The Importance of Quality Verification

This article discusses the importance of quality verification in the context of the Global Investment Performance Standards (GIPS®). It highlights the risks and negative impacts of using inexperienced verifiers who lack asset management and performance expertise. The document uses real examples from an anonymous country, to illustrate how subpar verification can lead to widespread non-compliance and false claims of GIPS compliance. It emphasises the need for proper education, asking the right questions, and improving the verification process to ensure firms truly comply with GIPS standards.
Does it really matter if a verifier is not that well qualified/experienced in GIPS? Is it not just easier to get verified?

Chris Lourens

is a director of Solve Consulting with a 30-year tenure in the financial markets. He has 24 years of involvement and practical experience in the Global Investment Performance Standards (GIPS). Chris’s journey into the world of GIPS began uniquely when he was tasked with delivering a GIPS presentation at a treasury conference in Monaco back in 1999. Since that pivotal moment, he has been involved in more than 50 GIPS projects. His contributions span the entire spectrum, from offering strategic advice to overseeing full implementations, providing outsourced services, and providing verification support. He has been involved with the South African GIPS development from its inception. Chris remains actively engaged with the GIPS sponsor, demonstrating an unwavering commitment to the standard. GIPS isn’t just a professional endeavour for Chris; it’s a passion that he has nurtured over the years. His dedication extends to sharing insights through regular LinkedIn posts, delving into the practical aspects of GIPS and exploring ways to enhance its value. Some of his articles have been published in industry magazines. During 2023 Chris was selected as a member of the CFA Promotions Subcommittee, and in 2024 as a member of the CFA Verification Subcommittee. Chris holds a master’s degree in Investment Management and a diploma in mathematical modeling of derivatives. His career included being a risk manager, lecturer, and consultant.

The Global Investment Performance Standards (GIPS), developed by the CFA Institute, are globally accepted standards for calculating and presenting investment performance. They aim to provide a standardised, industry-wide approach to performance reporting, ensuring that investors can compare investment performance across different firms on a like-for-like basis. The standards cover various aspects, including the definition of the firm, the firm’s discretion, and composite definitions, which are essential for firm-wide compliance.

GIPS standards verification involves a verifier evaluating whether a firm has adhered to the GIPS standards, ensuring that the firm’s performance calculations and presentations are accurate and consistent with the standards.

What do I mean by not qualified? I talk about a verifier that has no experience in asset management and no experience in performance or GIPS. Someone who can only go through a tick list and not add value. Yes, it is easier. With inexperienced verifiers, you will have to explain a lot and show the verifier how to do calculations. In the end, you are normally right, and you continue doing what you do in the same way.

In reality, you might have some GIPS standards that you are not complying with, but if the verifiers do not pick it up, you will keep doing it wrong. This becomes the norm, and the error keeps on growing bigger and bigger without the firm understanding or realizing that they are doing anything wrong. The longer your verifiers do not pick up the real issues, the worse your GIPS implementation will become, and the more difficult it will be to correct. It also means you are not learning anything. Being GIPS compliant should be progressively better, or easier, every year and not worse.

I have worked with clients who have gone through many verifications, and when I looked at their GIPS implementation, they missed key requirements. I have also encountered many compliant firms with aspects they could have done differently and better. If somebody looked at GIPS in any other way than just a tick, then they would see where things are wrong or could be better. To highlight the importance of good verification and the negative effect of subpar verification, I would like to tell you a true story about a country.

A STORY OF GIPS IN A SMALL COUNTRY

Once upon a time, there was a country called Aganarama. Aganarama had a very good financial market with many asset managers. In the year when investment performance standards became global, they were one of the leaders in adopting the standards. They had a proud sponsor. A strong committee was formed to promote GIPS. It was a race for the first firm to be compliant, and after five years there were already many compliant firms. The first compliant firms prided themselves on their commitment to excellence and transparency, and to showcase this, they sought to comply with the GIPS standards and get verified.

These standards were their beacon, guiding them toward fair representation and full disclosure of their investment performance. The number of compliant firms quickly grew during the next five years, to about 15 compliant firms. The asset consulting firms started to ask the firms to confirm if they are GIPS compliant for their surveys, and this meant more firms became compliant to be able to meet the GIPS Compliant requirements for the surveys and potential customers.
Verification quickly became a market dominated by a few companies doing verification. This was just a small part of their annual turnover, and they did not have specialists in the field. They created verification plans for GIPS and had a captive audience. The verifications were not bad, but without any industry knowledge or subject expertise, it was just a “tick-box” exercise to a list of requirements. Nowhere did they show clients how they could do things better. This meant that when clients were doing things wrong it was not fixed in that year and the next year it was the norm as everyone just believed it was right. The firms thought that everything was perfect because they were verified and did not know of major gaps in their GIPS implementations. Over time, this progressively worsened as errors were not fixed. As people involved in GIPS move from one company to another, the word also spread that GIPS is not worth much because so many issues are being dealt with wrongly and that verification does not mean much. Because it is just a tick-box exercise, you now start getting firms that just say they are GIPS compliant even though they are not.

Some get the calculations to be right, or their administration is done by an administrator who also does their performance calculations, so then they “must be” compliant. When a big asset owner becomes GIPS compliant, you find that suddenly six more asset managers are claiming compliance on surveys. At least a third of all the compliant firms in Aganarama are not registered on the CFA website. This is a requirement before you can claim compliance, so many of those firms should not be claiming compliance (firms can say their names should not appear on the CFA website, but firms normally want their names on to show they are compliant). Then you also have firms that do not go through verification but claim to be compliant—which they can do—but are they compliant? Their view is that it is not worth the money to get verified as there is no value added and it is not a requirement.

