GIPS Verification

If you've ever read or analyzed a company's 10-K or 10-Q, you know that the auditor's opinion of the financial results is highly likely to be an unqualified opinion, meaning that the financial statements were done correctly to the best of the auditor's knowledge. It's a one-page disclosure that investors rely on. Similarly, more and more firms are choosing to also be audited for GIPS performance, and just like an accounting audit, the process doesn't guarantee perfection, but provides the firm with several fantastic benefits. Off the top of your head, what would be one benefit of an external GIPS audit?

No, that's not right. GIPS implementation and auditing takes internal work from additional staff, which costs money.

That's not it. GIPS standards don't really help investment performance, only the processes and calculations of performance.

Who do you suppose the verification report should cover?

What time period do you think is probably recommended for verification?

Not quite. GIPS standards are applied broadly, not just to the internal GIPS team.

Definitely not. GIPS standards cover way more than the manager of the performance portfolio.

That's not right. Although five years is the minimum performance required, it's not the GIPS verification recommendation.

No, actually. GIPS standards are striving for total accuracy, so just 10 years of verification isn't the best.

So what do you think GIPS standards advise?

What audit accounting technique would cut down on time and still provide a high-quality verification process?

No way. That's definitely going to increase costs.

Well, no. That's a time and cost increase that doesn't give the principal verifier freedom to make decisions.

But suppose that the verifier finds that the firm's record keeping is deficient. What do you think should be the verifier's response in this situation?

No, that's not it. That will still take a lot of time, so it's not the allowed method.

No way. Interviewing all the employees is time-consuming, so it's not a good option.

Quite right. The verifier will need additional sampling to ensure that the presentations and composites are accurate and may also require additional verification procedures. The verification report must state that the verification has been conducted with the specified verification procedures. These verification procedures include understanding all GIPS requirements and recommendations, all laws and regulations regarding the calculation and presentation of performance, and any differences between the law and standards. Verifiers must also learn about the firm, including its operations, structure, policies, and procedures for compliance, as well as understand specifically the policies, procedures, and methods that the firm uses to value portfolios and compute investment performance.

No, actually. The firm clearly has trouble conducting its own documentation, so it shouldn't be in charge of the verification process.

Not quite. Record keeping may be deficient, but that doesn't mean that the presentations and composites aren't accurate.

What else will the verifier be looking for during the verification process?

How should the verifier ensure that the firm followed GIPS standards for performance calculations?

Not exactly. GIPS verifiers aren't concerned with regulatory oversight; they're concerned with GIPS compliance.

No way. Different composites will have different returns because they're different strategies.

Excellent. By recalculating the performance for selected portfolios, the verifier can ensure that the firm followed GIPS standards. This recalculation also includes composite returns and benchmark returns, along with any custom benchmarks created. Verifiers are also tasked with ensuring that discretionary portfolio treatments are consistent with firm policy, along with the creation and maintenance of composites. Again, verifiers will sample portfolios within composites to ensure that the investment mandate, objective, or strategy is applied consistently and ensure that all other GIPS requirements are followed. As a final step, the verifier must receive a representation letter from the firm that confirms that all policies and procedures are accurately recorded in the firm's documents and were consistently applied throughout the periods being verified.

That's not right. The verifier can't tell if the calculations are accurate by simply looking at them.

Not really. Even computer software can be manipulated to improve performance.

To sum it up: [[summary]]

Right. GIPS auditing, or verification, helps firms by improving their internal processes and procedures by requiring better documentation and communication. It also increases the knowledge of the performance measurement team, results in higher quality presentations, and can lead to advantages in potential marketing. Best of all, it puts the principles of fair representation and full disclosure firmly in everyone's mind. This is where the GIPS verification principles, which provide minimum procedures that _verifiers_ must use before issuing a verification report, come in. For example, verification must be performed by a qualified, independent third party to verify that the firm has complied with all composite construction and calculation and presentation of performance standards. If the firm meets these two requirements, then a verification report can be issued.

Absolutely. If GIPS standards apply to the whole firm, then the verification report should cover the entire firm as well. There's one verification report, and firms that claim verification can only do so if it has been issued. Firms must not claim verification on a specific composite, but can choose to have a detailed performance examination of one or more composites. This allows the firm to disclose that the specific composite has been examined. The _minimum_ verification period is one year, or the time from inception to date to period end if the firm has been in business less than one year. But that's just the minimum. GIPS standards actually recommend additional verification.

Exactly. Ideally, firms would be verified for all time periods, but it's not a requirement. Again, it's just the minimum of one year or since inception through the period end. But unfortunately, some firms don't measure up and they can't receive a positive verification report. If that happens, the verifier must explain why and GIPS standards require that the verifier not issue a verification report unless the firm is verified. And, as you can imagine, the work of verification is time-consuming, so many times the principal verifier will rely on the work of others, be it another verifier, or an independent, qualified, reputable third party. GIPS standards are rightly cautious about the principal verifier using third-party work of any sort; but at the same time, causing firms to have more expenses isn't ideal.

Yes. The principal verifier can use third-party work as long as the third party's qualifications, competency, objectivity, and reputation are evaluated. GIPS standards require that principal verifiers use professional skepticism when using third-party data; so the decision and ultimate verification is in the hands of the verifier. While GIPS allow the principal verifier to save some time by using third-party work, the entire firm is still subject to verification, which is still going to require a lot of work. So the principal verifier is allowed to use audit accounting techniques to verify compliance.

That's it. GIPS standards allow the verifier to perform control procedures that allow for sampling the portfolios. These control procedures include the number of composites at the firm, the number of portfolios within each composite, the type of composites, the total assets under management, the internal control structure of the firm, the years of examination, any technology used to calculate performance and maintain composites, the performance calculation method, and whether the firm uses external performance measurement firms.

Within the verification process, the principal verifier is concerned with the firm's ability to satisfy all the GIPS requirements, so any required provision is also mentioned within the specific verification provisions to make sure that the verifier confirms the compliance. In particular, verifiers are required to ensure that the treatment of certain input data, like income, interest, dividends, taxes, tax reclaims, tax accruals, purchases, sales, closing positions, and accounting treatments, meets the firm's documented policies and procedures, especially over multiple composites.

Definitely. Verifiers must be on the lookout for the consistency in the application of the firm's policies and procedures. This includes all GIPS requirements, which should be consistently applied. In fact, the verifier must determine that the firm has specifically calculated performance according to its policies.

Lower firm-wide costs

Greater investment performance

Improved internal process and procedures

The entire firm

The internal GIPS team at the firm

The manager that generated the performance

5 years

10 years

All years

Disallowing third-party work

Using professional skepticism

Verifying the third-party verifier's work

Sampling

Interviewing all the key managers for GIPS compliance

Evaluating all the individual firm compliance documentation

Require additional sampling

Require the firm to initiate its own audit

Insist that the firm not receive verified status

Consistency in application

Proper regulatory oversight

Equality in the returns of various composites

Recalculate a sampling of the returns

Make sure all the returns in one composite are roughly the same

Verify that the computer program used to calculate performance is accurate and up to date

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