, like issuing recommendations, can move prices, so all clients must be treated fairly in light of their objectives. In new offerings or secondary financings, the professional should spread the issue across every account for which it suits, following firm allocation policy. An oversubscribed issue should be prorated across suitable accounts in round lots so that odd lots are avoided, and the professional and immediate family must step aside to free shares for clients, unless the family accounts are managed just like other client accounts, in which case they are not excluded. Allocation procedures should be disclosed clearly enough for an informed decision, and even full disclosure cannot excuse an unfair method: the duty of fairness cannot be signed away by client consent to a plainly unfair allocation.

Recommended procedures

• Make new recommendations available to all interested clients, selecting by suitability and known interest rather than favored status, and ideally release them within the firm and to clients at the same time.
• Limit how many people know a recommendation is coming, and shorten the gap between the decision and its dissemination, issuing a short summary early if the full report will take weeks.
• Set rules for conduct before dissemination, and time announcements so no client group gains an edge.
• Keep a list of clients and their holdings to speed notification of changes.
• Document and time-stamp orders, execute on a first-in first-out basis, give every account in a block the same price and commission, and prorate partial fills by order size subject to a minimum lot.
• Disclose the allocation process, review accounts systematically for preferential treatment, and disclose any different service levels, which must not be offered selectively.

Standard III(C) sets out suitability duties. In an advisory relationship the professional must inquire into the client’s experience, objectives, and constraints and keep that current, ensure investments fit the client’s situation and written objectives, and judge suitability across the whole portfolio. When managing to a stated mandate, style, or strategy, the professional must keep to that mandate’s objectives and constraints.

The suitability duty and the advisory relationship

Whoever advises a client in an advisory relationship must weigh that client’s needs, circumstances, and objectives before recommending anything or acting. A sound suitability judgment does not guarantee against losses; it only ensures the investment fits. The professional should look at the investment’s risk against the client’s constraints, its effect on portfolio diversification, and whether the client has the means to bear the risk. Not every attractive opportunity belongs in a given portfolio. These duties fall on those who give advice; professionals who merely execute instructions, or sell-side analysts, often have no way to assess suitability for the end client.

The investment policy statement

At the start of the relationship the professional gathers the client’s financial situation, relevant personal details such as age and occupation, attitude toward risk, and objectives, and best practice is to record all of this in a written investment policy statement, or IPS. A good IPS captures risk tolerance and return needs plus every constraint, including time horizon, liquidity, tax, and legal or regulatory factors, and for some clients unique preferences such as an ESG framework. It also names the parties and their roles and sets a schedule for review. From there the professional can help build a suitable strategic asset allocation. An IPS should be revisited at least once a year and before any material change in recommendations, because clients’ lives change: dependents, tax status, health, liquidity needs, risk tolerance, and outside wealth all shift over time, as do institutional factors such as a pension funding gap or a foundation’s payout rules. Clients should be encouraged to disclose their entire financial picture, including assets held elsewhere; if they hold information back, the analysis can only rest on what was shared.

Risk profile, diversification, and derivatives

Measuring the client’s tolerance for risk is central, and the risk of any proposed strategy should be analyzed and quantified before it is used, with attention to how fast markets can turn. Synthetic and derivative products deserve particular caution because of the leverage they often embed; leverage and thin liquidity, depending on how far they are hedged, bear directly on suitability. Diversification is the norm for most portfolios because combining investments tends to neutralize the quirks of any single holding and produce a more acceptable level of risk. A holding that looks risky on its own can still suit a portfolio, or match a client who has asked for speculative exposure, and the professional assesses suitability only from the information the client actually provides.

Unsolicited trades and managing to a mandate

Clients sometimes ask for trades that do not fit their IPS. The professional should balance the request against the agreed policy, and when a requested trade is clearly unsuitable, hold off until the concern has been discussed, explaining how the request departs from the policy and asking the client to acknowledge that it goes against advice. If the trade would materially affect the portfolio, the moment is a chance to update the IPS. A client who refuses to change the IPS yet insists on the trade forces the professional to weigh whether the advisory relationship should continue. Where the job is to manage a fund to an index or mandate rather than for individuals, the duty is simply to invest consistently with that mandate: a large-cap income fund manager who loads up on speculative small-caps is off mandate. Managers of pooled assets are not responsible for deciding whether the fund suits any particular buyer; only someone in an advisory relationship carries that responsibility.

