Level 1 CFA® Exam Ethics, Standards III (D) & III (E)
This lesson is the last lesson on Standard III: Duties to Clients.
Standard III (D) deals with the presentation of your performance as a financial professional.
Investment performance must always be presented to clients in a credible way. No misrepresentation or selection of information is allowed. All past performance must be disclosed and it has to be measured adequately.
The GIPS or Other Principles
To comply with Standard III (D), CFA members and candidates are encouraged to follow the Global Investment Performance Standards or the GIPS for short (cf. your level 1 study lesson on GIPS).
Still, it is also possible to remain in compliance with the Standard without the strict adherence to the GIPS standards. Then, it is necessary to follow some generally accepted principles, such as:
- including also closed accounts in performance measurement and presentation,
- presenting the performance of the weighted composite of similar portfolios rather than using a single representative account,
- explaining the methodology of performance presentation, e.g., stating that the presentation takes the form of a simulation,
- keeping the data and records used to calculate the performance.
To quote the Code and Standards, performance information must be "fair, accurate, and complete". It concerns both individual and pooled accounts.
It is your duty to ensure that your performance is always adequately presented. Both past and forecast performance must be presented reasonably and thoroughly to your clients and prospective clients.
Suppose you are to produce some marketing materials for prospective clients. You take performance for the last three years in a row and state it according to your data files. It turns out that the numbers are not as appealing as you wished them to be, so you decide to see what would happen if you omitted some of the less profitable accounts – just to give it a chance. The numbers are now better.
What is the best you can do in such a situation and why?
- a. Present the better numbers to give the clients the best execution possible to obtain.
- b. Present the better numbers but only to the clients whose investment objectives as stated in the IPS will meet the new values.
- c. Present the numbers obtained before your simulation because you must not adjust the performance presentation even if it allows you to obtain new clients and then provide them with good service.
One more thing before we move on. Sometimes you will decide to communicate information concerning investment presentation to your clients very briefly. There’s nothing wrong with such a concise and effective form of communication but it should include reference to a more detailed presentation.
Standard III (E) talks about the necessity to preserve confidentiality in your professional actions and relationships.
In an advisory relationship with the client, you will often receive some private or otherwise special information from the client. In such cases, you are obliged to maintain the confidentiality of information regardless of whether you are still working for the client, whether you ended working for the client, or whether it is your prospective client.
But can you sometimes compromise the obligation to preserve confidentiality or are there no exceptions? Plus, is all client information always confidential?
Now, think what would happen if your client was engaged in illegal activity and the law required you to cooperate. Can you reveal the information that you are supposed to keep confidential?
Not all information obtained from the client is confidential.
Nevertheless, to remain in compliance with Standard III (E), it would be best not to disclose any of the information received from clients unless this information is shared with a clear aim to benefit the client.
Also notice that disclosing any client information for the sake of the Professional Conduct Program is not prohibited under Standard III (E), as members and candidates are always encouraged to care for moral and professional standards of conduct.
The problem of accidental disclosures is potentially important.
Because nowadays information is generally stored on computers and shared through electronic means of communication, it is especially important to ensure that the information is safe and cannot be accessed by unauthorized people. Firms should make sure that their employees know how to ensure the confidentiality of information also in this broader sense.
Remember that confidentiality is of crucial importance as it builds a strong relationship between you and your clients. It feels natural that you should care whether your clients trust you and whether they feel safe when investing with you or not.
As the general profile of an investment client changes over time, e.g., with the growing number of senior investors, some of your clients may be vulnerable investors.
Vulnerable investors include clients who have diminished capacity or can potentially be subject to financial exploitation by others. The utmost should be done to protect the interests of vulnerable investors and you should follow and encourage others to follow best practices such as:
- establishing policies and procedures for vulnerable clients,
- establishing a secondary contact at the start of your professional relationship with the client,
- internal reporting when concerns are raised,
- additional compliance review for the accounts of vulnerable investors,
- raising awareness by identifying issues related to vulnerable investors,
- getting trained on how to interact and address issues with clients who may exhibit diminished mental capacity, etc.
