Tuesday, October 9, 2012

True or False: Verification verifies a firm's claim of compliance with GIPS?

In The Spaulding Group's Fundamentals of Performance and GIPS(R) Fundamentals courses, I often pose this question to attendees:

Verification verifies a firm's compliance with GIPS:
true or false?

Simple question, right? What does it mean to be verified?

Is it not intuitive that verification would verify compliance with GIPS (Global Investment Performance Standards)? It's probably not surprising therefore that many, if not most, of those attending will respond "true."

Therefore, it's also not surprising that when they learn that the statement is false, they appear a bit perplexed.

If you check the Standards' glossary you'll learn that verification is "a process by which an independent verifier assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards."

Going through the Standards we also find that it "tests the construction of the firm’s composites as well as the firm’s policies and procedures as they relate to compliance with the GIPS standards." And while it "is intended to provide a firm and its existing clients and prospective clients additional confidence in the FIRM’S claim of compliance with the GIPS standards," and that it "brings additional credibility to the claim of compliance" [emphasis added] it does not specifically verify compliance.

Semantics? Perhaps, but we should be accurate in our claims.

We sometimes see statements such as "XYZ verified our compliance with the Standards." This is technically incorrect, since a verifier does not verify claims of compliance.

Under the AIMR-PPS(R), the verifier did verify compliance; however, this provision did not carry over to GIPS.

Confused? You're not alone.

2 comments:

  1. Stephen Campisi, CFAOctober 9, 2012 at 10:06 AM

    Interesting post. I would expect this to generate some cantankerous comments, as it does "go against the grain" of the common understanding of verification...plus this issue is close to the heart (and the pocketbook) for many.

    You are somewhat diplomatic when you suggest that this may simply be semantics. I think it's more likely to be simply "lawyer talk." One job of a firm's legal staff is to help avoid situations where the firm gets boxed into a corner - no one wants to be put into a situation that is legally actionable. Firms generally try to avoid making any statement that can be interpreted as a guarantee. As a result, we end up with relatively vague-sounding statements such as the ones you cited. Why? Because if you guarantee something, then you can be forced to make good on your statement when something goes wrong. You may ask: "What's wrong with that? That's what manufacturers do when they sell a product." True, but this is not like replacing a bad toaster; just consider how much recalls cost the auto industry. A small firm offering verification services could be bankrupted by an unfavorable judgment regarding a verification gone bad and the economic loss that can be attributed to an investment based on a firm's erroneous performance results.

    So this may raise the question: "What good is a verification?" Like most things, it's probably only as good as the firm performing the verification. The investment business is one where success is based on sound judgment. I think this helps to make the case for a program to verify the verifiers. If we have to content ourselves with only "additional confidence" in someone's "claim of compliance" then its wise to ask for a third-party validation of the credentials of those performing the audit... sorry, I meant "verification."

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  2. Steve, I agree completely. And yes, more than semantics; "lawyer talk" is probably a good point, too.

    Under AIMR-PPS, the "big 8" (now the "final 4") would not do "Level 1's" (analogous to GIPS "verifications") because, I believe, of this requirement to "verify compliance." It got dropped, and now these very firms WILL do verifications. I suggested to a former CFAI person that the "verification was weakened" because of this very reason. I was told I was incorrect. Perhaps THAT's a matter of semantics!

    Thanks for your contribution.

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