{"id":11295,"date":"2021-02-17T15:37:43","date_gmt":"2021-02-17T15:37:43","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=11295"},"modified":"2024-04-12T10:19:36","modified_gmt":"2024-04-12T10:19:36","slug":"standard-iiia-loyalty-prudence-care","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/standard-iiia-loyalty-prudence-care\/","title":{"rendered":"Standard III(A) \u2013 Loyalty, Prudence, and Care"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/49q4XUzEqNw\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients\u2019 interests before their employer\u2019s or their own interests.<\/p>\n<p>Client interests are the ultimate priority. Investment actions must be taken for the benefit of the client, given the Member or Candidate\u2019s knowledge of the facts and circumstance of their client. Standard III(A) \u2013 Loyalty, Prudence, and Care is not a substitute for a member or candidate\u2019s legal obligations. Members and Candidates must always comply with the strictest rule as highlighted in Standard I(A) \u2013 Knowledge of the Law. Members and Candidates must manage funds in accordance with the terms set by governing documents (such as investment agreements, investor policy statements), which identify the investment manager\u2019s duties and power.<\/p>\n<h2>Guidance<\/h2>\n<h3>Understanding the Application of Loyalty, Prudence, and Care<\/h3>\n<p>Standard III(A) sets a minimum benchmark for the duties of loyalty, prudence, and care required by all Members and Candidates. The standard <strong><em>does not<\/em><\/strong> impose a <span style=\"font-weight: normal !msorm; font-style: normal !msorm;\"><strong><em>fiduciary duty<\/em><\/strong><\/span> on Members and Candidates. However, Standard III(A) requires that Members and Candidates work in the best interest of clients at all times.<\/p>\n<h3>A Note on <span style=\"font-weight: normal !msorm;\">Fiduciary Du<\/span>ties<\/h3>\n<p>A fiduciary duty is a <span style=\"font-weight: normal !msorm; font-style: normal !msorm;\"><strong><em>legal<\/em><\/strong><\/span> requirement for an individual to act in the best interest of a client or entity. As such, an individual or entity found in breach of their fiduciary duties or responsibilities can face legal recourse.<\/p>\n<p>A fiduciary relationship exists when one party has the discretion and responsibility to act on behalf of another.<\/p>\n<p>Examples of a fiduciary relationship may include:<\/p>\n<ul>\n<li>The relationship between a financial advisor and his or her clients.<\/li>\n<li>A trustee and the beneficiaries of the trust.<\/li>\n<li>Corporate board members and shareholders.<\/li>\n<\/ul>\n<p>Standard III(A) does not <span style=\"font-weight: normal !msorm; font-style: normal !msorm;\"><strong><em>legally<\/em><\/strong><\/span> require members or candidates to act in the best interest of a client or entity. However, it strongly promotes putting a client&#8217;s interests first.<\/p>\n<h3>Identifying the Actual Investment Client<\/h3>\n<p>Members and Candidates should determine the identity of the \u201cclient\u201d that the duty of loyalty extends to. When an investment manager is managing the assets of an individual, the client is easily identified. When the manager is managing a pool of assets of a pension plan or trust, the client would be <strong><em>the beneficiaries<\/em><\/strong> of the trust or pension and <strong><em>not<\/em><\/strong> the hiring personnel.<\/p>\n<h3>Developing the Client\u2019s Portfolio<\/h3>\n<p>Typically, an investment manager has greater knowledge about the investment universe. This asymmetry reinforces the importance of the duty of loyalty, care, and prudence owed to clients.<\/p>\n<p><em>Investment managers should ensure that:\u00a0<\/em><em>\u00a0<\/em><\/p>\n<ul>\n<li>Client expectations and objectives are realistic and suitable to their risk profile and circumstance.<\/li>\n<li>Recommendation of investment strategies that take into account the long-term objectives of the client.<\/li>\n<li>Any potential conflicts of interest are disclosed explicitly.<\/li>\n<li>There is strict adherence to guidelines and agreements set by their clients.<\/li>\n<li>Investment actions are taken in the context of the total portfolio.