Standard IV(B) – Additional Compensa ...
Standard V(B) – Communication with Clients and Prospective Clients specifies that members must disclose the limitations and risks associated with investment recommendations and activities.
Compliance
Related to Standard III – Duties to Clients, Standard V(B) – Communication with Clients and Prospective Clients outlines the need for investment professionals to develop clear, frequent, and thorough communication practices. When clients and prospective clients understand the investment process and the actions of CFA members, they can make well-informed decisions.
To this end, members are obliged to explain the process by which recommendations are made. This includes assumptions, limitations, and risks associated with these methods. For example, if an individual stock accounts for 40% of an investment portfolio, fluctuations in that security will have a much greater impact than if it made up only 2% of a diversified portfolio.
Additionally, investment professionals are expected to outline risks associated with recommendations. Of course, as with any investment, there are inherent risks. That said, economic conditions, corporate liquidity, or volatility within an industry are specific risks that should be communicated to clients and prospective clients.
The length of communication should be appropriate to the recommendation. For example, an electronic communication that says little more than “buy” or “sell” should also include a reference to more detailed information available as a basis for making that recommendation. This allows clients to evaluate specifics should they desire to be more informed of the analysis behind a recommendation.
Violation
Violations often occur when thorough communication is not provided and when members fail to separate facts from opinions. Research-based on past circumstances can be verified as fact. However, projections of future performances are the basis of opinions. For example, an analyst may extrapolate the quantity of a natural resource-based on a limited sample (i.e., an overall reserve of platinum in a mine as inferred from core samples). This type of deduction cannot be proven as fact until the entire mine is quarried. Therefore, the extrapolation must be labeled as an opinion.
Appropriate designation of each type of communication will prevent violation of Standard V(B) – Communication to Clients and Prospective Clients.
Question
Johnna Black is composing a communique to be sent to her clients. The subject of her writing is Tall Boys Grocer, whose earnings have increased each of the past four years by an average of 9.3%. Based on current research, Ms. Black projects that Tall Boys’ earnings will increase by 10.6% in each of the next two years.
Black will violate Standard V(B) – Communication with Clients and Prospective Clients if she states the following:
I. Tall Boys Grocer’s earnings will grow 10.6% in each of the next two years
II. Tall Boys earning have been compounding at approximately 9.3% annually
III. I expect the earnings of Tall Boys Grocer to increase by 10.6% each year for the next two years.
A. I only
B. I & II only
C. I & III only
Solution
The correct answer is A.
Johnna Black’s projection of growth is opinion vs. fact. Therefore, it must be stated as such. If she makes a simple statement of “Tall Boys Grocer’s earnings will grow 10.6% in each of the next two years” then she is guaranteeing a growth outcome and is in violation of Standard V(B) – Communication with Clients and Prospective Clients.
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2021-07-23
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2021-07-17
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