I’m still a bit befuddled by the GIPS(R) error correction guidance, which goes into effect in three weeks. I guess I’m relieved that I’m not alone, but I’d feel a lot better if it was crystal clear. The guidance provides for four levels of errors:

1. Non-material: [“Take no action”] error is so minor that no action is needed.
2. Non-material: [“Correct the presentation with no disclosure of the change”] you’ll (a) correct the error, but (b) not document it (i.e., disclose it in your GIPS presentation) nor (c) not tell anyone
3. Non-material: [“Correct the compliant presentation with disclosure of the change and no distribution of the corrected presentation”] you’ll (a) correct the error, (b) document it, but (c) not tell anyone
4. Material: [“Correct the presentation with disclosure of the change and make every reasonable effort to provide a corrected presentation to all prospective clients and other parties that received the erroneous presentation”] you’ll (a) correct it, (b) document it, and (c) tell anyone who got a copy of the previously erroneous copy that an error was corrected.

Recall that the disclosure draft included the requirement to document any material errors for 12 months (as is written in the guidance). Also recall that the recently issued Q&A says that you don’t need to do this, at least in all cases. It reads: “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 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. This may result in the preparation of two versions of the corrected compliant presentation to be used for a minimum of 12 months following the correction of the presentation.” 

At last week’s Performance Measurement Forum meeting in Orlando we discussed this issue at some length. It appears that you don’t have to have rules for all four cases. My advice regarding the four levels (by level):

1. Identify the kinds of errors that you’d not bother correcting (immediately spelling and grammatical errors come to mind; you get to decide what else)
2. Identify the level that you feel needs to be fixed but is so minor that you don’t need to tell anyone (an example here might be a correction that increases your return).
3. I don’t see a need for this level. I base this on the Q&A, which basically says you don’t have to document the error unless you can’t determine if you gave a prospect a copy of the prior version. If this is the sole condition, since this level doesn’t require redistribution, why would you document it?
4. I’d establish the rules that would cause this to happen, but ensure that I’ve got records of who gets copies of what presentations, so that if a material error IS discovered, I can get them a copy of the revised presentation, if appropriate.

The big question that you need to decide on: what’s material? We’ve heard an error as high as 100 basis points, which I happen to think is pretty darn high. I think it depends (a) on the asset class (I’d have different levels for bonds than stocks, unless you adopt an approach like I suggest below) and (b) the relative size of the returns. For example, a 100 bp difference of 2% vs. 1% is a lot different than a 51% vs. 50%, right?

I’m thinking that perhaps a relative rule might be workable. For example, a 5% error of the return itself (example: if the return was 2% and has been corrected to 1.89%, that’s 11 bps, which is 11/200 = 5.5%, so it’s material). Perhaps at returns > 10% I’d say the level is 10% (again, of the return itself; example: if my return was 12% but corrected to 10.78%, that’s a 122 bp drop, and 122/1200 = 10.17%, so it’s material).

This approach might be better than simply saying “100 bps” or “50 bps.” I’m not saying to adopt these thresholds … you decide what works for you. But perhaps this approach would provide the necessary flexibility so that the rules will make sense? Your thoughts are, as always, invited.