GIPS Compliance Actions for the New Year 2023
Sean P. Gilligan, CFA, CPA, CIPM
January 3, 2023
As in years past, we are reposting this article. While your GIPS policies and procedures rarely need to materially change, as the standards, regulations and your firm evolves, performing a review of your GIPS compliance each year is beneficial to ensure your documented policies continue to align with your firm’s actual practices.
This year, conducting a review of your firm’s GIPS compliance is especially important because of the SEC’s New Marketing Rule that came into effect in November 2022. For information specific to the SEC Marketing Rule, please check out our Marketing Rule Checklist or the CFA Institute’s whitepaper on Reconciling the GIPS Standards with the SEC Marketing Rule.
The Right Team & Involvement
Even without the release of the New Marketing Rule, each year you should conduct a review. In the review, you should first make sure you have the right people involved. One person or department may be responsible for managing the day-to-day tasks that maintain your GIPS compliance; however, high-level oversight from a larger group should take place to help ensure that any decisions made or policies set will integrate well with your firm’s other strategic initiatives. This larger group, often called a GIPS Standards Committee, typically consists of representatives from compliance, marketing, portfolio management, operations/performance, and senior management.
Not everyone on the committee needs to be an expert in the GIPS standards. In fact, many will not be. What they will need is to be available to share their opinions and represent their department’s interests when establishing or changing key policies for your firm. Your GIPS compliance expert/manager can set the agenda for your meeting and can provide any background on the requirements that will be part of the discussion. If you do not have a GIPS expert internally, or need independent advice about your policies and procedures, a GIPS consultant can be hired to help.
High-Level GIPS Topics to Consider Annually
Once you select the right group to represent each major area of your firm, the following high-level questions can help determine if any action is necessary to improve your GIPS compliance this year:
- Have there been any changes to the GIPS standards?
- Did the New SEC Marketing Rule cause you to make changes to how you manage your composites or present the composite’s performance results?
- Have there been any material changes to your firm or strategies?
- Do your composites meaningfully represent your strategies or should their structure and descriptions be reconsidered?
- Are the materiality thresholds stated in your error correction policy appropriate for the type of strategies you manage and are they consistent with the thresholds set by similar firms?
- Are you presenting any new statistics in your GIPS Reports that now should have error correction thresholds in your error correction policy? For example, if you added 1-, 5-, and 10-year annualized returns to your GIPS Reports as part of complying with the SEC’s Marketing Rule, is your error correction policy clear on how errors to these numbers will be handled?
- Are you satisfied with the service received from your GIPS verifier for the fee that is paid?
- Is there any due diligence you need to conduct on your verification firm to ensure data security standards are being met or to confirm there is no breach of independence if the same firm is providing additional services to your firm beyond GIPS verification?
Changes to Regulations/GIPS Standards
It is important to consider whether there have been any changes to the GIPS standards since last year that would require your firm to take action. For example, if a new requirement is adopted, you should consider if any changes to your firm’s policies and procedures or GIPS Reports are needed. It is important to keep in mind that it is not only when updated standards are released that guidance is issued that could impact the way you implement the standards for your firm. Guidance may also be issued in the form of guidance statements or Q&A’s, which also must be followed by all GIPS compliant firms.
If your firm is verified or works with a GIPS consultant, these GIPS experts are likely keeping you informed of any changes to the standards. The best way to check for changes yourself is to visit https://www.gipsstandards.org/. Specifically, you should check the “GIPS Q&A Database” where you can enter the effective date range of the previous year to see every Q&A published during this period. You should also check the “Guidance Statements” section. The guidance statements are organized by year published, so it is easy to see when new statements are added.
As a result of the SEC Marketing Rule, there were several changes that may affect your GIPS Reports. If you are not aware of these changes, there are a number of resources available to help you better understand what is required (see the links listed in the second paragraph of this post).
Changes to Your Firm or Strategies
Similar to changes in the standards, it is important to also consider whether any changes to your firm or its strategies would require you to take action. Examples include material changes in the way a strategy is managed, a new strategy that was launched, an existing strategy that closed, mergers or acquisitions, or anything else that would be considered a material event for your firm.
Even if no changes were made this year, you should still read your entire policies and procedures document at least annually to make sure it adequately and accurately describes the actual practices followed by your firm. Regulators, such as the SEC commonly review firms’ policies and procedures to ensure that 1) the document includes actual procedures and is not simply a list of policies and 2) the stated procedures truly represent the procedures followed by the firm. We expect the SEC to be particularly vigilant in their reviews following the release of the New Marketing Rule.
Meaningful Composite Structure
The section of your GIPS policies and procedures requiring the most frequent adjustment is your firm’s list of composite descriptions, as you must make changes each time a new composite is added or if a composite closes. However, even without adding new strategies or closing older strategies, the list of composite descriptions should be reviewed at least annually to ensure they are defined in a manner that best represents the strategies as you manage them today.
Since your firm’s prospects will compare your composite results to those of similar firms, it is important that your composites provide a meaningful representation of your strategies and are easily comparable to similar composites managed by your competitors. If a review of your current list of composite descriptions leads you to realize that your strategies are defined too broadly, too narrowly, or in a way that no longer accurately describes the strategy, changes can be made (with disclosure).
