Series 65

Handling Client Funds - Prudent Investor Standards

For many years, the "Prudent Person Rule" stood as a guide for fiduciary investing. While designed to limit unsuitable investing by third parties, the rule basically placed a higher emphasis on preservation of capital than on income or growth, and looked at each investment to see if it was suitable.
  • History:
    • In 1994, the Uniform Prudent Investor Act was created as a model law for states to enact.
    • It essentially updated the old "prudent investing" standards to take modern portfolio theory into account.
    • As a result, fiduciary investors can take advantage of diversification and risk-reward tradeoffs and manage the portfolio as a whole.
Look Out!
While the Uniform Prudent Investor Act permits an IA to include growth investments if they are appropriate to the needs of the client, remember that the client\'s specific situation is the key factor. Look out for questions that imply that under the act stocks would be appropriate for any client account.

While the fiduciary role of IAs and IARs is discussed in a previous section, it's important to understand that these concepts must be considered in all dealings with the client - from investment recommendations to choice of trustees (for retirement accounts and other trusts) and investment managers.


Exam Tips and Tricks
Suitability is one of the prime concerns of an investment adviser. Questions could focus on either the practices that violate the suitability standard or the consequences of such a violation. Consider this sample question:
An IA is working with a new advisory client who is anxious to get a large sum of cash invested. When the IA tries to spend time to understand the client's financial objectives and other assets, the client tells her, "We'll do that later, just get my account invested first." Which of the following statements are true?
  1. The IA should explain that it is unethical to make investment recommendations without obtaining this information.
  2. The IA can make investment recommendations as long as the financial objectives are obtained within 10 days of investing the funds.
  3. The IA must cancel the client's advisory contract.
  4. The IA can make investment recommendations once she receives the client's other investment account statements.
The correct answer is "a". The IA must not invest the client's money until sufficient information is gathered to make suitable recommendations, and the IA should explain to the client why this is unethical and inappropriate.



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