Relying on GIPS® Verifiers to Maintain Compliance
Originally Published: February 20, 2014, Phocion Investments Inc.
The decision to become GIPS® compliant is a significant one in an investment firm’s progress. GIPS® compliance represents an increase in transparency and fair representation of performance. The overall objective of the GIPS® standards is “…to provide an ethical framework for the calculation and presentation of the investment performance history of an investment management firm.” Reaching compliance is a process that has a start and end date but maintaining compliance is a continuous one. While many firms have the internal resources to monitor compliance, others rely on verifiers to ensure that they are in compliance on an annual basis. Investment firms unfortunately have a misguided understanding of the role of verifiers and their own responsibilities with respect to the Global Investment Performance Standards.
In the whole process of GIPS® compliance, a verifier’s place is to assert that the investment management firm has complied with the standards. In other words, upon completion of verification, a verifier’s report opines that the firm has complied with the composite construction requirements and that the policies and procedures are in-line with the GIPS® standards on a firm-wide basis. Furthermore, verifiers are free to rely on past verifier reports as part of their verification.
The work that most verification firms undertake is based on a sampling methodology and not comprehensive performance examinations. Sampling will focus on what portfolios within each composite best represent the investment management operations of the firm. The GIPS® verification report can be viewed as an additional level of confidence of a firm’s performance to existing and potential clients.
Qualified verification firms will employ industry experienced verifiers with an expertise in performance and an understanding of processes and controls. In addition, verifiers should have the necessary designations in the area of performance such as, the CFA and CIPM. Anything less than the above may risk the investment firm of employing verifiers’ who do not understand their role and run the risk of producing erroneous verification reports.
Verification firms are not there to help firms maintain GIPS® compliance and ensure that every portfolio and process is complying with GIPS®. GIPS® compliance is not a static process wherein once implemented, investment firms can sit back and rely on annual verification reports to confirm compliance. Rather, it is a dynamic process wherein qualified and experienced performance personnel within a firm oversee GIPS® compliance on a continuous basis and rely on the verifier’s annual report as confirmation of compliance.
Over the course of time, firm controls, reporting, strategies and almost any other component of the investment process is likely to change, and sometimes with unintended negative consequences to compliance. The nature of the verifier’s work alone does not ensure that every single portfolio and process is evaluated, which increases the risk that such changes may go unnoticed in the report. Imagine an investment firm that advertises its GIPS® compliance and upon a potential client’s due diligence they are found that they have actually breached the minimum required standards. The reputation of the firm would be negatively impacted and leading to lost profits. Worse off, it may face regulatory consequences if the local regulatory agency has included any rules with respect to GIPS® advertising and compliance.
The best time for a firm to gain GIPS® knowledge is during the implementation process. During that period, the firm can design and implement controls to monitor compliance on a periodic basis and deal with issues that may arise in the future. It also affords the firm the opportunity to get to know the different GIPS® verifiers in the market and help them select the most qualified one.
Relying on verification firms to maintain GIPS® compliance will increase the reputational and regulatory risk of the investment firm. A verifier’s role is one of asserting compliance and not of maintaining it. That role belongs to the client who has already invested a considerable amount of time and effort in implementing the GIPS® standards. Dedicating experienced employee(s) to monitoring and maintaining the standards is the approach that every compliant firm should espouse.
 CFA Institute, “Global Investment Performance Standards Handbook,” 3rd Edition 2012, p.1.
 CFA Institute, “Global Investment Performance Standards Handbook,” 3rd Edition 2012, p.39.