Verification

 

All references made to GIPS below are relevant to the AIMR-PPS standards and references to verification are relevant to Level I Verification as well. Additional guidance on verification, including the procedures for conducting a Performance Examination (Level II), is available in Appendix D.

The primary purpose of verification is to establish that a firm claiming compliance with GIPS has adhered to the standards. Verification will also increase the understanding and professionalism of performance-measurement teams and consistency of presentation of performance results.

The verification procedures attempt to strike a balance between ensuring the quality, accuracy, and relevance of performance presentations and minimizing the cost to investment firms of independent review of performance results. Investment firms should assess the benefits of improved internal processes and procedures, which are as significant as the marketing advantages of verification.

The goal of the GIPS committee in drafting the verification procedures is to encourage broad acceptance of verification.

 

A. Scope and Purpose of Verification

1.	Verification is the review of an investment management firm's performance-measurement processes and procedures by an independent third-party "verifier." Verification tests (a)  whether the investment firm has complied with all the composite construction requirements of GIPS on a firmwide basis and  (b)  whether the firm's processes and procedures are designed to calculate and present performance results in compliance with the GIPS standards. A single verification report is issued in respect to the whole firm; GIPS verification cannot be carried out for a single composite.
2.	Third party verification brings credibility to the claim of compliance and supports the overall guiding principles of full disclosure and fair representation of investment performance. Verification is strongly encouraged and is expected to become mandatory (but no earlier than 2005). Countries may require verification sooner through the establishment of local standards.
3.	The initial minimum period for which verification can be performed is one year of a firm's presented performance. The recommended period over which verification is performed will be that part of the firm's track record for which GIPS compliance is claimed.
4.	A verification report must confirm that (a)  the investment firm has complied with all the composite construction requirements of GIPS on a firmwide basis and  (b)  the firm's processes and procedures are designed to calculate and present performance results in compliance with the GIPS standards. Without such a report from the verifier, the firm cannot claim that its claim of compliance with GIPS has been verified.
5.	After performing the verification, the verifier may conclude that the firm is not in compliance with GIPS or that the records of the firm cannot support a complete verification. In such situations, the verifier must issue a statement to the firm clarifying why a verification report was not possible.
6.	A principal verifier may accept the work of a local or previous verifier as part of the basis for the principal verifier's opinion.
7.	The minimum GIPS verification procedures are described in Section III.B Required Verification Procedures.

 

B. Required Verification Procedures
The following are the minimum procedures that verifiers must follow when verifying an investment firm's compliance with GIPS. Verifiers must follow these procedures prior to issuing a verification report to the firm:

1. Pre-Verification Procedures

A.	Knowledge of the Firm. Verifiers must obtain selected samples of the firm's investment performance reports, and other available information regarding the firm, to ensure appropriate knowledge of the firm.
B.	Knowledge of GIPS. Verifiers must understand the requirements and recommendations of GIPS, including any updates, reports, or clarifications of GIPS published by the Investment Performance Council, the AIMR-sponsored body responsible for oversight of the Global Investment Performance Standards.
C.	Knowledge of the Performance Standards. Verifiers must be knowledgeable of country-specific performance standards, laws, and regulations applicable to the firm, and must determine any differences between GIPS and the country-specific standards, laws, and regulations.
D.	Knowledge of Firm Policies. Verifiers must determine the firm's assumptions and policies for establishing and maintaining compliance with all applicable requirements of GIPS. At a minimum, verifiers must determine the following policies and procedures of the firm: i.  Policy with regard to investment discretion. The verifier must receive from the firm, in writing, the firm's definition of investment discretion and the firm's guidelines for determining whether accounts are fully discretionary. ii. Policy with regard to the definition of composites according to investment strategy. The verifier must obtain the firm's list of composite definitions with written criteria for including accounts in each composite. iii.  Policy with regard to the timing of inclusion of new accounts in the composites. iv.  Policy with regard to timing of exclusion of closed accounts in the composites. v.  Policy with regard to the accrual of interest and dividend income. vi. Policy with regard to the market valuation of investment securities. vii.  Method for computing time-weighted portfolio return. viii.  Assumptions on the timing of capital inflows/outflows. ix.  Method for computing composite returns. x.  Policy with regard to the presentation of composite returns. xi.  Policies regarding timing of implied taxes due on income and realized capital gains for reporting performance on an after-tax basis. xii.  Policies regarding use of securities/countries not included in a composite's benchmark. xiii.  Use of leverage and other derivatives. xiv. Any other policies and procedures relevant to performance presentation.
E.	Knowledge of Valuation Basis for Performance Calculations. Verifiers must ensure that they understand the methods and policies used to record valuation information for performance calculation purposes. In particular, verifiers must determine that: i.  the firm's policy on classifying fund flows (e.g., injections, disbursements, dividends, interest, fees, taxes, etc.) is consistent with the desired results and will give rise to accurate returns; ii.  the firm's accounting treatment of income, interest, and dividend receipts is consistent with cash account and cash accruals definitions; iii.  the firm's treatment of taxes, tax reclaims, and tax accruals is correct, and the manner used is consistent with the desired method (i.e., gross- or net-of-tax return); iv.  the firm's policies on recognizing purchases, sales, and the opening and closing of other positions are internally consistent and will produce accurate results; and v.  the firm's accounting for investments and derivatives is consistent with GIPS.

