3.3) Duties to clients III (A) : Loyalty, prudence and care

Question 1

Under standard 3 Duties to clients, what does substandard 3(A) loyalty, prudence and care state? (2)

Answer 1

• Duty of loyalty, must act with reasonable care, and exercise prudent judgment.
• Must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.

Question 2

What is the ‘prudent man rule’?

Answer 2

‘Prudent man rule’: exercise care and diligence that a prudent person familiar with the investment situation/ needs would exercise.

Question 3

How is 3(A) loyalty, prudence and care implemeneted for members? (4)

Answer 3

• Client’s interest to be placed before those of employer or self.
• Comply with fiduciary duty to those to whom it is owed (e.g. pension fund members and not the pension fund or pension fund trustees).
• Manage client assets in accordance with the terms of the governing documents or investment management agreements.
• “Soft dollars” or favourable commissions must be used to benefit the client (e.g. must still deliver lower trading costs).

Question 4

What is the recommended practices for members in line with 3(A) loyalty prudence and care? (8)

Answer 4

• Place clients first.
• Establish investment objectives of clients and act with reference to them. Periodically review investments to check compliance with mandates.
• Submit to clients at least a quarterly transaction and holdings statement with all info pertaining to assets held on their behalf.
• Maintain confidentiality.
• Diversify to minimise risk of loss.
• Treat all clients equally.
• Disclose all real or potential conflicts of interest.
• Disclose compensation arrangements.

Question 5

Example 19: Linda Norris is a portfolio manager at Benmore and Co. She routinely requests the trading desk to use Linkage Brokers to execute her funds’
transactions, even though Linkage charges a slightly higher commission than at least two other brokers for a similar level of service and efficiency. At least twice
a year Linkage treats Benmore’s employees to outings such as helicopter trips. Is Linda in contravention of standard III(A)?

Answer 5

Solution: Yes, Linda is in contravention of Standard III(A). Clients are ultimately paying the brokerage, which is charged against their asset portfolios. They are
therefore paying unnecessarily high broking commissions so that Benmore staff can benefit. This is a clear conflict of interest and Linda’s behaviour is not in the best interests of clients.

Question 6

Example 20: Donald Zuma manages a number of portfolios on behalf of high net worth clients. His company, Triumph, includes a broker division, and all transactions initiated within the company are executed through the in-house brokering division. Clients are informed of this and a very competitive broking
commission is charged. The income generated by the brokering division plays a large part in Triumph’s profits, which in turn determines staff bonuses. Zuma buys and sells appropriate shares based on his client profiles, but he tends to trade a lot more than is strictly necessary. Does Zuma’s behaviour contravene Standard III(A)?

Answer 6

Solution: Yes, Zuma is in contravention of Standard III(A). His excessive trading is in his own interest and not that of the clients. Note that this is in spite of him buying and selling the appropriate shares based on his clients’ needs, and also the fact that clients are aware that an in-house broker is being used (both elements of compliance with the CFA Institute Code of Conduct).