A financial advisor, Robert Davis, CFA, is approached by a high-net-worth client, Mr. Henderson, who expresses interest in investing a significant portion of his portfolio in a highly illiquid private equity fund. Mr. Henderson is 75 years old, relies on his portfolio for income, and has explicitly stated a low-risk tolerance in his IPS. Robert knows this fund is highly speculative and has a long lock-up period. What is Robert's most appropriate action under the CFA Institute Standards of Professional Conduct?
- AInvest a small portion of Mr. Henderson's portfolio in the fund to satisfy his interest, while maintaining overall portfolio suitability.
- BAdvise Mr. Henderson to seek a second opinion from another advisor before proceeding with the investment.
- CExplain the risks and unsuitability of the private equity fund to Mr. Henderson and decline to execute the transaction if it conflicts with the IPS.
- DExecute the transaction as requested by Mr. Henderson, since he is a sophisticated investor and is making an informed decision.
Show answer & explanationAnswer & explanation
Correct answer: C. Explain the risks and unsuitability of the private equity fund to Mr. Henderson and decline to execute the transaction if it conflicts with the IPS.
Robert's primary duty is to his client under Standard III(C) Suitability and Standard III(A) Loyalty, Prudence, and Care. The proposed investment directly conflicts with Mr. Henderson's stated low-risk tolerance, need for income, and the illiquid nature of the fund. Robert must explain the unsuitability and, if the client insists and it remains unsuitable, he must decline the transaction to protect the client's interests and uphold the Standards.
Why the other options are wrong
- A. Investing even a small portion in an unsuitable asset still violates suitability standards, especially given the client's profile.
- B. While seeking a second opinion might be helpful, it does not absolve Robert of his responsibility to ensure suitability. He cannot delegate his core duty to another advisor.
- D. Executing an unsuitable transaction, even for a sophisticated investor, violates Standard III(C) Suitability if it conflicts with the client's IPS and best interests.
Suitability and Client Insistence
If a client insists on an unsuitable investment that conflicts with their IPS, the advisor must explain the unsuitability and, if necessary, decline the transaction or terminate the relationship.
- Advisor must always prioritize client's best interests.
- IPS is the governing document for suitability.
- Must decline if investment is clearly unsuitable and client insists.
Memory trick: Unsuitable Request? Refuse, Explain, Protect.