A hedge fund you recommended loses 60% six months after purchase. Whether you violated Standard V depends entirely on what you did before the recommendation, not on the outcome.
Standard V has three parts: V(A) Diligence and Reasonable Basis, V(B) Communication with Clients and Prospective Clients, and V(C) Record Retention. Together they govern the analytical work behind a recommendation, what you tell clients about it, and what you keep on file to prove it.
You must exercise diligence, independence, and thoroughness in analyzing investments and must have a reasonable and adequate basis, supported by appropriate research and investigation, for any analysis, recommendation, or action.
How much work is "adequate" flexes with three things: the investment philosophy you or your firm follow, your role in the decision-making process, and the resources your employer provides. A quantitative analyst building a credit model owes a different standard of care than a portfolio manager consuming its output, but both owe something.
Attributes you may weigh when forming a basis include macroeconomic conditions, a company's operating and financial history, the industry's stage in the business cycle, a pooled fund's fee structure and...
Common mistakes
- Judging diligence by results. A 60% loss in an aggressive hedge fund after a documented review of track record, principals, fees, and risk profile is compliant. A profitable trade off an unvetted blog is not.
- Removing your name instead of assessing the process. On a group report you disagree with, ask whether the consensus has a reasonable and adequate basis. If it does, you may stay on it.
- Treating sophistication as a disclosure waiver. Private fund investors still get full fee disclosure, including fees an affiliate collects from portfolio companies.
Bottom line
- V(A) requires diligence, independence, thoroughness, and a reasonable and adequate basis supported by appropriate research
- Required effort scales with investment philosophy, your role in the process, and employer resources
- Secondary research is in-firm, third-party is outside; both need diligent verification on assumptions, rigor, timeliness, objectivity
- Model users must understand assumptions and limitations; model creators owe higher diligence and must test before distribution, including scenarios outside historical data
Exam shortcut
Ask two questions of every Standard V vignette. First: was there a process, or a shortcut? Time pressure, pricing by company size, picking on one metric, and copying a blog are all shortcut signals pointing at V(A). Second: did the client learn something they needed before acting?
The full lesson (about 1,941 words, 13 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- standard V investment analysis
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