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Put the Suitability standard, III(C), into practice

CFA® Level I · Ethical and Professional Standards · Guidance for Standard III: Duties to Clients · ET.4.d

The idea

A member in an advisory relationship must inquire into the client's experience, risk and return objectives and constraints and reassess them regularly, and should put that understanding in writing and update it at least annually. Recommendations are judged in the context of the client's total portfolio, not in isolation, so a speculative holding can be suitable within a diversified portfolio and unsuitable as a concentration. Where the member manages to a stated mandate or index rather than for an individual, suitability is assessed against that mandate, and a manager may not depart from it because they judge another strategy better.

A practice question

From the question bank, with the reason each wrong option is wrong.

How often must an investment policy statement be updated under Standard III(C)?

  1. At least annually — correct
  2. Only when the client requests itWhy not: Waiting to be asked leaves the portfolio managed against circumstances that may have changed some time ago.
  3. Every five yearsWhy not: Far too long for a document describing objectives and constraints that shift with a client's life.

Standard III(C) Suitability requires the investment policy statement to be reviewed at least annually, and sooner if the client's circumstances change.

A harder one

Against what is suitability assessed for an individual client?

  1. The security's own risk characteristics in isolationWhy not: A volatile holding can reduce the risk of a portfolio it diversifies, which is why the context is what matters.
  2. The client's total portfolio and objectives — correct
  3. The average holding of the firm's other clientsWhy not: What other clients hold reflects their circumstances and says nothing about this one's.

Standard III(C) assesses a recommendation against the client's total portfolio and their stated objectives and constraints, not against the security viewed on its own.

The hardest tier

A manager running a fund with a stated small-cap mandate believes large-cap stocks will outperform. May they shift the portfolio?

  1. Yes, if the shift is in the clients' financial interestWhy not: The manager's view of what will perform does not override what investors were sold, and they may be relying on the exposure elsewhere.
  2. Yes, provided the change is disclosed in the next reportWhy not: By then investors have held something other than the fund they bought for a full reporting period.
  3. No, suitability is measured against the mandate — correct

Standard III(C) measures suitability against the stated mandate where a member manages to one. Investors chose the fund for that exposure and may hold it inside a wider plan.

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