Thursday, January 28, 2010

Examinations...the whys and wherefores

No doubt you recall a time when we wouldn't tear off those tags on our mattresses, because to do so would violate the law! We were convinced that there was a special agency (the Mattress Police) who, unannounced, would appear at your bedroom door to inspect your mattresses: God be with anyone who foolishly removed their tags. And the reason why everyone behaved this way? Ignorance. The tag writers assumed everyone would know that the prohibition only applied BEFORE a mattress was sold ... who cared what you did once you got it home!

Well, I liken this behavior to GIPS(R) examinations: why do people get them done? By far, most U.S. firms that claim compliance with the Global Investment Performance Standards undergo examinations: but why? And because so many firms do, does that make this behavior correct?

Our firm is, perhaps a bit unusual in that when we meet with verification clients, especially ones that we won over from competitors, we ask them why they previously underwent examinations. I recall one NYC client who, at one time, had ALL of their composites examined (probably to the tune of tens of thousands of dollars). Then, a few years ago, they decided only to have their "marketed" composites examined. When we asked why they had this done, the basic answer was "well, we just always have; our verifier recommended it." Okay, and so how has this benefited them? Did prospects or clients regularly ask if they had their composites examined? Well, upon further review our client determined that no, this work hadn't been beneficial at all to them. And so, they decided to stop having them done.

Another client, who we won over a few years ago from a "big 4" firm, had previously undergone examinations; we encouraged them to think twice about spending the money (even though it would mean money in our pockets). They decided to stop and have continued to avoid having them done; and, apparently this hasn't cost them any business.

Outside the States, hardly anyone gets examined. And why is this? Well, let's consider the history of examinations. To put it simply, they are equivalent to the old, AIMR-PPS(R) Level II verifications. Recall that the "big 8" (now "final 4") wouldn't do Level I (firm-wide) verifications but would do the Level IIs. And so, if a firm wanted to be verified by one of the "big boys," they had to settle for Level IIs. When the GIPS draft came out, it only had firm wide verifications, but when the first version (1999) appeared, examinations were included. And so, U.S. firms who had always had Level IIs not surprisingly now had examinations done (and today the large CPA firms are willing to do GIPS verifications).

We are aware of at least one of our competitors who is actively trying to convince people to have examinations done. We will be happy to do examinations, too: we ARE a for profit company. But, we don't want to take our client's money if we don't feel that it's being well spent. We'd prefer that they become convinced that yes, they're necessary, and then engage us to do them.

No doubt that the Bernie Madoff scandal can be a justification for having examinations done, but I'd argue only when the client isn't getting reports from third parties (e.g., custodians): recall that Bernie did everything for their clients (how nice), including custody, trading (right!), and management.

If the basis for encouraging firms to undergo examinations is because so many other firms do them, then that's like saying "I won't remove the tag from my mattress because no one else does." Well, be a tag puller! Don't be a lemming! Be convinced that this expenditure truly is an investment and not merely an expense! (As your mother no doubt asked you, would you jump off a bridge just because your friends did?)

We're conducting a "mini survey" to determine what people see in RFPs. We believe that it's unusual to be asked if composites have been examined. The preliminary results suggest we're right; we'll provide more details once they're available.

p.s., Please do not construe this post as an attack at verification firms that offer, recommend, and conduct examinations. This is solely our opinion. I don't feel that verifiers who conduct examinations are unethical, charlatans, self-serving, or anything like that. They offer a service which there is clearly a market for; we just question its value.

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