Keep in mind that changes should not be made frequently and cannot be made for the purpose of making your performance appear better. Changing your composite structure for the purpose of improving your performance results, as opposed to improving the composite’s representation of your strategy, would be considered “cherry picking.”
Two examples of cases that may require a change in your composites include:
- A strategy has evolved and certain aspects of the way the strategy was managed and defined in the past are different from today. This can be addressed by redefining the composite. Redefining the composite requires you to disclose the date and description of the change. This disclosure will help prospects understand how the strategy was managed for each time period presented and when the shift in strategy took place. Changes like this should be made to your composite descriptions at the time of the change, but an annual review can help you address any items that may have been overlooked when the change occurred.
- A composite is defined broadly to include all large capitalization accounts. Within this large capitalization composite, there are accounts with a growth focus and others with a value focus. If your closest competitors are separately presenting large capitalization growth and large capitalization value composites, your broadly defined large capitalization composite may be difficult for prospects to meaningfully compare to your competitors. To address this, you can create new, more narrowly defined composites to separate the accounts with the growth and value mandates. In this case, the full history will be separated and the composite creation date disclosed for these new composites will be the date you make the change. Note that this will demonstrate to prospective clients that you had the benefit of hindsight when determining the definition.
Materiality Thresholds Stated in Your Error Correction Policy
Another section of your firm’s GIPS policies and procedures that should be reviewed in detail is your error correction policy. Your error correction policy includes thresholds that pre-determine which errors (of those that may occur in your GIPS Reports) are considered material versus those deemed immaterial. These thresholds cannot be changed upon finding an error; however, they can be updated prospectively if you feel a change would improve your policy.
Many firms had a difficult time setting these thresholds when this requirement first went into effect back at the start of 2011. Now that much more information is available to help you determine these thresholds, such as the GIPS Error Correction Survey, you may want to revisit your policy to ensure it is adequate.
Setting and approving materiality thresholds that determine material versus immaterial errors is a task best suited for your firm’s GIPS committee rather than your GIPS Standards department or manager. The reason for this is that opinions of what constitutes a material error may vary from one department to another. Your committee can help find a balance between those with a more conservative approach and those with a more aggressive approach to ensure the thresholds selected are appropriate.
GIPS Verifier Selection and Due Diligence
If your firm is verified, it is important to periodically evaluate whether you are satisfied with the quality of the service received for the fees paid. You may also want to consider whether you need to conduct any periodic due diligence on your verification firm with respect to data security or ensuring the firm conducting your verification is still considered independent from your firm. This is especially important if your firm receives multiple services from your verifier that could overlap.
With several mergers, acquisitions, and start-ups in the verification community over the last few years, you may want to do some research to ensure you are familiar with what your options are when selecting a verification firm.
All verifiers have the same general objective: to test and opine on 1) whether your firm has complied with all the composite construction requirements of the GIPS standards and 2) whether your firm’s GIPS processes and procedures are designed to calculate and present performance in compliance with GIPS. Where they differ is in the fees charged and process followed to complete the verification.
Regarding fees, much of the difference between verifiers is based on their level of brand recognition rather than differences in the quality of their service. In our experience, smaller firms specialized in GIPS verification may have more experience with the intricacies of GIPS compliance than a global accounting firm; yet, a global accounting firm will likely charge a higher fee. When selecting a higher-fee firm, it is important to consider whether the higher fee is offset by the benefit your firm receives when listing their brand name as your verifier in RFPs you complete.
With regard to process, each verifier has its own method for how it arrives at an opinion on the points listed above. If you found last year’s process frustrating, there’s no harm in seeing what else is available. Our team has worked with most, if not all the verifiers out there and is happy to share our experience on how each verifier works. In addition, some verifiers offer access to a team and other ancillary services while others are a one-person shop. Here, you’ll want to consider how the engagement team is structured, whether you can expect to work with the same team each year, and how much experience your main contact has. Prior to the Covid-19 era, some verifiers conducted the verification on-site while others worked remotely. While remote work is now the norm, on-site work, in general, is making a comeback. You’ll want to consider which approach works best for the team that is fielding the verification document requests. The onsite approach may result in finishing the verification in a shorter period but may be disruptive to your other responsibilities while the verification team is in your office. The remote approach may be less disruptive to your other responsibilities, but likely will take longer to complete and may be less efficient as documents are exchanged back and forth over an extended period of time.
Regardless of whether the verification is conducted onsite or remotely, be sure to ask any verifier how your proprietary information and confidential client data is protected. If the work is done remotely, how are sensitive documents transferred between your firm and the verifier (e.g., is it through email or a secure portal) and once received by the verifier, do they have strong controls in place to ensure your data is not at risk.
If the work is done onsite, it is important to ask what documents (or copies of documents), if any, the verifier will be taking with them when they leave, and whether these documents are saved in a secure manner. Documents saved locally on a laptop are at higher risk of being compromised.
For more information on how to maximize the benefits your firm receives from being GIPS compliant or for other investment performance and GIPS compliance information, contact us or email Sean Gilligan at firstname.lastname@example.org.