We recently conducted a verification for a new client who had previously been verified for several years by the another firm. Now, one might argue about "gray areas," but disclosures? Our client's presentations didn't have composite descriptions! Come on, didn't our competition even have a checklist? And when I mentioned this infraction they informed me that they used to have them but their prior (not to be named) verifier told them this was no longer a requirement! Really, and where exactly is this written?
This verifier did this firm the favor (or more correctly, disservice) of providing them with a formula to handle carve-outs: take their equity returns and add 5% for the T-bill rate to represent cash. Interesting. And where exactly did they dream this up? Isn't this what one might call "hypothetical returns"? When I told them this was invalid our client at first said "let's get XYZ on the phone," to which I responded, "great, lets!" But, our client quickly decided this was fruitless. Unfortunately, this isn't the first time I have found that this particular verifier uses creative but non-compliant methods for carve-outs.
Verifiers who perform poor verifications do nothing to enhance the image of this important review process. In addition, they put their clients at risk. CFA Institute and/or GIPS Executive Committee: are you listening? Let's offer a certification for verifiers! PLEASE! I've been asking for this since 1992 ... surely it's time!
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Great blog! I totally agree. It's completely absurd that there are no requirements/certifications to be a verifier. How do you know that the GIPS Verification is even appropriate when the verifier may not be qualified to give such a claim?!
ReplyDeleteAgreed! I've been asking for this for almost 20 years. It's frustrating. Hopefully some day. Thanks!
ReplyDeleteI may be the minority here, but I disagree. I think the market can decide this. RFP's are starting to ask the name the firm who did the verification, and the SEC is starting to crack down on claims of GIPS compliance. If a manager wants to forgo doing diligence and pinches pennies, then that's a risk they knew (or should have known) they were taking.
ReplyDeleteObviously creating barriers to entry in your industry (verification) gives you an advantage over a new firm that wants to enter.
So my question is this, is this David Spaulding the verifier talking (meaning there is a conflict of interest) or David Spaulding the independent advocate of the performance industry?
David, your point is very relevant and the quality of verification services is a matter of great importance. The real question is who has jurisdiction to impose qualification or registration requirements on verification firms. It is clear that CFA-I do not believe that they have this, and I would agree with them. Surely what is required is some form of recognised authority that has a duty of oversight on the quality of work done by verifiers. Many verification firms are already accountable to such bodies (such as PCAOB for CPA firms in the US, and equivalent bodies in other countries). If a firm doing a poor job is accountable to such a body then that body should be made aware of the failings and they are duty bound to investigate and to require an improvement or take punitive action.
ReplyDeleteThis would then leave only those verification firms which are not accountable to such bodies, and maybe the rules should be written to require professional accountability as the qualification for being a verification firm.
I appreciate that no such structure is a perfect guarantee of quality across all work done (Enron, BCCI etc are testimony to this) but at least this approach would make use of existing extensive oversight and will provide the most effective cover available.
In the meantime, Investment Management Firms seeking verification of their compliance with GIPS should ask themselves whether the firm that they are engaging with for the work has credibility. Are they capable of doing a good job? Do they have staff with adequate knowledge and experience? Do low fees reflect efficiency or process or lack of rigour? Will their name really add credibility to my business in the eyes of my clients if they ask for a copy of the verification report? For this reason, I supported the requirement to name the verifier within the claim of compliance, as proposed for the 2010 edition of GIPS, and I do not understand the reluctance of some verification firms to agree to this. Surely if they don't want their name to be associated with their work then they shouldn't be doing the work.
Regarding specific incidents where a verification firm is found to have given poor guidance or accepted incorrect treatment. The correct approach would be to bring this issue to the attention of the senior management of the firm (depending on the firm involved these people may well not be directly involved in verification, but they should certainly be concerned to hear if their firm is doing poor quality work) If they do not react appropriately then this should be escalated to PCAOB, or equivalent, if relevant.
To date, I am not aware of any significant action that has been taken against any verification firm that has failed to do a good job, although several have been "spoken to". The current court case in the USA will provide an interesting benchmark for future treatment when it concludes.
Good point about the market; you're right that there seems to be a bit more sensitivity to the perceived quality of the verifier's work. However, this is the minority of cases and it's unclear how this will catch on; a certification program will formalize the process. If verifiers verify asset managers, why not verify the verifiers?
ReplyDeleteOh, and I don't see the distinction as to which Dave Spaulding this is; it was Dave Spaulding the verifier who came across yet another example of a poor job, so I guess it's from that voice that this blog piece originated.
Thanks for your comments and insights. We're aware of one verifier who is facing two or more lawsuits right now because of their work, though I don't know the details other than that they both involve them giving a positive verification to firms that apparently were committing fraud.
ReplyDeleteThe CFA Institute won't take this on and probably for some good reasons. I believe that the GIPS Verification subcommittee has wrestled with this, but I don't have any details. There has to be an answer. Verifiers themselves can structure something, but this may be more than what even they want to take on.
In the end, we believe that many firms KNOW their verifier is doing a poor job but because they still get that letter all GIPS firms want to receive, they ignore it figuring that the risk of them being found out is rather low. It's a shame, but we believe this happens more often that we'd like to believe.
Is this firm being sued by their client? It seems to me the management confirmation letter we sign explicitly states that the money manager "bears all responsibility" for GIPS. Seems to me like there is no case.
ReplyDeleteI don't think they'll sue, but I think they should. Yes, managers sign letters but the verifier is expected to know the standards. If the verifier gives them a method to do carve-outs which is in total conflict w/the standards, that puts the manager at risk. As for me, I'd sue! But, it's not up to me.
ReplyDeleteDavid, you seem to have quite a bit of anomosity towards a few of your competitors. Why don't you reach out to them? The media sensationalizes alot of information and your posts seem to be based on what has been reported in an article or two. This is a professional industry and before people start throwing their competition under the bus publically we should at least be informed of all the facts. Unless we are guilty until proven innocent which we may now be in the US.
ReplyDeleteNo animosity. Frustration. Thanks for the thoughts, though.
ReplyDelete