Standard V (B) – Communication with Clients and Prospective Clients

Members and Candidates must:

1. Disclose to clients and prospective clients the basic format and general principles of the investment processes they use to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes.
2. Disclose to clients and prospective clients significant limitations and risks associated with the investment process.
3. Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients.
4. Distinguish between fact and opinion in the presentation of investment analysis and recommendations.

Standard V(B) addresses the appropriate conduct required by a Member or Candidate when communicating with clients and prospective clients. Clear and effective communication with clients is essential in providing high-quality financial services. Frequent and timely information assists clients in making well-informed investment decisions.

Members and Candidates should communicate the significant factors that inform an investment recommendation. Additionally, Members and Candidates should clearly distinguish between opinions and facts in the presentation of all recommendations.

Informing Clients of the Investment Process

Clients should understand the basic characteristics of any investment asset or product. This knowledge will help a client judge the suitability of an investment (in isolation) and the impact of the investment on the entire portfolio.

Members and Candidates should:

• Wholly describe how the firm conducts its investment decision process.
• Disclose the risks and limitations of the investment process.
• Disclose any changes to the investment process (especially newly identified risks and limitations).
• Inform clients of expertise provided by external advisers.

Different Forms of Communication

All types of client communication, in all mediums (not only written reports or written communications), are covered by this standard. Members and Candidates should ensure that information is disseminated fairly regardless of the method of communication used.

Identifying Risks and Limitations

To comply with this standard, Members and Candidates must:

• Highlight the risks and limitations of any investment action or recommendation.
• Adequately disclose market risks and risks involved when using complex financial instruments.
• Describe the limitations of the investment decision process e.g. liquidity and capacity

Members and Candidates are only responsible for informing clients about risks that are known at the time of disclosure. Members and Candidates are not responsible for disclosing risks they were unaware of at the time when a recommendation or investment action was taken.

Report Presentation

A Member or Candidate responsible for the preparation of a research report must include factors that are important to the analysis and conclusions of the report. Investment recommendations that are quantitatively driven must be supported by readily available source materials, e.g., data, assumptions. Any changes in the applied methodology should be acknowledged and disseminated.

Distinction between Facts and Opinions

Members and Candidates must ensure that they separate opinions from facts. In the case of quantitatively driven analysis, members should distinguish between statistical “talk” and outline any limitations of their analysis.

Members and Candidates should discuss the limitations and assumptions of any financial models and processes that facilitate their analysis. Additionally, Members and Candidates should be cautious when discussing the accuracy of the output generated by models or processes. The output of quantitative models are estimates of future outcomes and not concrete results.

Compliance Recommendations

The selection of disclosures of important factors in a research report is subjective. As such, Members and Candidates should maintain records of their research and analysis and make readily available reference material and supplementary information on request.

Application 1: Opinion as Fact

Emmanuel Oluwo works as an oil and gas analyst at GeoField Consultancy Group. He has been working on a report that attempts to assess the crude oil production capacity of Naija Oil Corporation. His assessment will form part of his updated investment recommendation.

Naija Oil Corporation has recently tapped a significant oil resource on the northwest coast of Nigeria. Oluwo’s report includes his estimate (through a series of calculations) of the expanded production capacity of the newly tapped oil field.

In his conclusion, Oluwo states:

“Based on the increase in the production capacity of 500,000 barrels per day, I recommend that Naija Oil Corp is a strong BUY.”

Has Oluwo violated Standard V(B) – Communication with Clients and Prospective Clients?

         A. Yes, because he presents his estimate of the increase in capacity of 500,000 barrels per day as a fact and not opinion.

         B. No, because he is permitted to include any relevant information in his research report.

         C. Yes, because he does not provide a detailed explanation about the methodology applied in his estimate of the production capacity of the new oil field.

Solution

The correct answer is A.

Oluwo has violated Standard V(B) – Communication with Clients and Prospective Clients. Oluwo’s calculation of the increase in production is a quantitative estimate (an opinion) and not fact. Opinions must clearly be distinguished from facts in research reports. Oluwo should have details about his estimation methodology prepared and available on request.

Application 2: Notification of Fund Mandate Change

Regis Partners is a fund manager that specializes in large-cap European stocks. One of the key screening criteria is selecting stocks that have a minimum market capitalization of EUR 5 Billion. The Eurozone’s economic outlook and growth prospects have diminished over the past five years, and Regis has altered the growth rate estimates for several of the firms found in its ‘Euro large-cap growth’ fund.

In an attempt to broaden the investment universe of the fund, Regis’s CFO changes the permitted market capitalization to EUR 2.5 Billion. Regis CFO ensures that the firm’s marketing and promotional material include the change in the market capitalization criteria and informs all prospective clients about the updated investment process.

Are any of Regis’s CFO actions in conflict with Standard V(B) – Communication with Clients and Prospective Clients?

        A. None of his actions conflict with Standard V(B).

        B. Yes, his failure to inform the firm’s existing clients of the change in the market capitalization.

        C. Yes, he is not permitted to change the screening criteria of the fund without notifying the firm’s existing clients.

Solution

The correct answer is B.

To comply with Standard V(B) – Communication with Clients and Prospective Clients, Regis’s CFO must inform all potential and existing clients about the change in the investment process.

Regis’s CFO took appropriate but incomplete measures in communicating the change in the fund’s investment mandate. Communicating the change in the mandate is a necessary step in providing clients the information required to judge the suitability of their investment in Regis’s Euro large-cap growth fund.

Reading 46: Guidance for The Standards of Professional Conduct (I-VII)

LOS 46 (a) Demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations.