This standard has two parts:
- A. Diligence and Reasonable Basis
- B. Communication with Clients and Prospective Clients
- C. Record Retention
A. Diligence and Reasonable Basis
This standard states that the member must exercise diligence, independence, and thoroughness while analyzing investments, making recommendations, and taking investment actions.
The member must also have a reasonable basis supported by research and investigation for investment analysis, recommendations, and actions.
Guidance
- While arriving at an investment recommendation, you should make reasonable effort to cover all relevant issues.
- If you are using third-party research, you must determine the soundness of the research by reviewing the underlying assumptions, timeliness, and independence of analysis in the report.
Example of Violation
- Example 1: An investment advisor comes across a stock that is expected to substantially rise in value because of a change in government regulations. However, the investment advisor does not have sufficient resources to conduct research on this matter. Instead he goes by his gut feeling and recommends the stock to his clients. This is a violation of law as the investment advisor has not conducted sufficient due diligence before making a recommendation to his client.
- Example 2: A student of finance, while pursuing his education becomes a part-time analyst at an investment firm. He is expected to provide one research report with his recommendation every month. Because of the time pressure due to studies and work, he prepares the next month’s report based on the news reports and general discussions about a stock in the discussion forums. This is a violation of law because his research and recommendation does not have a reasonable basis.
- Example 3: An investment analyst has just completed his research report, after one month of researching. The report is due to be published in the next two days. Just then he finds out that one of the sources of information has updated their data correcting a major reporting error concerning the stock. The investment analyst gets to know about this update but does not update his research report with the updated information. Two days later, the report is published as it is. This is a violation of the law.
- Example 4: A small investment firm makes recommendations to their clients based on third-party research. The members can rely on third-party research but if they don’t make reasonable effort and diligence to validate the report’s recommendations, then it will be considered a violation of law.
