CFA Level 3 Ethics: Applying the Standards as a Portfolio Manager

CFA Level 3 ethics questions rarely ask you to recite a Standard. Instead, they put you in the chair of a portfolio manager who runs discretionary accounts, places block trades, votes proxies and manages a personal brokerage account, and they ask what that person should do next. This guide shows how the Code and Standards apply to real portfolio management decisions, using short fictional cases you can practise with.

Why CFA Level 3 Ethics Feels Different

At Level I you learn what each Standard covers; at Level II you spot violations in vignettes. At Level III the questions assume you know the rules and test whether you can apply them while managing other people's money, often with a manager facing competing pressures from clients, the employer and their own finances.

If you want a quick refresher on how the levels build on each other, read our comparison of CFA Level 1 vs Level 2 vs Level 3 ethics. For a reminder of the full framework, our guide to the Code and Standards covers every Standard in plain language.

Duties to Clients in Discretionary Portfolios

When a client gives you discretion, you decide what to buy and sell without asking first. That freedom raises the bar. Standard III(A), Loyalty, Prudence, and Care, requires you to put the client's interests ahead of your own and your employer's, and to act with the care a prudent professional would use. Standard III(C), Suitability, requires every investment decision to fit the client's objectives, constraints and written investment policy statement (IPS), judged in the context of the whole portfolio.

Know who the client is

For an individual, the client is the person. For a pension plan, the duty runs to the plan's participants and beneficiaries, not to the company that sponsors the plan or the trustee who hired you. Level III cases often test this by having a sponsor's executive ask the manager to buy the sponsor's own shares or to time trades to suit the company's accounting. The correct response puts the beneficiaries first.

Stay inside the mandate

Consider a fictional manager, Meera Rao at Lotus Peak Advisors, who runs a conservative income mandate for a retired couple. She believes a small-cap biotech stock is about to rise sharply. Even if she is right, buying it for this account breaks the IPS and the suitability requirement. Her proper options are to stay within the mandate, or to discuss a change with the clients and update the IPS in writing before acting.

Fair Dealing and Trade Allocation

Standard III(B), Fair Dealing, requires you to treat all clients fairly when you disseminate recommendations and when you take investment action. Fair does not mean identical; firms may offer different service levels for different fees, as long as these levels are disclosed and available to everyone who pays for them. What is not allowed is favouring some clients at the expense of others in a hidden way.

In practice, Level III questions focus on:

• Block trades: when an order for many accounts fills only partially, the shares should be allocated in a fair, pre-set way, usually pro rata based on the original order sizes, at the same average price.
• Oversubscribed IPOs: hot new issues must be shared fairly among the client accounts for which they are suitable. Managers and their families should not take shares that clients would otherwise receive.
• Written allocation policies: firms should document how trades are allocated, apply the policy consistently, and disclose it to clients.

Example: Arjun Mehta at Silverline Capital receives only half of a requested IPO allocation. He gives all of it to his three largest accounts because they generate the most fees. That violates fair dealing. A pro-rata split across all eligible accounts would have been appropriate.

Soft Dollars and Client Brokerage

Brokerage commissions are paid out of client assets, so the commission "budget" belongs to the client. Using those commissions to obtain research and services (soft dollars) is acceptable only when the services genuinely help the manager make investment decisions for the clients whose trades generated the commissions. Using them to pay for the firm's office rent, marketing software or travel is a breach of loyalty.

The manager also has a duty to seek best execution, meaning the best overall result for the client considering price, commission, speed and reliability, not simply the lowest commission. Directed brokerage, where a client asks you to route trades through a particular broker, is allowed, but you should disclose that the client may not get best execution as a result.

Situation	Generally acceptable?	Reason
Commissions pay for third-party equity research used to manage the accounts	Yes	The service benefits the clients who paid
Commissions pay for the firm's new CRM marketing tool	No	Benefits the firm, not the clients
Client directs trades to a broker it has a relationship with	Yes, with disclosure	Client's money, client's choice, but execution risk should be explained
Manager routes trades to a broker that refers new clients to the firm	No, unless it is still best execution and is disclosed	Client assets are being used to win business for the firm

Proxy Voting as Part of the Duty of Loyalty

When you manage equity portfolios, the right to vote on company resolutions is an asset of the client. Unless the client keeps that right, voting proxies is part of your duty of loyalty and care. You should have a written proxy voting policy, vote in the clients' best interests, and disclose the policy to clients.