 

 2. Verification Procedures

A.	Definition of the Firm. Verifiers must determine that the firm is, and has been, appropriately defined.
B.	Composite Construction. Verifiers must be satisfied that: i.  the firm has defined and maintained composites according to reasonable guidelines in compliance with GIPS; ii.  all of the firm's actual discretionary fee-paying portfolios are included in a composite; iii.  the manager's definition of discretion has been consistently applied over time; iv.  at all times, all accounts are included in their respective composites and no accounts that belong in a particular composite have been excluded; v.  composite benchmarks are consistent with composite definitions and have been consistently applied over time; vi. the firm's guidelines for creating and maintaining composites have been consistently applied; and vii.  the firm's list of composites is complete.
C.	Nondiscretionary Accounts. Verifiers must obtain a listing of all firm portfolios and determine on a sampling basis whether the manager's classification of the account as discretionary or nondiscretionary is appropriate by referring to the account agreement and the manager's written guidelines for determining investment discretion.
D.	Sample Account Selection. Verifiers must obtain a listing of open and closed accounts for all composites for the years under examination. Verifiers may check compliance with GIPS using a selected sample of a firm's accounts. Verifiers should consider the following criteria when selecting the sample accounts for examination: i.  number of composites at the firm; ii.  number of portfolios in each composite; iii.  nature of the composite; iv.  total assets under management; v.  internal control structure at the firm (system of checks and balances in place); vi.  number of years under examination; and vii.  computer applications, software used in the construction and maintenance of composites, the use of external performance measurers, and the calculation of performance results. This list is not all inclusive and contains only the minimum criteria that should be used in the selection and evaluation of a sample for testing. For example, one potentially useful approach would be to choose a portfolio for the study sample that has the largest impact on composite performance because of its size or because of extremely good or bad performance. The lack of explicit record keeping, or the presence of errors, may warrant selecting a larger sample or applying additional verification procedures.
E.	Account Review. For selected accounts, verifiers must determine: i.  whether the timing of the initial inclusion in the composite is in accordance with policies of the firm; ii.  whether the timing of exclusion from the composite is in accordance with policies of the firm for closed accounts; iii.  whether the objectives set forth in the account agreement are consistent with the manager's composite definition as indicated by the account agreement, portfolio summary, and composite definition; iv.  the existence of the accounts by tracing selected accounts from account agreements to the composites; v.  that all portfolios sharing the same guidelines are included in the same composite; and vi.  that shifts from one composite to another are consistent with the guidelines set forth by the specific account agreement or with documented guidelines of the firm's clients.
F.	Performance Measurement Calculation. Verifiers must determine whether the firm has computed performance in accordance with the policies and assumptions adopted by the firm and disclosed in its presentations. In doing so, verifiers should: i.  recalculate rates of return for a sample of accounts in the firm using an acceptable return formula as prescribed by GIPS (i.e., time-weighted rate of return); and ii.  take a reasonable sample of composite calculations to assure themselves of the accuracy of the asset weighting of returns, the geometric linking of returns to produce annual rates of returns, and the calculation of the dispersion of individual returns around the aggregate composite return.
G.	Disclosures. Verifiers must review a sample of composite presentations to ensure that the presentations include the information and disclosures required by GIPS.
H.	Maintenance of Records. The verifier must maintain sufficient information to support the verification report. The verifier must obtain a representation letter from the client firm confirming major policies and any other specific representations made to the verifier during the examination.

 

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