Standard V: Investment Analysis,

Recommendations, and Actions

CFA Standards
 Standard V: Investment Analysis,
Recommendations, and Actions
• A.Diligence and Reasonable Basis
• B.Communication with Clients and
Prospective Clients
• C. Record Retention
Diligence and Reasonable basis
• At a basic level, clients want assurance that
members and candidates are putting forth the
necessary effort to support the
recommendations they are making.
• Communicating the level and thoroughness of
the information reviewed before the member or
candidate makes a judgment allows clients to
understand the reasonableness of the
recommended investment actions.
 Diligence and Reasonable basis
• As with determining the suitability of an investment
for the client, the necessary level of research and
analysis will differ with the product, security, or
service being offered. In providing an investment
service, members and candidates typically use a
variety of resources, including company reports, third-
party research, and results from quantitative models.
A reasonable basis is formed through a balance of
these resources appropriate for the security or
decision being analyzed. The following list provides
some, but definitely not all, examples of attributes to
consider while forming the basis for a
recommendation:
Diligence and Reasonable basis
• global, regional, and country macroeconomic conditions,
• a company’s operating and financial history,
• the industry’s and sector’s current conditions and the
stage of the business cycle,
• a mutual fund’s fee structure and management history,
• the output and potential limitations of quantitative models,
• the quality of the assets included in a securitization, and
• the appropriateness of selected peer-group comparisons.
Diligence and Reasonable basis
• If members and candidates rely on secondary or
third-party research, they must make reasonable
and diligent efforts to determine whether such
research is sound. Secondary research is defined as
research conducted by someone else in the
member’s or candidate’s firm. Third-party research is
research conducted by entities outside the member’s
or candidate’s firm, such as a brokerage firm, bank,
or research firm. If a member or candidate has
reason to suspect that either secondary or third-
party research or information comes from a source
that lacks a sound basis, the member or candidate
must not rely on that information.
Diligence and Reasonable basis
• Criteria that a member or candidate can
use in forming an opinion on whether
• research is sound include the following:
• ●● assumptions used,
• ●● rigor of the analysis performed,
• ●● date/timeliness of the research, and
• ●● evaluation of the objectivity and
independence of the recommendations.
Diligence and Reasonable basis
• Standard V(A) applies to the rapidly expanding use
of quantitatively oriented research models and
processes, such as computer-generated modeling,
screening, and ranking of investment securities; the
creation or valuation of derivative instruments; and
quantitative portfolio construction techniques. These
models and processes are being used for much
more than the back testing of investment strategies,
especially with continually advancing technology
and techniques. The continued broad development
of quantitative methods and models is an important
part of capital market developments.
Diligence and Reasonable basis
• Members and candidates should encourage their
firms to consider the following policies and
procedures to support the principles of Standard
V(A):
• Establish a policy requiring that research reports,
credit ratings, and investment recommendations
have a basis that can be substantiated as
reasonable and adequate. An individual employee
(a supervisory analyst) or a group of employees (a
review committee) should be appointed to review
and approve such items prior to external circulation
to determine whether the criteria established in the
policy have been met.
Diligence and Reasonable basis
• Develop detailed, written guidance for analysts
(research, investment, or credit), supervisory
analysts, and review committees that
establishes the due diligence procedures for
judging whether a particular recommendation
has a reasonable and adequate basis.
• Develop measurable criteria for assessing the
quality of research, the reasonableness and
adequacy of the basis for any recommendation
or rating, and the accuracy of recommendations
over time. In some cases, firms may consider
 Diligence and Reasonable basis
• implementing compensation arrangements that depend on these
measurable criteria and that are applied consistently to all related
analysts.
• Develop detailed, written guidance that establishes minimum levels
of scenario testing of all computer-based models used in developing,
rating, and evaluating financial instruments. The policy should
contain criteria related to the breadth of the scenarios tested, the
accuracy of the output over time, and the analysis of cash flow
sensitivity to inputs.
