CFA Level I · CFA Level I Exam

Guidance for Standard III: Duties to Clients: formula sheet

Full chapter guide

Key formulas

Loyalty rule: Client interest > employer interest and personal interest; When interests conflict, act for the client's benefit. Disclosure alone does not excuse putting yourself ahead.
Prudence test: Judge the decision process at the time, not the result; Ask what a prudent person would do with the same facts. A loss alone is not a violation.
Who is the client?: Individual = the person; Trust = the trust (duty runs to its beneficiaries); Plan = participants and beneficiaries; The sponsor or manager who pays or hires you is not the client. A trustee who hires you acts for the trust, so your duty runs to its beneficiaries.
Soft dollar rule: Client commissions → only for client-benefiting research and services; Using them for the firm's own expenses breaches loyalty.
Care in practice: Follow the mandate, seek best execution, document, monitor; Departing from the investment policy or mandate without the client's agreement is a red flag.
Standard III(B) wording: Deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities; Fair and objective, not identical. The exam tests whether an action disadvantages some clients.
Recommendation rule: Disseminate recommendations and changes to all clients at about the same time; Avoid selective early access. Limit pre-release circulation and document distribution.
Trade allocation rule: Allocate by a written, consistent policy (e.g. pro rata) decided before the trade; Do not allocate based on account performance, fees or favouritism, and do not reallocate after seeing results.
Differing service: Different service levels are acceptable if disclosed and available to all at the stated terms; Disclosure and equal availability separate legitimate tiers from preferential treatment.
Core duty: Reasonable inquiry → suitable recommendation → regular update; Gather client information first, act only on what fits, and revisit it regularly (the Handbook suggests at least annually as good practice) and on material change.
Information to gather: Experience + risk and return objectives + constraints (liquidity, time horizon, tax, legal and regulatory, unique circumstances); These are the standard IPS inputs. Risk tolerance combines willingness and ability to take risk.
Suitability test: Suitable = fits the client's IPS and improves or fits the whole portfolio; Judge in a portfolio context, not by looking at one security alone.
Update rule: Update client information regularly and after material changes; The Standard says "regularly"; the Handbook suggests at least annually as good practice. Do not wait for the client to raise a change. A new job, retirement or inheritance can trigger a review.
Mandate rule: Pooled funds: follow the stated mandate; If you manage to a fund mandate, the mandate defines suitability, not any one investor's profile.
Standard III(D) wording: Make reasonable efforts to ensure performance information is fair, accurate, and complete; Performance information must be fair, accurate and complete. A violation occurs when misleading information is presented without reasonable efforts to ensure it meets all three. Memorize all three words.
GIPS status: GIPS = voluntary; III(D) = mandatory for CFA members and candidates; Not using GIPS is not a violation. Misusing the GIPS claim is.
GIPS claim rule: Full compliance or no claim; Do not state partial compliance. Wording must be accurate if the firm claims compliance.
Composite and representative account: Use composites or fair representation of all comparable accounts; Showing only one best account misleads unless it is truly representative.
Gross vs net: Label gross-of-fees or net-of-fees clearly; Unlabeled returns can mislead clients about what they earned.
Duty under Standard III(E): Keep confidential: information about current, former and prospective clients; Applies to all three groups and continues after the relationship ends.
Exception 1: Information concerns illegal activity by the client or prospective client; Disclosure is permitted. Seek compliance or legal advice first.
Exception 2: Disclosure is required by law; For example a valid court order or regulator request. Disclose only what the law requires.
Exception 3: Client or prospective client permits disclosure; Get clear permission, preferably in writing, and keep within its scope.

Quick revision

III(A) Loyalty, Prudence, and Care: act for the benefit of clients and place their interests before your employer's or your own.
Use reasonable care and prudent judgment, and act in the client's best interest when you manage assets for them.
Identify who the client is. In trusts and plans the duty is often owed to the beneficiaries, not just the person who hired you.
III(B) Fair Dealing: treat all clients fairly when giving investment advice, making recommendations, taking investment action or in other professional activities.
Fair does not mean identical. Different service levels are fine if they are disclosed and do not disadvantage other clients.
III(C) Suitability: collect client information, and consider needs and circumstances, objectives and constraints before advice or action.
Review the IPS regularly and update client information. Judge suitability for the whole portfolio, not one security in isolation.
III(D) Performance Presentation: make reasonable efforts to ensure performance information is fair, accurate and complete.
Do not promise or guarantee returns, and do not cherry-pick the best periods or accounts.
III(E) Confidentiality: keep information about current, former and prospective clients confidential unless an exception applies.
Confidentiality exceptions: (1) the information concerns illegal activities by the client or prospective client, (2) disclosure is required by law, or (3) the client or prospective client permits disclosure.
If the law requires disclosure, you must comply. For illegal activities by the client, you may (not must) disclose, where the law permits, to the appropriate authorities and only as far as needed. With client permission, you may disclose what the client has allowed.
When two options look similar, choose the one that is client-first and documented.

Common mistakes

Treating the person who pays the fee as the client Fix: For plans, the client is the participants and beneficiaries. For trusts, the client is the trust and your duty runs to its beneficiaries. Loyalty runs to them, not to whoever pays you.
Judging prudence by whether the investment made money Fix: Prudence is about process and information at the time of the decision. A loss is not automatically a violation, and a gain does not cure a careless process.
Thinking fair dealing means treating all clients identically. Fix: Remember that differing mandates and disclosed service tiers are allowed. What is banned is disadvantaging clients unfairly.
Allocating a hot IPO to the largest fee-paying or best-performing accounts. Fix: Allocate on a fair, pre-set basis across suitable accounts, such as pro rata. Do not use fees or performance.
Rejecting a high-risk investment just because it is risky. Fix: Judge it in a portfolio context. A risky asset can be suitable if it fits the client's objectives and the overall portfolio.
Treating willingness to take risk as the whole of risk tolerance. Fix: Risk tolerance has two parts: willingness and ability. Ability depends on constraints such as liquidity, horizon and wealth. Under the IPS and portfolio management curriculum, when the two conflict, the more conservative (lower) of the two governs. Standard III(C) itself does not state this rule.
Thinking III(D) requires GIPS compliance. Fix: Remember GIPS is voluntary. III(D) applies to everyone, but a GIPS claim must be fully accurate.
Treating accurate numbers as enough. Fix: Check all three tests. Correct figures can still be unfair or incomplete if bad periods or accounts are omitted.
Thinking the duty ends when the client leaves Fix: Remember the text covers current, former and prospective clients.
Forgetting prospective clients Fix: Anyone who shared information while considering your services is protected.

Exam tips

Always name the client first. Trust questions point to the trust and its beneficiaries; pension questions point to participants and beneficiaries.
If an option favours the employer, sponsor or member over the client, eliminate it.
Remember prudence is process-based. Be wary of options that say a loss proves a violation.
Watch for soft dollar stems. The correct option uses commissions only for client-benefiting services.
With three options and no penalty for wrong answers, always answer. Narrow to two using the client-first filter, then pick the one that keeps the process sound.
Look for the unfair driver: fees, performance, relationship, or the manager's own account.
Remember that disclosed, available service tiers and mandate-driven differences are acceptable.
For recommendations, the best answer usually spreads information broadly at about the same time.