<\/li>\n<\/ul>\n<h3>Soft Commission Policies<strong>\u00a0 <\/strong><\/h3>\n<p>\u201cSoft Dollars\u201d or \u201cSoft Commissions\u201d can be defined as the exchange of brokerage business (through client commissions) for research services or any other brokerage offerings. Investment managers direct transactions to their choice of broker, and in return, the brokerage may offer research services. Brokerage commissions are an asset of the client and consequently, any soft dollars obtained should <strong><em>directly benefit<\/em><\/strong> the client.<\/p>\n<p>Clients are allowed to direct their managers to a particular brokerage, a practice referred to as \u2018directed brokerage\u2019 without violating Standard III(A) \u2013 Loyalty, Prudence, and Care. Members and Candidates are required to seek the \u201cbest price\u201d and \u201cbest execution\u201d for any goods and services purchased from a brokerage. \u201cBest execution\u201d is defined as trading practices that aim to maximize the value of a client\u2019s portfolio subject to the client\u2019s objectives and constraints. Additionally, managers should disclose any benefits they receive through client brokerage.<\/p>\n<h3>Proxy Voting Policies<\/h3>\n<p>Members and Candidates are required to vote on proxies responsibly. A member or candidate\u2019s failure to vote or cast votes with little consideration or in line with management would be a violation of Standard III(A). Voting proxies may not always be beneficial for a client. Members and Candidates must always disclose their proxy voting policies.<\/p>\n<h2>Compliance Recommendations<\/h2>\n<h3>Regular Account Information<\/h3>\n<p><em>Members and Candidates should:<\/em><\/p>\n<ul>\n<li>Share with each client the securities in custody or held by the member or candidate as well as all transactions that occurred over the period <span style=\"font-weight: normal !msorm; font-style: normal !msorm;\"><strong><em>a<\/em><\/strong><\/span><span style=\"font-weight: normal !msorm; font-style: normal !msorm;\"><strong><em>t least quarterly<\/em><\/strong><\/span>.<\/li>\n<li>Disclose where the assets are maintained or moved.<\/li>\n<li>Separate the client assets\u2019 from every other party\u2019s assets, including the member or candidates.<\/li>\n<\/ul>\n<h3>Client Approval<\/h3>\n<p>If a Member or Candidate is unsure about any investment actions, they should disclose the concern in writing to the client and receive approval.<\/p>\n<h3>Firm Policies<\/h3>\n<p><em>Members and candidates should:<\/em><\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Follow all applicable rules and laws<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Comply with all legal requirements and applicable parts of the Code and Standards.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Establish the investment objectives of the client<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Inquire into a client\u2019s investment experience, risk and return objectives, and constraints before making investment recommendations or taking investment actions.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Consider all the information when taking actions<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Consider the appropriateness and suitability of the investment relative to:<\/p>\n<ul>\n<li>A client\u2019s requirements and circumstances.<\/li>\n<li>The investment\u2019s characteristics.<\/li>\n<li>The characteristics of the entire portfolio.<\/li>\n<\/ul>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Diversify<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Diversify investments to minimize portfolio risk and loss \u2013 unless stated otherwise.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Carry out regular reviews<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Establish frequent reviews to ensure that investment actions comply with the terms stated in the governing documents.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Deal fairly with all clients concerning investment actions<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Avoid any favoritism of clients and create policies on trade allocation and the dissemination of recommendations.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Disclose conflicts of interest<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Disclose all potential and actual conflicts of interest.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Disclose compensation arrangements<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Disclose all forms of compensation.