That does not mean you must vote every routine item regardless of cost. A cost-benefit approach is acceptable: if voting on a minor matter for a tiny foreign holding would cost more than any possible benefit, a documented decision not to vote can be reasonable. What is not acceptable is voting with management automatically, or voting to please a company that also gives your firm other business.

Example: Kavita Iyer at Northgate Investments manages a pension account holding shares of a company whose CEO is a friend of her firm's chairman. The chairman asks her to support a generous executive pay package. If her analysis says the package harms shareholders, she should vote against it. Her loyalty is to the pension beneficiaries.

Personal Trading and Priority of Transactions

Standard VI(B), Priority of Transactions, sets the order clearly: client and employer transactions come before trades in which the manager has a beneficial interest. Portfolio managers are allowed to invest personally, but they must not front-run client orders, trade ahead of research changes, or take scarce investment opportunities away from clients.

Sound firm procedures that frequently appear in Level III answers include:

1. Pre-clearance of personal trades by compliance.
2. Blackout or restricted periods around client trading and research releases.
3. Restrictions on participation in IPOs and private placements, with prior approval required.
4. Duplicate broker statements and periodic holdings reports sent to compliance.
5. Disclosure of the firm's personal trading policy to clients.

Example: Rohan Desai plans to sell a large block of a mid-cap stock across all client accounts tomorrow. He also holds the stock personally. Selling his own shares today would let him avoid the price drop the client sale might cause. That is front-running and puts his interest ahead of his clients. He should sell, if at all, only after client orders have been executed and in line with firm policy.

Conflicts that cannot be avoided must be fully and clearly disclosed under Standard VI(A). If you hold a meaningful stake in a company you recommend, or receive incentives tied to selling particular products, clients and your employer should know.

Performance Presentation and the GIPS Context

Standard III(D), Performance Presentation, requires that any performance you communicate is fair, accurate and complete. Showing only your best-performing account, dropping terminated portfolios, or presenting simulated results as if they were real are all violations.

The Global Investment Performance Standards (GIPS) go further. They are voluntary, apply to the firm as a whole rather than to an individual, and require firms to group all actual, fee-paying, discretionary portfolios into composites with similar strategies. A firm cannot claim partial compliance. Level III candidates should understand why GIPS exists (comparability and full disclosure) and how its main ideas reinforce Standard III(D). Our article on GIPS explained for CFA candidates covers composites and the compliance claim, and the CFA Level 3 Ethics course includes a dedicated GIPS chapter.

A Simple Method for Level 3 Ethics Cases

When you meet a long portfolio manager case, try this sequence:

1. Identify the parties: client, employer, manager, third parties.
2. Find the asset at stake: client money, commissions, votes, information, an investment opportunity.
3. Ask whose interest is being served: if the manager or firm benefits at the client's expense, something is wrong.
4. Check disclosure and policy: many actions are fine if disclosed and applied consistently.
5. Pick the most appropriate action, not merely an acceptable one.

The Level 3 mock tests use portfolio-manager scenarios, and the chapter notes summarise each Standard with Level III-style examples.

Frequently Asked Questions

Is ethics still tested at CFA Level 3?

Yes. Ethics remains part of the Level III curriculum, with an emphasis on applying the Code and Standards in portfolio management and on performance presentation. Check the CFA Institute website for the current topic outline for your exam.

Can a portfolio manager use client commissions for research?

Yes, if the research actually assists investment decisions for the clients whose trades paid the commissions and the manager still seeks best execution. Using commissions for the firm's own overheads is not acceptable.

Must a manager vote every proxy?

Not necessarily. Managers should follow a written policy and vote in clients' best interests, but a documented cost-benefit decision not to vote on immaterial items can be reasonable.

Can a portfolio manager own the same stocks as clients?

Yes. Personal holdings are allowed as long as client trades take priority, firm pre-clearance and reporting rules are followed, and any material conflicts are disclosed.

Ready to test yourself on portfolio-manager ethics cases? Start with the free demo mock test, first chapter test and first chapter notes in the CFA Level 3 Ethics practice course, or explore all three levels on the CFA Exam Series page.