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
Related Articles
  1. 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.
  2. Professionals

    Understanding Series 6

    Upon successful completion of the Series 6, an individual will have the qualifications needed to sell open end mutual funds and variable annuities
  3. Professionals

    Top Strategies on How to Become a Stock Broker

    Gunning to be a stock broker and want an edge? Here's some veteran advice.
  4. Trading Systems & Software

    Steps to Starting Up an Independent Broker Dealer

    Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
  5. Professionals

    Understanding Series 63

    Series 63 is a securities license that entitles the holder to sell securities in a particular state.
  6. Professionals

    How To Answer Option Questions On The Series 7 Exam

    Learn how to answer option questions on the Series 7 exam. Pass your Series 7 exam with the help of these tips.
  7. Insurance

    Municipal Bond Tips For The Series 7 Exam

    Learn to distinguish between general obligation and revenue bonds to ace this test.
  8. Retirement

    6 Proven Tips For Series 6 Success

    These techniques can help you pass this test without the added stress.
  9. Insurance

    Tips For Passing The Series 6 Exam

    Find out what you can do during the test to make sure you get a passing score.
  10. Professionals

    Banker Or Broker: Which Career Is Right For You?

    Bankers and stock brokers may share similar traits, but there are many differences between the two professions.
RELATED TERMS
  1. Series 6

    A securities license entitling the holder to register as a limited ...
  2. Series 79

    A examination to ensure a candidate is qualified to become a ...
  3. Research Analyst

    A person who prepares investigative reports on equity securities. ...
  4. Series 34

    An exam required for individuals seeking to engage in off-exchange ...
  5. Financial Advisor

    One who provides financial advice or guidance to customers for ...
  6. Series 23

    An exam offered by the Financial Industry Regulatory Authority ...
RELATED FAQS
  1. If I have only a limited amount of time to study for the Series 6, what should I ...

    The Series 6 Investment Company and Variable Contracts Products Representative Qualification Examination is administered ... Read Full Answer >>
  2. What role does the 'chip cycle' play in the electronics sector?

    There are several highly acclaimed private Series 6 Exam courses in the United States. Many can be completed online. Popular ... Read Full Answer >>
  3. What does passing the Series 6 enable me to do?

    The Series 6, or the Investment Company Products/Variable Contracts Limited Representative, exam is administered by the Financial ... Read Full Answer >>
  4. What are the differences between the Series 6 exam and the Series 7 exam?

    The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
  5. Do I have to successfully complete the Series 7 exam before I can register for the ...

    There are no prerequisites to register for the Series 63 exam. However, once you have registered for the exam, you must schedule ... Read Full Answer >>
  6. I completed the Series 6, do I have to complete the entire Series 7?

    After having written the Series 6 examination, there would be significant overlap with the Series 7 in areas such as mutual ... Read Full Answer >>
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!