CFA® Level 1 Ethics: Fair Dealing vs Suitability, Explained

Fair dealing vs suitability is one of the CFA® Level 1 Ethics distinctions where both answer choices can look right. Standard III(B), Fair Dealing, and Standard III(C), Suitability, sit next to each other under Duties to Clients, and both describe an adviser treating clients properly. They answer different questions, though. This guide explains what each one is about, the one question that separates them, and the traps that send a reader to the wrong Standard.

The short version

Fair dealing is about how clients are treated relative to each other. Suitability is about whether an investment fits one client's situation.

If a vignette makes you compare clients (who heard first, who got the allocation, who was left out), think fair dealing. If it makes you compare an investment with a client's objectives and constraints (risk, return, time horizon, liquidity, taxes, legal limits, unique circumstances), think suitability.

Standard III(B), Fair Dealing: what it covers

Fair dealing applies when a member or candidate gives investment analysis, makes recommendations, or takes investment action for clients. The obligation is fairness and objectivity across the whole client base. Three points are worth knowing cold.

Fair does not mean equal. A firm can offer different levels of service, such as a premium tier with more frequent reviews. That is allowed as long as the different levels are disclosed and the service is available to every client willing to pay for it. What is not allowed is quietly giving some clients an advantage that hurts others.

Recommendations go out fairly. When an analyst issues or changes a recommendation, clients who might be interested should get it at roughly the same time. Phoning the three largest clients an hour before the written note goes to everyone else is the classic violation.

Trades are allocated fairly. When an order is filled only in part, or a new issue is oversubscribed, the shares go to eligible client accounts on a fair basis, usually pro rata, and client accounts come before the firm's own accounts and the employees' personal accounts. Steering a scarce allocation to favored or family accounts is a fair dealing problem even if every account that received shares was a suitable home for them.

Standard III(C), Suitability: what it covers

Suitability applies when a member or candidate is in an advisory relationship with a client. The duty runs through a sequence.

Know the client. Before recommending anything, the adviser gathers the client's investment experience, objectives and constraints, and reviews them regularly. A written investment policy statement is the usual record.

Judge the fit in the context of the whole portfolio. A single volatile holding can be suitable inside a diversified portfolio that matches the client's risk tolerance. The question is the portfolio, not the position in isolation.

Handle unsolicited trades with care. If a client asks for a trade the adviser considers unsuitable, the adviser discusses it with the client first. If the trade is a small part of the portfolio, the adviser may follow the client's instruction after explaining the concern. If it would change the portfolio materially, the adviser may need to update the investment policy statement with the client, or decline to proceed under the existing relationship.

Fund managers follow the mandate. When someone manages a fund to a stated strategy, suitability is judged against that mandate, not against the circumstances of each individual investor in the fund.

The one question that separates them

When a vignette describes an adviser treating clients badly, ask this before anything else:

Is the problem that one client got something before, or instead of, another client? Or is the problem that this investment does not fit this client?

The first is fair dealing. The second is suitability.

Here are four quick hypotheticals with that question applied. Every person and firm is fictional.

1. The early call. Priyanka Rao, an analyst at Northcrest Capital, downgrades a stock. Before the downgrade is released, she calls two large clients so they can sell first. One client got something before another. Fair dealing, Standard III(B).

2. The wrong product. Daniel Osei advises a retired client who needs steady income and cannot afford large losses. He puts most of her savings into a concentrated, illiquid growth fund. The investment does not fit this client. Suitability, Standard III(C).

3. The hot issue. Meridian Securities receives a small allocation of an oversubscribed new issue. The portfolio manager gives all of it to the accounts of his largest clients and his brother, and none to smaller accounts with the same mandate. Some clients got something instead of others. Fair dealing, Standard III(B).

4. The client's own idea. A client of Elena Marquez asks her to buy a speculative stock worth about 2% of a large, diversified portfolio. Elena thinks it is a poor fit, tells the client so, and then places the trade at the client's request. A small unsolicited trade after the concern is discussed. No violation of Standard III(C).

The traps that send you to the wrong Standard

Trap 1: the allocation that was also unsuitable. Suppose a manager allocates a risky new issue only to her favored clients, and one of those clients is a cautious retiree. Two problems are present: the favoritism (fair dealing) and the poor fit for the retiree (suitability). To choose, ask which Standard names the conduct the vignette is built around. If the story is about who got the shares, it is fair dealing. If the story is about the retiree, it is suitability.

Trap 2: "equal" read as "fair." A distractor may claim that a premium service tier violates fair dealing because some clients receive more. It does not, as long as the tiers are disclosed and available to all. The violation is a hidden advantage that disadvantages other clients.

Trap 3: suitability judged position by position. A distractor may call one aggressive holding unsuitable on its own. Suitability looks at the whole portfolio against the client's objectives and constraints. One aggressive position can sit inside a suitable portfolio.

Trap 4: the client's instruction treated as a violation. Following a client's lawful, unsolicited request after discussing the concern is not a suitability violation when the trade does not materially change the portfolio. A distractor may label it imprudent. Read whether the adviser discussed it and how large it is.

Trap 5: fund investors treated as individual clients. A fund manager who sticks to the fund's stated mandate is not responsible for whether the fund suits each person who bought it. A distractor may say the manager should have checked every investor's circumstances.

How to practice this distinction

Reading the two Standards side by side helps, but the distinction sticks through vignettes.

• For every Duties to Clients question, write "relative" or "fit" in the margin before you look at the choices. Relative points to III(B). Fit points to III(C).
• When two choices both seem right, pick the one that names the specific conduct in the story, not the broader one.
• Keep a short error log of every III(B) and III(C) question you miss, with the one fact that should have pointed you to the right Standard.

The complete guide to Ethics covers where Duties to Clients fits in the full set of Standards, and how to study Ethics covers working vignettes step by step.

Test yourself on mixed Ethics questions

Fair dealing and suitability show up alongside every other Standard, so mixed practice is the real test. The free 90-question CFA® Level 1 mock exam at Totten Prep covers all ten topic areas and includes an explanation for every question. It takes a free account.

FAQ

What is the difference between fair dealing and suitability? Fair dealing (Standard III(B)) is about treating clients fairly relative to each other when issuing recommendations and allocating trades. Suitability (Standard III(C)) is about whether an investment fits a particular client's objectives and constraints, judged in the context of the whole portfolio.

Does fair dealing mean every client must get the same service? No. Different service levels are allowed if they are disclosed and available to every client willing to pay for them. Fair dealing prohibits giving some clients an advantage that disadvantages others.

Is it a suitability violation to follow a client's unsolicited trade request? Not when the adviser discusses the concern first and the trade does not materially change the portfolio. If it would change the portfolio materially, the adviser may need to update the investment policy statement with the client or decline under the existing relationship.

How is suitability judged for a fund manager? Against the fund's stated mandate or strategy, not against the circumstances of each investor in the fund.

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