Ethics and Standards - Standard V-B: Communication With Clients And Prospective Clients

Members and Candidates must:

Standard V-B: Communication with Clients and Prospective Clients

Members and Candidates must:

1. Disclose to clients and prospective clients the basic format and general principles of the investment processes used to analyze investments, select securities and construct portfolios, and must promptly disclose any changes that might materially affect those processes.

2. Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations or actions, and include those factors in communications with clients and prospective clients.

3. Distinguish between fact and opinion in the presentation of investment analysis and recommendations.

Reasoning behind Standard V-B
This Standard establishes guidelines for one specific product of an analyst: the research report that is prepared for public dissemination, rather than being tailored for use by a particular individual's account. Of course, some analysts write reports for a particular individual account or fund, and these guidelines apply in these cases as well. However, Standard V-B was drafted with the idea that many reports are researched and distributed by banks, full-service brokers and research boutiques, among other entities. Traditionally, these types of entities employ a staff of analysts that will be assigned a certain industry or sector and be required to write a buy, sell or hold recommendation on a number of the companies in the sector and maintain a watch list over the entire group.

Look Out!

The term "research report", as it applies to this Standard, is very broad and covers much more than the traditional research reports as defined above.

For example, any form of communication can potentially apply, including (but not limited to):

  • face-to-face recommendation
  • speech or panel discussion
  • telephone conversation
  • TV appearance
  • internet webcast or blog

For example, any form of communication can potentially apply, including (but not limited to):

  • face-to-face recommendation
  • speech or panel discussion
  • telephone conversation
  • TV appearance
  • internet webcast or blog

Because many reports are packaged as soundbites or recommended lists, the Standard provides for an inclusion of the caveat that additional information is available upon request. In other words, it is not a violation to publish a recommended list with a quick sentence or two on a large list of companies, provided the analyst implemented a diligent and thorough process to arrive at that buy or sell conclusion on the security, and his or her company can provide more detail to those who are interested.

A number of research methodologies are more quantitative or technical in nature – for example, the analyst may employ a technique that takes short positions from a list of stocks that are trading within 5% of their 52-week high prices, have reached a technically overbought condition based on the shape of their price charts and have experienced a reduction in institutionally based trading volume over the last month. These reports and techniques are fully compliant with this Standard, provided they are supported by reference material and the applied methodology is consistent with previous recommendations.

Applying Standard V-B
Here are some questions to consider when applying this Standard:

  • Are opinions and projections separated from factual information?
    When presented with a hypothetical situation on the exam, start by asking this question. If the CFA exam addresses Standard V-B in a question, the most likely reason for a violation will be that the author of the research report either presented his or her own opinions as factual information, or else was not clear to differentiate between data that represented actual results and that which represented projections. Quantitative methods can be particularly confusing in this regard – for example, many methodologies assemble a statistical fair price for a security, which is then used in such a careless manner that it appears to represent the actual price of the security.
  • In the gathering of information on a company, has this information been reviewed for accuracy by a representative of that company?
    Such techniques are perfectly legitimate – after all, acquiring and reviewing a company's most recent 10-K is usually a good initial step to discover more about that firm. However, a company's internal projections of its own revenue and earning potential may be excessively optimistic or misleading. A fundamental research report should include those areas of greatest importance in the mind of the analyst, not the data most relevant to the public-relations specialists at the company.
  • Has a newsletter or watch list omitted too much relevant information?
    The Standard indicates that it is the prerogative of the author of the research to use reasonable judgment when presenting a report and deciding which factors to include and exclude. However, there are cases where the resulting package will fail to cover pertinent information related to technique. For example, a complex analytical system may produce a monthly list of recommended mutual funds within a 401(k) plan and a second list of funds to reduce or sell. If a manager's reputation was built on managing and trading accounts within that plan based on a correlation model, it would be a violation of Standard V-B to simply list the five to seven highest-rated funds in a newsletter without including any information on the underlying methodology and techniques for allocating the funds into a portfolio. Focusing purely on recommendations is a likely violation without any appropriate caveats.
  • Has a research report adequately outlined the risk factors, or failed to analyze less optimistic scenarios?
    The CFA Program tends to place a great deal of emphasis on analyzing risk and protecting the investing public from downside risk as a result of the actions of its members. A derivative or synthesized product, for example, may be excessively risky in periods of rising interest rates, and if a research report recommending the security simply assumes that interest rates will fall, the report is in violation of this Standard.
  • Does a research report omit the analyst's real reason for making a specific recommendation?
    For example, Wall Street observers in recent years have coined the term "whisper number" to refer to a quarterly earnings-per-share (EPS) result or quarterly revenue number that some analysts (if not a consensus of analysts) believe is most likely for the firm in question. However, since none of the leading experts covering a stock are prone to updating EPS projections, the public consensus estimate for quarterly earnings remains the same. If an analyst chooses to upgrade a company recommendation based on the rising whisper numbers (or reduces the stock to a hold because the whisper numbers are plummeting), the research report outlining the reason for change needs to address the relevant factors, as required by this Standard.