- Performance information must be always "fair, accurate, and complete".
- No misrepresentation or selection of information is allowed. All past performance must be disclosed and it has to be measured adequately.
- In the case of a concise investment performance communication, reference to a more detailed presentation is required.
- As a rule, maintain the confidentiality of client information.
- Compromise the obligation to preserve confidentiality only in special circumstances, e.g. when required by law.
- Always ensure that the client information is safe and cannot be accessed by unauthorized people.
- Confidentiality builds a strong relationship and trust between you and your clients.
CFA Exam: Performance Presentation
SOME KEY PHRASES: clients and prospective clients; performance presentation; performance measurement; credible performance information; fair, accurate, and complete presentation; full disclosure of investment performance data
- misstate performance or distort its measurement,
- mislead clients/prospective clients about your or your company’s investment performance,
- state or imply that the client will obtain or benefit from a rate of return generated in the past,
- misrepresent the historical performance,
- misrepresent the facts in the promotional material sent to (prospective) clients,
- modify the attribution methodology without proper notification to the client (give reasons why the new methodology is better to allow the client to make a meaningful comparison to prior results and future attributions),
- provide brief presentations without a reference to some more detailed information,
- falsely claim the GIPS compliance (when claiming compliance with the GIPS standards, the company must meet all of the requirements, make mandatory disclosures, and meet any other requirements applicable to a specific situation).
- provide fair, accurate, and complete performance presentation,
- provide sufficient information to help the client judge the performance generated by the company,
- disclose the source of the historical performance, e.g., when showing past performance of funds managed at a prior employer as part of a performance track record,
- disclose performance calculation methodology to give an accurate picture of the performance generated,
- clearly identify simulated performance results,
- notify the client about the modification of the attribution methodology.
CFA Exam: Preservation of Confidentiality
SOME KEY PHRASES: clients, prospective clients, and former clients; maintain confidentiality; preserve the confidentiality of information; confidentiality of personal information; accidental distribution of confidential information; privacy protection measures; sensitive information
SOME KEY ASPECTS:
- CONFIDENTIALITY OF CLIENT INFORMATION: Protect the confidentiality of client information and maintain the confidentiality of client records even after the client relationship has ended.
- LAW: Maintain confidentiality if applicable law requires that you keep the information confidential (even if it concerns illegal activities on the part of the client) and disclose confidential information if applicable law requires that you disclose it. Follow the limitations on information flow about a client imposed by law. Also, follow applicable law on permitted disclosures.
- NO THIRD PARTIES: As a rule, keep client information confidential from third parties.
- VULNARABLE CLIENT: Safeguard the interests of all clients, especially potentially vulnerable investors who can possess diminished capacity or become victims of financial exploitation by others.
- SECONDARY CONTACT: At the beginning of the client relationship, establish a secondary contact, e.g., a trusted family member, legal adviser, or some other third-party intermediary, in case you need to consult some outside party if there are concerns about the client’s vulnerability and/or their inability to make informed investment decisions. Remember that if no such party is agreed on, the NO THIRD PARTIES rule applies.
- CLIENT FILES: Document the conversations with the client and any outside parties and retain the documentation of the reasons for disclosing the sensitive information.
- SOCIAL MEDIA: Take all reasonable steps to protect the confidentiality of client information while using social media. Always verify if the information posted can be publicly viewed by all group members and warn against communicating confidential information on social media. If any accidental disclosure of confidential information happens, take steps to remove the information as soon as you become aware of it.
- STRICT REGULATIONS: To avoid possible accidental disclosures of sensitive client information that is electronically communicated and stored, there are stricter and stricter data security laws applying to the use of mobile remote digital communication, including social media.
- EDUCATION: Get regular periodic training on confidentiality regulations and procedures!