Error Correction Policy ... some ideas and clarifications

The revised GIPS(R) (Global Investment Performance Standards) Error Correction Guidance Statement provides clarity over the earlier version, though I suspect that many individuals whose firm claims compliance with the Standards haven't read it (but should!). This topic is one that is often confusing and sometimes results in policies which are lacking in substance and clarity.

Next Month (Friday, May 27, to be exact) I will host a webinar that will touch on many of the policies we expect to see a GIPS compliant firm to have. But given some recent questions that have arisen about error correction, I thought it would be a good idea to touch on this topic here, though in cursory fashion. I may take this up in greater detail in next month's newsletter.

Levels of errors

A firm can have as many as four levels of errors, and perhaps more, if they wish to be creative. Here's what is included in the guidance statement:

1. Do nothing! We would expect this to exist for errors deemed so immaterial that there is no need to take any action at all. While this is an option, most of our verification clients don't avail themselves of it.
2. Correct only These errors are still deemed "immaterial," though they are of a level that at least warrants correcting them. 
3. Correct, and disclose the error Here the firm will not only correct it, but also indicate in their materials that an error was corrected. By the GS (guidance statement), this is still considered an immaterial error, which to me adds some confusion, as I'll touch on below.
4. Correct, disclose, and redistribute This is the only level of "material" errors the GS references. It is deemed to be of a level that warrants giving corrected copies to individuals who (a) received the prior version (with the error) and have since become clients and (b) are still legitimate prospects. And, in some cases, requires you to disclose the error for 12 months!

To disclose or not to disclose

Let's take up the subject of "disclosure" for a moment.  Recall that the idea of retaining a disclosure of errors in presentations for 12 months wasn't well received when it was included in the GIPS 2010 Exposure Draft, and was subsequently removed from the final edition. A Q&A was published to try to add clarity to the revised intent, following the decision to abandon the verbiage from the Standards. I, like many others I suspect, interpreted what was here to suggest that as long as the firm maintained a list of recipients of their presentations, the disclosure wasn't required. Well, the disclosure isn't required for new recipients, but is for those individuals who you gave the prior version to (this point was clarified in the revised GS).

Okay, so for material errors, as long as you track recipients, when you discover material errors you need only disclose the error in the corrected materials you give to prior recipients; new recipients don't need to know of your error(s). The wording from the GS:

"Firms are not required to disclose the material error in a compliant presentation that is provided to prospective clients that did not receive the erroneous presentation. However, for a minimum of 12 months following the correction of the presentation, if the firm is not able to determine if a particular prospective client has received the materially erroneous presentation, then the prospective client must receive the corrected presentation containing disclosure of the material error." (emphasis added)

Well, what about the 3rd case of errors: immaterial that warrant correction, not redistribution, but disclosure? First, there is no indication as to how long the disclosure must be included in the materials (and since for other required disclosures that have no sunset provision, "forever" is the implied rule) and second, there is no option (as with case #4) to not include the disclosure.

I can't think of a situation where one would want to go with option #3 (immaterial but worthy of letting future recipients know that you had made an error). I can see someone going with three (#1, #2, and #4) or two (#2 and #4) levels of errors. If you can think of why you'd want #3, please let me know.

Materiality ... what is it?

I think that like former U.S. Supreme Court Justice Potter Stewart's remarks about obscenity (not knowing how to define it, but knowing it when he saw it), the same applies with materiality. I heard someone once suggest that you should establish a level that wouldn't require you do make too many changes; sorry, but that isn't approaching the subject in the spirit that it should. Essentially, the level should be such that it would cause the recipient to think differently from how they previously did. Of course there is no way to know generally how this would be, so we should select a level that we feel is appropriate.

What to include? 

When developing your policy you should cover everything that is in your presentations: numbers and words. For numbers we mean returns (composite and benchmark), dispersion, assets, etc. For words, we mean disclosures, such as firm definition, composite definition, etc. Errors can mean forgetting something or stating something incorrectly.

This is a rather long post, but it only scratches the surface. Again, I'll touch on this at our upcoming webinar, and most likely in next month's newsletter. To learn about the webinar, please contact Patrick Fowler.