Performance Perspectives Blog

Is compliance enough?

by | Jul 11, 2011

A firm we consulted to a few years ago responded to one of our marketing pieces about verification, wondering if they should make the investment to undergo this exercise. They have claimed compliance with the Global Investment Performance Standards (GIPS(R)) for some time, but have noticed that they aren’t getting the business that they thought they’d get, especially their above average returns.

To put it simply, YES! Verification is not an expense but an investment, that serves multiple purposes.

Claiming compliance is critically important today, especially when marketing in the institutional space. However, these institutions want some assurance that your claim has a degree of validity, and verification does just that. Granted, contrary to common belief, verification doesn’t verify compliance. Rather, as GIPS 2010 points out, “Verification 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.” But for many this is seen as being tantamount to affirming, though not in so many words, that the firm’s compliance is correct.

And given that both our research and experience have shown that most firms who have not undergone a verification but claim compliance are falling short of the requirements (i.e., not really complying), the claim without the verification doesn’t carry a lot of weight.

Another advantage for SEC registered firms: while the SEC offers “free verifications,” you don’t want to fail them (i.e., you don’t want them to be the ones to tell you that you’re not actually in compliance). Therefore, isn’t it better to make the investment to avoid having these problems?

How frequently should you have a verification done? We recommend annually; we don’t in any way support quarterly. Not because we don’t like to visit our clients, but because there is no benefit for this level of frequency, other than to keep the verifier’s employees busy throughout the year. We believe that quarterly visits are also disruptive to the client. Granted, some of the firms that do these verifications don’t actually visit their clients, but we do, and none of ours has the need for us to see them that often (unless, of course, we’re engaged in some other work for them).

Our research has also shown that most firms that claim compliance do have verifications done. And so, firms like the one cited above are in the minority. Yes, it’s nice to be able to “tick off” the box in the RFP (Request for Proposal) that asks “Do you claim compliance with the GIPS standards?” But if you can’t also tick off the “Have you had a GIPS verification done?,” then the likelihood of being hired, or even considered, is significantly reduced.

And so to these firms I have to ask: you made the investment to achieve compliance; isn’t it worth the investment to undergo a verification, too? We (and most of the industry) would say “yes.”

p.s., a point of clarification is in order. The SEC doesn’t actually offer “free verifications.” They do freely come in once in a while to check registered investment advisors out, and in the course of their work may conduct tests to validate a firm’s compliance, but aren’t in the business of conducting verifications. Please don’t call them and say “Dave Spaulding said you offer free GIPS verifications and we’d like you to come in and conduct one for us.” I have used this line about “free verifications” in a number of talks I’ve given, thinking that surely everyone understood it was meant as a joke, but apparently some in attendance believed me.

p.p.s., while the suggestion that verification become mandatory has died away, the new requirement (as part of the 2010 edition) to declare whether or not the firm has undergone verification should encourage more firms who haven’t made the investment yet to do so. That’s at least the expectation.