Beware of the SEC When It Comes to GIPS Claims of Compliance

The CFA Institute created and administers the GIPS Standards. However, a ruling in this SEC case demonstrates that while the SEC did not develop the GIPS Standards, it will take action against investment advisors that falsely claim compliance or omit key disclosures.

The case involves an advisor that advertised its performance in several magazines and investment newsletters. The advertisements cited the firm’s GIPS claim of compliance, but did not include all of the disclosures required by the GIPS Advertising Guidelines (including since inception returns, currency used, and how an interested party can obtain a GIPS Report).

The judge in the case ruled that, among other things, the advisor violated Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 by misrepresenting its compliance with GIPS standards in the advertisements and newsletters. The judge also ruled that the advisor’s owner aided and abetted the firm’s violations. The firm was censured and ordered to pay civil penalties. The firm’s owner received a permanent bar from association with any advisor or broker-dealer, a cease-and-desist order, and an order to pay civil penalties.

The case serves as a reminder that a firm’s claim of compliance is often an advertising claim. Claiming GIPS compliance involves more than having formal policies and procedures for calculating and presenting composite performance presentations. The GIPS standards also include the GIPS Advertising Guidelines. If a firm mentions GIPS in an advertisement, the GIPS Advertising Guidelines require certain presentation and disclosure items to be included.

As a reminder, here is the way the GIPS Advertising Guidelines define “advertisement”:

An advertisement includes any materials that are distributed to or designed for use in newspapers, magazines, firm brochures, pooled fund fact sheets, pooled fund offering documents, letters, media, websites, or any other written or electronic material distributed to more than one  party, and there is no contact between the firm and the reader of the advertisement. One-on-one presentations and individual client reporting are not considered advertisements.

Presentation and disclosure items required by the GIPS Advertising Guidelines vary depending on whether a firm includes performance in its advertisement, versus just basic language that it is GIPS compliant. While the 2020 edition of the GIPS Standards, effective January 1, 2020, did not see large scale changes to the GIPS Advertising Guidelines (now included in Section 8 of the GIPS Standards for Firms), there were updates made to certain criteria for advertisements including performance. As an alternative to meeting the requirements of the GIPS Advertising Guidelines, firms may provide a GIPS Report with the advertisement to satisfy the GIPS Advertising Guidelines.

As firms begin to evaluate their advertising policies in response to the release of the SEC’s Marketing Rule, which is required to be adopted by all firms no later than November 2022, it may be prudent for firms to take a fresh look at their policies and procedures related to their advertisements and compliance with the GIPS Advertising Guidelines. Policies and procedures often incorporated into a firm’s regulatory review of advertisements should include:

  • The process for determining whether the document is considered an advertisement under the GIPS Standards.
  • Utilization of a checklist designed to ensure the completeness of the presentation and disclosure requirements in the advertisement. This checklist may also include any regulatory requirements and should be completed by the preparer of the advertisement.
  • The policy for reviewing the advertisements, with documentation that the review occurred. Ideally, these advertisements should be reviewed by someone other than the preparer (often a representative from legal and compliance) and should include a review of the completed disclosure checklist related to the advertisement.

And as a reminder, while it is important to have documented policies and procedures, it is equally important to have a documented process that demonstrates how the firm has followed them. If any errors or deficiencies are noted, the firm should proactively correct them and then  adopt policies and procedures to reduce reoccurrence. Independent oversight by internal or external compliance counsel is highly recommended.

If you are currently claiming compliance with the GIPS standards or would like to claim compliance in the future, and would like to know more information about this subject, please contact us.

Todd E. Crouthamel, Director, Audit & Accounting can be reached at tcrouthamel@kmco.com.


Ashley Jiang, Senior Accountant, Audit & Accounting can be reached at ajiang@kmco.com

 

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