Standards III(B) And III(C)

• 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.

Guidance Do not discriminate against any clients when disseminating recommendations or taking investment action. Fairly does not mean equally. In the normal course of business, there will be differences in the time emails, faxes, etc., are received by different clients.

Different service levels are okay, but they must not negatively affect or disadvantage any clients. Disclose the different service levels to all clients and prospects, and make premium levels of service available to all who wish to pay for them.

Guidance, Investment Recommendations Give all clients a fair opportunity to act upon every recommendation. Clients who are unaware of a change in a recommendation should be advised before the order is accepted.

Guidance, Investment Actions

Treat clients fairly in light of their investment objectives and circumstances. Treat both individual and institutional clients in a fair and impartial manner. Members and candidates should not take advantage of their position in the industry to disadvantage clients (e.g., in the context of IPOs).

Recommended Procedures for Compliance

Encourage firms to establish compliance procedures requiring proper dissemination of investment recommendations and fair treatment of all customers and clients. Consider these points when establishing fair dealing compliance procedures:

• Limit the number of people who are aware that a change in recommendation will be made. Shorten the time frame between decision and dissemination.
• Publish personnel guidelines for pre dissemination, have in place guidelines prohibiting personnel who have prior knowledge of a recommendation from discussing it or taking action on the pending recommendation. Simultaneous dissemination of new or changed recommendations to all clients who have expressed an interest or for whom an investment is suitable. Maintain list of clients and holdings, use to ensure that all holders are treated fairly.
• Develop written trade allocation procedures, ensure fairness to clients, timely and efficient order execution, and accuracy of client positions. Disclose trade allocation procedures.
• Establish systematic account review, ensure that no client is given preferred treatment and that investment actions are consistent with the account’s objectives. Disclose available levels of service.

Application of Standard III(B) Fair Dealing Example 1:

A member gets options for his part in an IPO from the subject firm. The IPO is oversubscribed and the member fills his own and other individuals’ orders but has to reduce allocations to his institutional clients.

Comment:

The member has violated the Standard. He must disclose to his employer and to his clients that he has accepted options for putting together the IPO. He should not take any shares of a hot IPO for himself and should have distributed his allocated shares of the IPO to all clients in proportion to their original order amounts.

Example 2:

A member is delayed in allocating some trades to client accounts. When she allocates the trades, she puts some positions that have appreciated in a preferred client’s account and puts trades that have not done as well in other client accounts.

Comment:

This is a violation of the Standard. The member should have allocated the trades to specific accounts prior to the trades or should have allocated the trades proportionally to suitable accounts in a timely fashion.

Example 3:

Because of minimum lot size restrictions, a portfolio manager allocates the bonds she receives from an oversubscribed bond offering to her clients in a way that is not strictly proportional to their purchase requests.

Comment:

Since she has a reason (minimum lot size) to deviate from a strict pro rata allocation to her clients, there is no violation of Fair Dealing.

• III(C) Suitability

1. When Members and Candidates are in an advisory relationship with a client, they must:

a. Make a reasonable inquiry into a client’s or prospective clients’ investment

experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action and must reassess and update this information regularly.

b. Determine that an investment is suitable to the client’s financial situation and

consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action. c. Judge the suitability of investments in the context of the client’s total portfolio.

2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must make only investment recommendations or take only investment actions that are consistent with the stated objectives and constraints of the portfolio.

Guidance In advisory relationships, be sure to gather client information at the beginning of the relationship, in the form of an investment policy statement (IPS). Consider clients’ needs and circumstances and thus their risk tolerance. Consider whether or not the use of leverage is suitable for the client.

If a member is responsible for managing a fund to an index or other stated mandate, be sure investments are consistent with the stated mandate.

Guidance, Unsolicited Trade Requests

An investment manager might receive a client request to purchase a security that the manager knows is unsuitable, given the client’s investment policy statement. The trade may or may not have a material effect on the risk characteristics of the client’s total portfolio and the requirements are different for each case. In either case, however, the manager should not make the trade until he has discussed with the client the reasons (based on the IPS) that the trade is unsuitable for the client’s account.

If the manager determines that the effect on the risk/return profile of the client’s total portfolio is minimal, the manager, after discussing with the client how the trade does not fit the IPS goals and constraints, may follow his firm’s policy with regard to unsuitable trades. Regardless of firm policy, the client must acknowledge the discussion and an understanding of why the trade is unsuitable.

If the trade would have a material impact on the risk/return profile of the client’s total portfolio, one option is to update the IPS so that the client accepts a changed risk profile that would permit the trade. If the client will not accept a changed IPS, the manager may follow firm policy, which may allow the trade to be made in a separate client directed account. In the absence of other options, the manager may need to reconsider whether to maintain the relationship with the client.

Recommended Procedures for Compliance Members should:

• Put the needs and circumstances of each client and the client’s investment objectives into a written IPS for each client. Consider the type of client and whether there are separate beneficiaries, investor objectives (return and risk), investor constraints (liquidity needs, expected cash flows, time, tax, and regulatory and legal circumstances), and performance measurement benchmarks. Review investor’s objectives and constraints periodically to reflect any changes in client circumstances.

Application of Standard III(C) Suitability Comment:

Example 1:

A member gives a client account a significant allocation to non dividend paying high- risk securities even though the client has low risk tolerance and modest return objectives.

Comment:

This is a violation of the Standard.

Example 2:

A member puts a security into a fund she manages that does not fit the mandate of the fund and is not a permitted investment according to the fund’s disclosures.

Comment:

This, too, is a violation of the Standard.

Example 3:

A member starts his own money management business but puts all clients in his friend’s hedge funds.

Comment:

He has violated the Standards with respect to suitability. He must match client needs and circumstances to the investments he recommends and cannot act like a sales agent for his friend’s funds.