Understanding the Application of Loyalty, Prudence, and Care
Standard III(A) establishes a minimum benchmark for the duties of loyalty, prudence, and care that are required of all members and candidates regardless of whether a legal fiduciary duty applies. Although fiduciary duty often encompasses the principles of loyalty, prudence, and care, Standard III(A) does not render all members and candidates fiduciaries. The responsibilities of members and candidates for fulfilling their obligations
under this standard depend greatly on the nature of their professional responsibilities and the relationships they have with clients. The conduct of members and candidates may or may not rise to the level of being a fiduciary, depending on the type of client, whether the member or candidate is giving investment advice, and the many facts and circumstances surrounding a particular transaction or client relationship.
Fiduciary duties are often imposed by law or regulation when an individual or institution is charged with the duty of acting for the benefit of another party, such as managing investment assets. The duty required in fiduciary relationships exceeds what is acceptable in many other business relationships because a fiduciary is in an
enhanced position of trust. Although members and candidates must comply with any legally imposed fiduciary duty, the Code and Standards neither impose such a legal responsibility nor require all members or candidates to act as fiduciaries. However, Standard III(A) requires members and candidates to work in the client’s best interest
no matter what the job function.
A member or candidate who does not provide advisory services to a client but who acts only as a trade execution professional must prudently work in the client’s interest when completing requested trades. Acting in the client’s best interest requires these professionals to use their skills and diligence to execute trades in the most favorable
terms that can be achieved. Members and candidates operating in such positions must use care to operate within the parameters set by the client’s trading instructions.
Members and candidates may also operate in a blended environment where they execute client trades and offer advice on a limited set of investment options. The extent of the advisory arrangement and limitations should be outlined in the agreement with the client at the outset of the relationship. For instance, members and candidates should inform clients that the advice provided will be limited to the propriety products of
the firm and not include other products available on the market. Clients who want access to a wider range of investment products would have the information necessary to decide not to engage with members or candidates working under these restrictions.
Members and candidates operating in this blended context would comply with their obligations by recommending the allowable products that are consistent with the client’s objectives and risk tolerance. They would exercise care through diligently aligning the client’s needs with the attributes of the products being recommended.
Members and candidates should place the client’s interests first by disregarding any
firm or personal interest in motivating a recommended transaction.
There is a large variety of professional relationships that members and candidates have with their clients. Standard III(A) requires them to fulfill the obligations outlined explicitly or implicitly in the client agreements to the best of their abilities and with loyalty, prudence, and care. Whether a member or candidate is structuring a new securitization transaction, completing a credit rating analysis, or leading a public company, he or she must work with prudence and care in delivering the agreed- on services.
Identifying the Actual Investment Client
The first step for members and candidates in fulfilling their duty of loyalty to clients is to determine the identity of the “client” to whom the duty of loyalty is owed. In the context of an investment manager managing the personal assets of an individual, the client is easily identified. When the manager is responsible for the portfolios of
pension plans or trusts, however, the client is not the person or entity who hires the manager but, rather, the beneficiaries of the plan or trust. The duty of loyalty is owed to the ultimate beneficiaries.
In some situations, an actual client or group of beneficiaries may not exist. Members and candidates managing a fund to an index or an expected mandate owe the duty of loyalty, prudence, and care to invest in a manner consistent with the stated mandate. The decisions of a fund’s manager, although benefiting all fund investors, do not have
to be based on an individual investor’s requirements and risk profile. Client loyalty and care for those investing in the fund are the responsibility of members and candidates who have an advisory relationship with those individuals.
Situations involving potential conflicts of interest with respect to responsibilities to clients may be extremely complex because they may involve a number of competing interests. The duty of loyalty, prudence, and care applies to a large number of persons in varying capacities, but the exact duties may differ in many respects in accord
with the relationship with each client or each type of account in which the assets are managed. Members and candidates must not only put their obligations to clients first in all dealings but also endeavor to avoid all real or potential conflicts of interest.
Members and candidates with positions whose responsibilities do not include direct investment management also have “clients” that must be considered. Just as there are various types of advisory relationships, members and candidates must look at their roles and responsibilities when making a determination of who their clients
are. Sometimes the client is easily identifiable; such is the case in the relationship between a company executive and the firm’s public shareholders. At other times, the client may be the investing public as a whole, in which case the goals of independence and objectivity of research surpass the goal of loyalty to a single organization.
Developing the Client’s Portfolio The duty of loyalty, prudence, and care owed to the individual client is especially
important because the professional investment manager typically possesses greater knowledge in the investment arena than the client does. This disparity places the individual client in a vulnerable position; the client must trust the manager. The manager in these situations should ensure that the client’s objectives and expectations for the performance of the account are realistic and suitable to the client’s circumstances and that the risks involved are appropriate. In most circumstances, recommended investment strategies should relate to the long- term objectives and circumstances of the client.
Particular care must be taken to detect whether the goals of the investment manager or the firm in conducting business, selling products, and executing security transactions potentially conflict with the best interests and objectives of the client.
When members and candidates cannot avoid potential conflicts between their firm and clients’ interests, they must provide clear and factual disclosures of the circumstances to the clients.
Members and candidates must follow any guidelines set by their clients for the management of their assets. Some clients, such as charitable organizations and pension plans, have strict investment policies that limit investment options to certain types or classes of investment or prohibit investment in certain securities. Other organizations
have aggressive policies that do not prohibit investments by type but, instead, set criteria on the basis of the portfolio’s total risk and return.
Investment decisions must be judged in the context of the total portfolio rather than by individual investment within the portfolio. The member’s or candidate’s duty is satisfied with respect to a particular investment if the individual has thoroughly considered the investment’s place in the overall portfolio, the risk of loss and opportunity
for gains, tax implications, and the diversification, liquidity, cash flow, and overall return requirements of the assets or the portion of the assets for which the manager is responsible.