Recommended procedures

• Put each client’s needs, objectives, and constraints into a written IPS covering client identification, return objectives, risk tolerance, and constraints such as liquidity, cash flows, investable assets, time horizon, tax, regulatory and legal factors, unique preferences including any ESG framework, and proxy responsibilities, plus performance benchmarks.
• Review objectives and constraints periodically and update the IPS for changes, at least annually unless conditions call for more frequent review.
• Apply firm suitability tests that look past return to the impact on diversification, the fit with the client’s risk tolerance, and the fit with the required strategy.

Standard III(D) requires that, when communicating performance information, members and candidates make reasonable efforts to keep it fair, accurate, and complete.

What the standard covers

The point is to give clients and prospects credible performance and to avoid misstating or misleading them about how the professional or the firm has done. It reaches both presentation and measurement, and it bars misrepresenting past results or expected results. Whenever performance is shown, whether for individual accounts, composites, or groups of accounts, it must be fair and complete, and this holds for pooled funds too and for analysts promoting the accuracy of their calls. A brief presentation is fine as long as the supporting detail is available on request, and best practice is to flag that a short presentation is limited in nature.

The GIPS route and practical steps

For those showing the performance of assets they manage, complying with the Global Investment Performance Standards (GIPS) is the surest way to meet the obligation, and professionals should push their firms toward compliance. Where a firm does not comply, it can still meet the standard by tailoring the presentation to the sophistication of the audience, showing a composite of similar portfolios rather than a single hand-picked account, folding terminated accounts into the composite history, adding disclosures that explain the results (flagging simulated or model results, noting when the record belongs to a prior firm, and stating the fee basis, that is, whether the figures are after tax, net of fees, or gross of fees), and keeping the underlying data and records.

Standard III(E) requires members and candidates to hold information about clients, whether current, former, or prospective, in confidence, with three exceptions: when the information concerns the client’s illegal activity, when disclosure is required by law, or when the client permits it.

The duty and its three exceptions

Confidentiality applies when the professional learns something because of a special role in the client’s affairs, and when that information arises from, or bears on, the part of the client’s business covered by the confidential relationship. The duty survives the relationship: former clients’ records stay protected. It may be lifted in three situations.

• The information relates to illegal activity by the client.
• A law requires the information to be disclosed.
• The client, current or former, expressly authorizes disclosure.

Where the law requires disclosure, the professional must comply; where the law instead requires confidentiality, the professional must stay silent even about a client’s illegal acts. When the right course is unclear, compliance staff or legal counsel should be consulted before anything is disclosed. Because Standard I(A) Knowledge of the Law governs, the applicable law controls.

Vulnerable investors and a secondary contact

Confidentiality can create a dilemma when a professional suspects a client’s mental sharpness is fading and feels the need to involve someone outside the relationship. The recommended safeguard is to agree a secondary contact at the very start, a trusted family member, legal adviser, or other intermediary the client authorizes the professional to reach if concerns about decision-making arise. Without such an agreement, confidentiality rules may block any discussion with anyone but the account holder, and local law may not say clearly when consultation is allowed, so pre-agreed parameters and solid firm policies matter. Where the law permits, the duty of loyalty may allow limited disclosure about the existence of an account and worries about the client’s vulnerability, often to a regulator or agency equipped to investigate; acting to protect the client within the law does not breach the standard. Every such conversation, and the reasons for any sensitive disclosure, should be documented and kept in the client file.

Electronic records and cooperation with CFA Institute

Because so much client information is stored electronically, professionals need to guard against accidental disclosure. They are not expected to become security experts, but they must know and follow their employer’s rules for communicating and storing sensitive information on laptops, mobile devices, and external systems. Standard III(E) also does not stand in the way of cooperating with a Professional Conduct investigation by CFA Institute; members and candidates must cooperate with inquiries into their own conduct, and into the conduct of others, unless the law prevents it, and Professional Conduct handles the material it receives confidentially.