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Vote proxies<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Determine who is permitted to vote shares and always vote proxies in the best interest of clients or ultimate beneficiaries.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Maintain confidentiality<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Preserve the confidentiality of client information.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Seek best execution<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Unless directed otherwise (by the ultimate beneficiary), always seek best execution.<\/p>\n<p><i><span style=\"font-weight: normal !msorm;\"><strong>Place client interests first<\/strong><\/span><\/i><span style=\"font-weight: normal !msorm;\"><strong>:<\/strong><\/span> Serve in the best interests of clients.<\/p>\n<blockquote>\n<h3>Application 1: Soft Dollars<\/h3>\n<p>Grace Morris is the CEO of a financial advisory firm \u2013 Morris Advisors. Morris routinely uses the same broker for all her client-account trades. The broker offers average prices and below-average execution and research. In exchange, the broker pays Morris Advisors\u2019 employees\u2019 travel expenses and the firm\u2019s rent. All research obtained is used to inform her investment recommendations and advice for her clients.<\/p>\n<p>Is Morris in conflict with Standard III(A) \u2013 Loyalty, Prudence, and Care?<\/p>\n<p>\u00a0 \u00a0 \u00a0A. No, because it is to her discretion which broker, she selects.<\/p>\n<p>\u00a0 \u00a0 \u00a0B. Yes, because she fails to get the best execution and price for her clients.<\/p>\n<p>\u00a0 \u00a0 \u00a0C. No, because the research received is a benefit to all her clients.<\/p>\n<h4>Solution<\/h4>\n<p><strong><em>The correct answer is B.<\/em> <\/strong><\/p>\n<p>Morris has violated Standard III(A) \u2013 Loyalty, Prudence, and Care. She uses her client\u2019s brokerage for services that do not <strong><em>directly<\/em><\/strong> benefit her clients. Additionally, she fails to get the best execution and price for her clients.<\/p>\n<h3>Application 2: Identifying the Client<\/h3>\n<p>Isaac Freeman is a mutual fund portfolio manager. The fund has a strong small-cap value bias. Recently, a large family office expressed interest in allocating a substantial part of their assets in the fund. The only condition put across by the family office was that Freeman needed to include the five best performing growth stocks in the S&amp;P 500. Freeman takes the family office as a client but has yet to include the growth stocks into the fund<\/p>\n<p>Would Freeman\u2019s inclusion of the growth stocks violate Standard III(A) \u2013 Loyalty, Prudence, and Care?<\/p>\n<p>\u00a0 \u00a0 \u00a0 A. Yes, because he is bound to a duty of loyalty to all the beneficiaries of the fund.<\/p>\n<p>\u00a0 \u00a0 \u00a0 B. No, the family office is a big client; they are allowed to make suggestions about asset allocation.<\/p>\n<p>\u00a0 \u00a0 \u00a0 C. No, because the inclusion of the best performing growth stocks would benefit all the beneficiaries of the fund.<\/p>\n<h4>Solution<\/h4>\n<p><strong><em>The correct answer is A.<\/em><\/strong><\/p>\n<p>Freeman\u2019s duty of loyalty extends to <strong><em>all<\/em><\/strong> the beneficiaries of the fund. Freeman is required to take investment actions based on the objectives and rules found in the fund\u2019s investment policy statement. The size of the family office\u2019s investment is irrelevant.<\/p>\n<h3>Application 3: Client Approval<\/h3>\n<p>Hadassah Zachary, CFA, manages Kate Chege\u2019s investment portfolio. Chege has a heavily concentrated position in SunBeam Technologies. She received the majority of her shares after her father \u2013 the ex-CEO of Sunbeam \u2013 passed away. Zachary has expressed the need for and benefits of diversifying her portfolio. Chege has refused to diversify her holdings and has prohibited the sale of Sunbeam stock in her investment policy statement. News has just broken about SunBeam Technology filing for bankruptcy. Zachary is quick to act and attempts to get in touch with Chege, with no success. The stock price is falling dramatically, and Zachary proceeds to sell the shares and reinvest the proceeds into safer yielding assets.<\/p>\n<p>Has Zachary violated Standard III(A) \u2013 Loyalty, Prudence, and Care?