The result of below-par verification in Aganarama is that they have many firms that are claiming compliance. Some spend a lot of money to do everything right and get verified, while others claim compliance without much effort and without spending any money. Why does this happen in a well-developed financial market like Aganarama?

I have the following theories and advice for Aganarama:

Education/Training: There is not enough education about GIPS for trustees and asset consultants. Trustees learn about performance fees, but not about GIPS. At conferences, you have talks on everything from ESG to AI, but you rarely find any talks about GIPS and how it could help. Verifiers only have “internal training” on GIPS – normally based on theory and no practical experience.

Wrong Questions: Asset consultants and trustees are asking the wrong questions when they want to find out about a firm’s GIPS Status. It should not just be, “Are you GIPS compliant, and have you been verified?” It should also insist on a GIPS report for a composite. How will the asset consultant or trustee know that a firm is truly compliant if they do not see the composite reports? The value of GIPS is that I get reports from different firms that look the same and are built on the same standards. If they only ask me if I am GIPS compliant, then I will only say yes. They should also ask for the composite list.

When a company is doing a survey where they will indicate whether a firm is GIPS compliant or not, then they should get the right documentation from them. You cannot just ask the question and then tick them as compliant. If only this could be done correctly, a third of the issues in the market of Aganarama would be sorted.

Inadequate Verification Process: The verification process should be questioned:

when a verified firm claims compliance and does not know they should be registered on the CFA website,
when a verified firm’s policies and procedures do not include an error correction policy or some of the other required policies and procedures,
if a verified firm does not have all the disclosures they should have,
if a verified firm does not have a list of composites.

All of this makes the market negative about the true value of GIPS and it nullifies the efforts of at least two-thirds of the firms in this country that are spending millions of Aganarama dollars between systems, internal effort, and verification to try and be truly GIPS compliant. It is a total waste of money if the market does not value the status of GIPS.

When the issues discussed here occur, it is not because a firm wants to do something wrong, it is because they are human and can miss something in this busy environment. Because it was not picked up five years ago in a verification, it has escalated and become the norm.

Verification not required: Because verification is not a requirement and because of the first two points above, there are no checks to see if a firm claiming compliance is compliant. I believe that in every country the GIPS standards sponsor and the CFA society should have the right to ask for some proof from all firms claiming to be compliant. You do not need a verification to see if a firm is attempting to be compliant. This should just be a check by someone who fully understands GIPS.

DOES IT INCREASE A FIRM’S RISK IF THEY BELIEVE THEY ARE COMPLIANT, BUT THEY ARE NOT?

Because the firm might believe that they are GIPS compliant, while not being compliant, they could falsely claim compliance in advertisements and surveys. This would be seen as false advertising. A ruling in a case against ZPR Investment Management demonstrates that while the Securities and Exchange Commission (“SEC”) did not develop the GIPS Standards, it will take action against investment advisors that falsely claim compliance or omit key disclosures.
Regulators, like the SEC, often review claims of compliance with the GIPS standards to ensure that they are accurate and that investors are not being misled. This has a major effect on multiple risks within the firm:

Regulatory Risk: Firms that make false or unsupported claims can face severe regulatory actions, including fines, cease and desist orders, and even being barred from the industry.
Reputational Risk: Inaccurate claims of GIPS compliance can damage a firm’s reputation. Investors and clients rely on GIPS compliance as a mark of credibility and transparency. Misleading claims can erode trust and lead to the loss of clients and business opportunities.
Legal Risk: Firms can face legal consequences for making false claims of GIPS compliance. This can include lawsuits from clients or investors who feel misled by the firm’s performance claims. Legal battles can be costly and time-consuming.
Financial Risk: Regulatory fines and legal settlements can have a significant financial impact on a firm. Additionally, the loss of clients and business due to reputational damage can lead to decreased revenue and profitability.
Compliance Risk: Firms must maintain ongoing compliance with the GIPS standards, including regular reviews and updates to policies and procedures. If firms believe they are compliant, they will not update any of their processes.

HOW DO WE IMPROVE THIS SITUATION?

Improving this situation is indeed challenging, especially since many of the verifiers performing substandard verifications are well-respected companies. The 2020 GIPS Standards introduced specific guidelines for verifiers, which is a step in the right direction. However, we still need to ensure that the individuals conducting the verifications have thoroughly read and understood the standards and have a solid grasp of investment performance. Training the people doing the verification is crucial. We can’t just rely on a senior person with a CIPM or CFA qualification to provide occasional guidance. The best way to improve the situation is by using verifiers who have real investment management and performance experience. Firms need to understand the importance of high-quality verification and the risks of substandard verification. Verifying the verifiers is difficult, and currently, there’s no established way to do this. Firms need to recognise that they cannot blame the verifier if they are not truly compliant; it remains their responsibility and risk. Firms should demand high-quality verification that they feel confident in. If a verifier does not meet this standard, firms should consider switching to another verifier.

Good quality verification is essential. Not to catch out firms that do things wrong, but to help firms ensure they are fully compliant with the GIPS standards. Verification should not be something to look up to annually, but something to look forward to.