    Look Out!

    The CFA exam is usually very topical in presenting its ethical situations to candidates, and the quality (or lack of quality) in Wall Street-produced research has been a primary point of discussion in recent years, especially following the bear market earlier in this decade. Debacles involving firms such as Enron and Worldcom uncovered the fact that the leading analysts were little more than cheerleaders for the main companies they cover, arousing concern. Why is virtually every leading stock reported as a buy or a strong buy? The Standards relating to research reports may be of particular importance to the CFA examiners in this climate.


    How to Comply
    Each subsection of this Standard relates to a specific goal that needs to be addressed when preparing research reports for public distribution:

  • Using Reasonable Judgment on Factors to Include/Exclude - This procedure is in many ways the most subjective requirement within this Standard, as it is largely a function of an analyst's experience in preparing research reports and understanding what factors are of greatest importance to readers and users of the research. A specific checklist is not relevant to a standard of conduct where each case needs to be individually evaluated. As with the other Standards guiding the investment process, one would start by archiving all records relating to the report, so that conclusions can be explained and additional information can be supplied upon request.
  • Distinguishing between Facts and Opinions - This goal avoids the most obvious violations of the Standard, but given that most reports use facts as the basis for investment opinions (i.e. all reports will have both), it's important to make such distinctions in as clear a manner as possible. Moreover, any data presented as fact must be properly scrutinized for reliability and accuracy. Financial databases that cover hundreds of data points for thousands of companies may produce misleading data – for example, they may show a negative price-to-earnings (P/E) ratio on a cyclical company, which then draws down the average P/E of a portfolio. In such a case, an analyst must ensure that the data presented is processed in a manner that provides for such situations.
  • Indicate Basic Characteristics - This goal in particular provides some indication of the degree of risk that an investor will assume. A star system (1 through 5 stars, with 5 being safest) or a letter grade ("A" being the safest) will accomplish the task in the least amount of space. Other summary reports specify low, medium, high or very high risk. These labels are often an invaluable guide to determine whether the research should be used.
Standard V-C: Record Retention
Related Articles
  1. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  2. Investing

    Asset Manager Ethics: Investment Process and Actions

    Managers, in developing their investment process, need to determine some “general rules” that make it meaningful. We offer six.
  3. Professionals

    Career Advice: Financial Analyst Vs. Investment Banker

    Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
  4. Professionals

    Advisors: Which Certifications Are Essential?

    The right advisor credentials can make all the difference, but wading through some 100 certifications can be a challenge. Here's some help.
  5. Investing Basics

    Asset Manager Ethics: Valuation Is A Tricky Business

    Asset managers must accurately represent all of a clients assets in the client portfolio. This can be tricky for unique and hard-to-value assets.
  6. Personal Finance

    Top 10 Most Valuable Sports Teams in 2015

    Cleats, pads and profits: we take a look at the top 10 most valuable sports teams in the world.
  7. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  8. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  9. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  10. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!