<\/p>\n<p>\u00a0 \u00a0 \u00a0A. No, because she acted in Chege\u2019s best interest.<\/p>\n<p>\u00a0 \u00a0 \u00a0B. Yes, because she failed to diversify Chege\u2019s portfolio.<\/p>\n<p>\u00a0 \u00a0 \u00a0C. Yes, because she did not follow instructions found on the investment policy statement.<\/p>\n<h4>Solution<\/h4>\n<p><strong><em>The correct answer is C.<\/em><\/strong><\/p>\n<p>Zachary was trying to act in Chege\u2019s best interest. However, Chege\u2019s investment policy statement <strong><em>prohibits<\/em><\/strong> the sale of Sunbeam stock. While it may appear that Zachary did the right thing for Chege\u2019s portfolio, she has violated Standard III(A) \u2013 Duties to Client. To comply with Standard III(A), Zachary must disclose any investment action and wait for Chege\u2019s approval.<\/p>\n<h3>Application 4: Excessive Trading<\/h3>\n<p>Samuel Taylor is a wealth manager at Schuster Partners. A percentage of her management fees is derived from trading commissions. Taylor trades excessively in each of his client trading accounts, but the trades are appropriate and in line with his client\u2019s asset allocations. However, the trading activity exceeds what is required to implement her client\u2019s objectives.<\/p>\n<p>Do Taylor\u2019s actions comply with Standard III(A) \u2013 Loyalty, Prudence, and Care?<\/p>\n<p>\u00a0 \u00a0 A. Yes, because he is using his client\u2019s assets to benefit himself.<\/p>\n<p>\u00a0 \u00a0 B. No, because the trading activity is within his client\u2019s allocations.<\/p>\n<p>\u00a0 \u00a0 C. No, because Taylor is allowed to direct trading activity and frequency.<\/p>\n<h4>Solution<\/h4>\n<p><strong><em>The correct answer is A.<\/em><\/strong><\/p>\n<p>Taylor has violated Standard III(A) \u2013Loyalty, Prudence, and Care. Her actions are in her interest. Regardless of whether the trades were appropriate, Taylor put his needs before his clients.<\/p>\n<h3>Application 5: Client Loyalty<\/h3>\n<p>Betty Davis is responsible for performing periodic reviews on her firm\u2019s trading activity and allocation practices. In her analysis, she finds that her firm failed to place a large sell order for one of its major clients, Gratus Asset Managers. Correcting this omission will result in a substantial loss for Gratus. Davis is worried that her disclosure of this omission will lead Gratus to terminate its brokerage business with her firm.<\/p>\n<p>What actions should Davis take to <span style=\"font-style: normal !msorm;\"><em>best<\/em><\/span> comply with Standard III(A) \u2013 Loyalty, Prudence, and Care?<\/p>\n<p>\u00a0 \u00a0 \u00a0A. She should take no action. Her correction would lead to her firm losing Gratus\u2019s business.<\/p>\n<p>\u00a0 \u00a0 \u00a0B. She should inform Gratus and her firm of the omission.<\/p>\n<p>\u00a0 \u00a0 \u00a0C. She should ask the traders in her firm to follow through with the sell order.<\/p>\n<h4>Solution<\/h4>\n<p><strong><em>The correct answer is B.<\/em><\/strong><\/p>\n<p>Even though disclosing the omission may lead to Gratus Asset Managers terminating its business with her firm, withholding this information would not be in the best interest of the client. Davis\u2019 duty of loyalty, prudence, and care is owed to the client before her employer.<\/p>\n<\/blockquote>\n<p>Reading 46: Guidance for The Standards of Professional Conduct (I-VII)<\/p>\n<p><em>LOS 46 (a) <\/em><em>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.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients\u2019 interests before their employer\u2019s&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,196],"tags":[216,197,198],"class_list":["post-11295","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-ethical-and-professional-standards","tag-cfa-level-2","tag-ethical-and-professional-standards","tag-standard-iiia","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Standard III(A) \u2013 Loyalty, Prudence, and Care - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Understand fiduciary duties, soft commission policies, proxy voting, and compliance recommendations through practical applications.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/standard-iiia-loyalty-prudence-care\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Standard III(A) \u2013 Loyalty, Prudence, and Care - 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