Standard III (B) – Fair Dealing

Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.

Members and Candidates are required to treat all clients fairly when sharing investment recommendations, taking investment actions, or making material changes to older research recommendations.

In this context, “fairly” means that Members and Candidates must not discriminate against any of their clients. Discrimination may take on various forms – dissemination of investment recommendations to some clients, prioritizing investment actions for some clients, and not the rest. Members and Candidates must take note that “fairly” and “equally” cannot be interpreted as the same thing.

Members and Candidates cannot ensure that dissemination of any information would reach clients at the same time and provide them all with equal opportunity to take action. Additionally, there may be some investment opportunities that are suitable for one client and not another.

Members and Candidates are permitted to provide specialized services and charge higher management or brokerage fees. Members or Candidates who offer differentiated services must disclose this to all potential and current clients. All clients should be able to access differentiated service levels.

Investment Recommendations

This conduct relates to members or candidates who work on preparing investment recommendations that are disseminated to the public or shared internally to inform investment decisions.

Each member and candidate should:

• Ensure that information is disseminated in such a way that all clients have a fair opportunity to take investment action.
• Encourage their firms to implement dissemination structures and policies that allow for fair disclosures among all clients.

Standard III(B) – Fair Dealing may be even more important when it relates to material changes in initial recommendations. Members and Candidates should inform all clients of changes in recommendations, with greater consideration to those who acted upon earlier information. Members should inform clients who may be unaware of a change in recommendation before accepting and placing any orders on their behalf.

Investment Action

This conduct relates to Members and Candidates who take investment actions based on recommendations prepared internally or received from external sources.

Each member and candidate should:

• Treat all clients fairly relative to their investment objectives and circumstances.
• Distribute all new issues/secondary financings – to all clients for whom this may be suitable – in a manner consistent with their firm’s allocation policies.
• Forgo any personal and family allocations if an issue is oversubscribed.
• Treat family-member accounts that are managed similarly to client accounts equally. In this case, family members can still participate in purchasing shares in oversubscribed issues.
• Disclose to prospective and current clients the firm’s documented allocation policies.

Compliance Recommendations

Develop Firm Policies

Members and Candidates should encourage their firms to develop compliance policies that require Members and Candidates to disseminate investment recommendations fairly.

Members and Candidates should consider the following when creating fair dealing compliance procedures:

• Limit the number of people involved: Limit the number of people aware of an upcoming change in recommendation.
• Shorten the time frame: Limit the time between the decision of a change or initial investment recommendation and dissemination or publishing.
• Guidelines for pre-dissemination actions: Encourage firms to develop policies that forbid employees with knowledge of investment recommendation changes from taking action or discussing the recommendation.
• Simultaneous dissemination: Create procedures that ensure that the timing of the dissemination of all recommendations happens approximately at the same time for all clients.
• List of client holdings: Maintain a list of all clients and their holdings of securities and other investments to enable easy communications of any changes in investment recommendations.
• Develop and document trade allocation policies: Develop a set of policies that ensure:
  1. 1. Fairness to all clients;
     2. Timeliness and efficiency in execution of orders; and
     3. Accurate client records.

Disclose Trade Allocation Procedures

Trade allocation procedures should be fair and equitable. Members and Candidates should disclose to all prospective and current clients their firm’s allocation practices.

Establish Systematic Account Reviews

Members and Candidates should encourage their firms to establish review procedures to ensure or to identify that there has been no favoritism in trading practices and allocation.

Disclose Levels of Service

Members and Candidates should disclose to all clients if their firm offers differentiated services at different fees. Different service levels should be available to all clients.

Application 1: Selective Disclosure

Mari Dudek is a widely followed automobile analyst. She frequently has lunch meetings with clients who have subscribed to the firm’s “Platinum” service tier.  In a lunch meeting, she discloses that she is about to issue a change in her investment recommendation on T-Electric to a “sell” – pending approval from her boss and the firm’s internal fact-checkers. She receives approval three days after the meeting and goes on to disseminate her recommendation to her other clients.

Which of Dudek’s actions are most likely in conflict with Standard III(B) – Fair Dealing?

    A. No actions conflict with Standard III(B) – Fair Dealing.

    B. Her frequent lunch meeting with “Platinum” tier clients can be interpreted as favoritism.

    C. Her disclosure of the change in her recommendation of T-Electric.

Solution

The correct answer is C.

Dudek is permitted to offer differentiated service levels provided that she discloses this to her current and prospective clients. In this instance, her lunch meeting with “Platinum” tier clients would not be a violation of Standard III(B) – Fair Dealing. She has violated Standard III(B) – Fair Dealing, because she disclosed her change in the recommendation to some clients before others.

Application 2: IPO Distribution

Adam McNarry is the CFO of Astra Capital Advisors (ACA). ACA specializes in corporate advisory and capital raising activities. His client, GreenFarm Ltd., is looking to go public. ACA receives an overwhelming amount of expression of interest from both retail and institutional investors. The new issue is twice oversubscribed. McNarry proceeds to remove all shares allocated to fee-paying family-member accounts. The shares are then prorated among all the clients.

Has McNarry violated Standard III(B) – Fair Dealing?

    A. No, because his exclusion of family-member accounts would increase the allocation to his other clients.

    B. Yes, because fee-paying family accounts should be treated the same way as all his other clients.

    C. No, because he was prioritizing his client’s accounts over his family member accounts.

Solution

The correct answer is B.

McNarry has violated Standard III(B) – Fair Dealing. McNarry should treat all his fee-paying clients equally. In this case, McNarry should not have removed his family members’ allocation in GreenFarm Ltd.

Application 3: Additional Services for Select Clients

Josephine Clark sends an email to all her clients to inform them about a change in her investment recommendation of Nix Technologies. She then calls her two biggest clients to go over her conclusions and respond to any queries.

Would Clark’s actions violate Standard III(B) – Fair Dealing?

     A. Yes, because she is giving greater consideration to her two biggest clients.

     B. No, because she informed all her clients about the change in her recommendation.

     C. Yes, because she has discriminated against some clients and favored others.

Solution

The correct answer is B.

Clark has not violated Standard III(B) – Fair Dealing. Clark disseminated her change in the recommendation to all her clients. Clark is allowed to offer personal services to clients that may have a significant amount of assets in the firm. Clark would be in violation if she failed to disseminate her recommendation to all her clients but a select few.

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.