CFA Level II · CFA Level II Exam

Guidance for Standard III: Duties to Clients: formula sheet

Full chapter guide

Key formulas

Core duty: Client interests > employer interests and personal interests; When interests conflict, the client comes first. Employer interests are not ignored, but they cannot override the client.
Prudence test: Act as a prudent person would, with reasonable care and judgment; Judged on the process and the facts known when the decision was made, not on hindsight results.
Who is the client?: Trust: beneficiaries | Pension plan: participants and beneficiaries | Fund: investors; The duty is owed to the underlying beneficiaries, not the sponsor or the fund manager.
Soft dollar rule: Soft dollars may be used only for client-benefiting goods and services; Research that helps investment decisions qualifies. Office rent and staff salaries do not.
Best execution: Best execution = most favorable overall terms for the client; Not always the lowest commission. Consider price, speed, liquidity, and certainty of execution.
Proxy voting: Vote in the client's interest; skip only if cost exceeds expected benefit; Document the policy and rationale. Disclose the policy to clients.
Core rule: Fair dealing = fair and objective treatment of all clients, not identical treatment; Different treatment is acceptable when it rests on valid, non-discriminatory reasons such as mandate, fee level or stated service level.
Recommendation dissemination: Limit the number of people who know in advance; give all affected clients a fair chance to act; Clients who hold or are suited to the security should be able to receive the recommendation at a similar time.
Changed recommendation: Rating change communicated to all affected clients before or alongside trading on it; Do not trade for favoured accounts first and then tell others.
Oversubscribed issue allocation: Client allocation = shares available × (client order ÷ total client orders); Pro rata is the typical fair method. Apply it consistently, and do not give shares to your own or your firm's accounts ahead of clients.
Trade allocation: Allocate by a documented, pre-set policy such as pro rata, and give each account the same average price on a block trade; Average pricing is a way to price a block trade fairly across accounts, not an allocation method. Do not allocate after the fact to benefit selected accounts.
Duty 1: Know the client: Reasonable inquiry (experience, risk and return objectives, constraints) → before advice or action → reassess and update regularly; Update at least periodically and after a material event, such as a change in circumstances or market conditions.
Duty 2: Test suitability: Investment suitable = fits client's financial situation AND consistent with written objectives, mandates and constraints; Both parts must hold. Use the IPS as the benchmark.
Portfolio context: Judge the investment by its effect on the whole portfolio, not in isolation; A risky asset may be suitable as a small, diversifying part of a portfolio.
IPS contents: Objectives: risk and return. Constraints: liquidity, time horizon, tax, legal and regulatory, unique circumstances; If the client's wishes conflict with the IPS, discuss and update the IPS.
Pooled funds: For a fund, suitability = consistent with the fund's stated mandate; Not each investor's personal circumstances.
Core duty of Standard III(D): Reasonable efforts to ensure performance information is fair, accurate and complete; The test is reasonable efforts, not a guarantee. Use all three words when you reason about a case.
Fair, accurate, complete test: Fair = no cherry picking or spin; Accurate = correct calculation; Complete = no material omission; Match each fact in the vignette to one of the three words.
No misleading claims: Do not state or imply that past performance is certain to continue; Past results are not a promise. Guarantees about future returns also breach Standard I(C).
GIPS compliance claim: Claim only if the firm meets all applicable GIPS requirements; Partial compliance claims are not allowed. Compliance is voluntary but the claim must be true.
Recommended practices: Consider GIPS, use consistent calculation methods, include all relevant accounts in a composite, and keep supporting records; Records link to Standard V(C). Show gross or net of fees clearly.
Core duty: Keep confidential all information about current, former and prospective clients; The duty covers all three groups and does not end when the relationship ends.
Exception 1: Information concerns illegal activity by the client; Disclosure to the proper authorities is permitted. It is not a general licence to share.
Exception 2: Disclosure is required by law; Comply with a legal or regulatory duty to disclose, for example a valid court order.
Exception 3: Client or prospective client permits disclosure; Disclosure goes only as far as the permission allows.
Scope limit: Duty applies to information received through the client relationship; Keep it distinct from Standard II(A), which deals with material nonpublic information.

Quick revision

III(A): act for the benefit of clients and place their interests before your employer's and your own.
Duty of loyalty, prudence and care applies to the client's interests, and a fiduciary standard may apply under the relevant law.
Vote proxies and use client brokerage only in ways that benefit the client.
III(B): treat clients fairly when disseminating recommendations and when taking investment action.
Fair dealing does not mean equal results for all clients; it means no group is unfairly disadvantaged.
III(C): gather client objectives, constraints and circumstances before advising, and update them regularly.
Suitability applies to the client's whole portfolio, not only a single security.
III(D): present performance that is fair, accurate and complete.
III(E): keep client information confidential unless the information concerns illegal activity by the client, disclosure is required by law, or the client permits disclosure.
In every item set, name the Standard first, then choose the action that fixes the breach and protects the client.

Common mistakes

Treating the plan sponsor or the employer as the client Fix: For a pension plan, the duty runs to participants and beneficiaries. For a fund, it runs to the fund's investors.
Judging prudence by the outcome Fix: Prudence is about the process and the facts available at the time. A loss alone is not a violation, and a gain does not excuse a poor process.
Treating fair dealing as identical treatment for every client. Fix: Remember that different service levels are allowed if disclosed and not discriminatory. The Standard bans unfair disadvantage, not difference.
Thinking you must contact every client at the exact same moment. Fix: The expectation is reasonable procedures that give clients a fair opportunity to act, and that limit the number of people who know in advance.
Judging a security as unsuitable because it is risky on its own. Fix: Ask how the holding changes total portfolio risk and return. Small, diversifying positions can be suitable.
Treating the IPS as a one-time document. Fix: Remember the duty to reassess regularly and after material changes in the client's situation or the markets.
Thinking GIPS compliance is required by Standard III(D) Fix: Remember that GIPS is voluntary. The Standard requires fair, accurate, complete information. If a GIPS claim is made, it must be true.
Accepting a statement like "compliant with GIPS except for..." Fix: Partial compliance claims are not allowed. A firm is either compliant or does not claim compliance.
Thinking the duty ends when the client leaves Fix: Remember the Standard covers current, former and prospective clients. The duty survives the end of the relationship.
Believing the member must always report client illegal activity Fix: The Standard permits disclosure of illegal activity. Any duty to report comes from law, which is a separate exception and links to Standard I(A).

Exam tips

Always name the client first. Many wrong options fail because they serve the sponsor, employer, or manager.
When two options look alike, choose the one with a documented process and disclosure.
Do not mark an action a violation just because the trade lost money. Look for the process failure or the conflict.
For soft dollars, sort each item into client-benefiting or firm-benefiting. Research is usually in. Overhead is out.
If law and the Code conflict, the stricter rule applies, and this often decides the answer.
Look for the words 'first', 'before', 'favoured' and 'largest' in answer options. They often signal a violation of fair dealing.
If an option says clients with different service levels get different services and this is disclosed, it is usually compliant.
For oversubscribed issues, pro rata or a written, consistently applied policy is the safe choice. Do the arithmetic if numbers are given.