• Develop measurable criteria for assessing outside providers,
including the quality of information being provided, the
reasonableness and adequacy of the provider’s collection practices,
and the accuracy of the information over time. The established policy
should outline how often the provider’s products are reviewed.
• Adopt a standardized set of criteria for evaluating the adequacy of
external advisers. The policy should include how often and on what
basis the allocation of funds to the adviser will be reviewed.
 Communication with Clients
and Prospective Clients
• Standard V(B) addresses member and candidate
conduct with respect to communicating with clients.
Developing and maintaining clear, frequent, and
thorough communication practices is critical to providing
high-quality financial services to clients. When clients
understand the information communicated to them, they
also can understand exactly how members and
candidates are acting on their behalf, which gives clients
the opportunity to make well-informed decisions about
their investments. Such understanding can be
accomplished only through clear communication.
Communication with Clients and
Prospective Clients
• Similarly, in preparing a recommendation about,
for example, an asset allocation strategy,
alternative investment vehicle, or structured
investment product, the member or candidate
should include factors that are relevant to the
asset classes that are being discussed. Follow-
up communication of significant changes in the
risk characteristics of a security or asset strategy
is required. Providing regular updates to any
changes in the risk characteristics I
recommended.
 Communication with Clients and
Prospective Clients
• For purposes of Standard V(B), communication is not confined
to a written report of the type traditionally generated by an
analyst researching a security, company, or industry. A
presentation of information can be made via any means of
communication, including in-person recommendation or
description, telephone conversation, media broadcast, or
transmission by computer (e.g., on the internet). Computer and
mobile device communications have rapidly evolved over the
past few years. Members and candidates using any social
media service to Standard V(B) communicate business
information must be diligent in their efforts to avoid unintended
problems because these services may not be available to all
clients. When providing information to clients through new
technologies, members and candidates should take reasonable
steps to ensure that such delivery would treat all clients fairly
and, if necessary, be considered publicly disseminated.
 Communication with Clients and
Prospective Clients
• Standard V(B) requires that opinion be separated from
fact. Violations often occur when reports fail to separate
the past from the future by not indicating that earnings
estimates, changes in the outlook for dividends, or future
market price information are opinions subject to future
circumstances. In the case of complex quantitative
analyses, members and candidates must clearly
separate fact from statistical conjecture and should
identify the known limitations of an analysis. Members
and candidates may violate Standard V(B) by failing to
identify the limits of statistically developed projections
because such omission leaves readers unaware of the
limits of the published projections.
 C. Record retention
• Members and candidates must retain records
that substantiate the scope of their research and
reasons for their actions or conclusions. The
retention requirement applies to decisions to buy
or sell a security as well as reviews undertaken
that do not lead to a change in position.
• Which records are required to support
recommendations or investment actions
depends on the role of the member or candidate
in the investment decision-making process.
Records may be maintained either in hard copy
or electronic form.
 C. Record retention
• Some examples of supporting documentation that assists
the member or candidate in meeting the requirements for
retention are as follows:
• personal notes from meetings with the covered company,
• press releases or presentations issued by the covered
company,
• computer-based model outputs and analyses,
• computer-based model input parameters,
• risk analyses of securities’ impacts on a portfolio,
• selection criteria for external advisers,
• notes from clients from meetings to review investment
policy statements, and
• outside research reports
 C. Record retention
• As a general matter, records created as part of a
member’s or candidate’s professional activity on behalf of
his or her employer are the property of the firm. When a
member or candidate leaves a firm to seek other
employment, the member or candidate cannot take the
property of the firm, including original forms or copies of
supporting records of the member’s or candidate’s work,
to the new employer without the express consent of the
previous employer. The member or candidate cannot use
historical recommendations or research reports created at
the previous firm because the supporting documentation
is unavailable. For future use, the member or candidate
must re-create the supporting records at the new firm with
information gathered through public sources or directly
from the covered company and not from memory or
sources obtained at the previous employer.