Series 66

AAA

Handling Client Funds - Prudent Investor Standards

For many years, the "Prudent Person Rule" stood as a guide for fiduciary investing. While it was designed to limit unsuitable investing by third parties, it basically placed a higher emphasis on preservation of capital than on income or growth. Furthermore, the rule required looking at each investment to see if it was suitable.

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 can manage a 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 consideration. 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 was discussed earlier in the section, it is important to understand that all topics discussed in this section 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 primary concerns of an IA. Questions could focus on either the practices that violate suitability standards or the consequences of such violations. 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 take the 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 is TRUE?

  1. The IA should explain that it is unethical to make investment recommendations without first 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 she should explain to the client why failure to follow this rule is unethical and inappropriate.

Introduction
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