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

The CFA Institute created and administers the GIPS Standards. However, a recent ruling in an 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, originally filed by the SEC in April 2013, with an initial decision by an administrative law judge in May 2014, 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).

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 provide rules on disclosures that must 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, letters, media, websites, or any other written or electronic material addressed to more than one prospective client. Any written material, other than one-on-one presentations and individual client reporting, distributed to maintain existing clients or solicit new clients for a firm is considered an advertisement.

Disclosures required by the GIPS Advertising Guidelines vary depending on whether a firm includes investment returns in its advertisement, versus just basic language that it is GIPS compliant. As an alternative, firms may provide a compliant presentation with the advertisement to satisfy the GIPS Advertising Guidelines.

In addition, firms should consider reviewing 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 disclosures 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.

Read more about the initial decision referenced in this article.

We will be happy to provide further information relating to this subject. For more information, contact Todd E. Crouthamel, Director, Audit & Accounting at tcrouthamel@kmco.com or 215.441.4600.

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