Wednesday, November 17, 2021
9:00 AM – 11:30 AM
Agenda items included:
Click here to download the slides from the presentation.
Tuesday, November 17, 2020
9:30 AM – 12:00 PM
This seminar covered:
Presenters:
Click here to download the slides from the presentation.
Craig B. Evans, Director, Audit & Accounting
Earlier today, President Trump signed the $484 billion bill passed by the House Thursday afternoon and intended to provide additional relief to businesses impacted by the COVID-19 pandemic. The bill includes approximately $310 billion in additional funding for the Paycheck Protection Program (PPP). Of the $310 billion, $60 billion is reserved for smaller lenders, including community financial institutions, small insured depository institutions, and credit unions with assets less than $10 billion.
Unfortunately, hedge funds and private equity firms will be unable to take advantage of PPP loans. In its interim final rule, the Treasury Department clarified that hedge funds and private equity firms are primarily engaged in investment or speculation, and that Congress did not intend for these types of business to obtain PPP financing.
As more details of business relief efforts are made available, specifically those related to the investment industry, Kreischer Miller’s Investment Industry Group will provide additional updates. We also regularly update our COVID-19 Resource Center, which you can access here. If you have any questions about these or any other matters, please contact your Kreischer Miller relationship professional or any member of our team.
Craig B. Evans can be reached at cevans@kmco.com or 215.441.4600.
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In order to address the question of whether or not you should perform operational due diligence as part of your process to evaluate an investment manager, a broad analysis of the primary 
underlying risks is helpful. There are two main types of risk that investors need to assess: investment risk and operational risk.
Investment Risk
Investment risk is the risk that the actual return on an investment will be lower than the investor’s expectations. The risk is inherent to a manager’s strategy. Investment plans often manage investment risk by focusing on several key factors, including:
Additional investment risk is often taken with the expectation of receiving additional investment returns.
Operational Risk
Operational risk is the risk that the way the investment manager conducts its operations and business could lead to lower investment returns. It includes many qualitative elements such as an investment manager’s internal controls, design and implementation of systems, and oversight of employees. Taking on additional operational risk is never expected to improve returns. For this reason, operational risk is an uncompensated business risk.
The following operational items are things to watch out for:
It is difficult to anticipate operational risk. Because human error is unpredictable, weak controls or sloppy systems are difficult to price into the risk calculation. Investors, therefore, must assume that human error will be prevented by tight controls in the manager’s systems, in order to rationalize using a manager.
How do Investors Assess and Manage Risk?
Investors assess risk by understanding the investment strategy and determining how it fits into the overall asset allocation model, and by using consultants and other professionals to help provide additional guidance. Sometimes this includes a detailed analysis of returns in different environments and other statistical measures.
Operational risk is impossible to assess from investment returns alone or other purely quantitative measures. This risk is best assessed by performing operational due diligence, which typically addresses the following:
Operational due diligence allows for a deeper understanding of an investment manager’s policies and procedures and whether they are designed to minimize these types of uncompensated risks.
Objectives of Operational Due Diligence
Although the core objective of operational due diligence is to provide investors with information that helps them make investment decisions, the process impacts managers as well. The objectives of operational due diligence can generally be summarized as follows:
While it is impossible to eliminate all risks involved with any investment, a strong operational due diligence program can help mitigate such risks and provide investors with valuable insight to help them make investment decisions.
We would be pleased to provide further information related to this subject. For more information, contact Thomas A. Peters, Director, Audit & Accounting at tpeters@kmco.com.
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Verifier independence is not a new topic within the GIPS Standards. In 2005, the GIPS Executive Committee released the Guidance Statement on Verifier Independence, which laid the foundation for verifier independence as well as outlined the minimum guidelines for verification firms and clients. The newly-proposed Guidance Statement on Verifier Independence is being issued with the purpose of clarifying and strengthening the existing guidance surrounding verifier independence.
Verifier Independence Clarified
The proposed Guidance Statement stresses that independence is the responsibility of the verification firm as well as the verification client. The assessment of independence is initially performed at the commencement of an engagement acknowledged by both parties through an engagement letter. However, it should be an ongoing process throughout the engagement, affirmed by both the verification firm and verification client upon completion of the engagement via the verification report and representation letter, respectively. Any new information potentially impacting the initial assessment of independence should be reviewed and documented by both the verification firm and verification client, along with the conclusions reached.
With respect to the guiding principal that verification firms should not step into a management role on behalf of a verification client or assume any responsibility in any management function, the proposed Guidance Statement defines “management functions” as tasks and responsibilities that are relate to the GIPS-compliance process. Some examples given within the proposed Guidance Statement include:
What the Proposed Guidance Requires
In an attempt to strengthen the independence assessment made by the verification firm, the proposed Guidance Statement will require verifiers to create and document policies and procedures surrounding the independence assessment at both the firm and the employee level. This is a change from prior guidance. Although verifiers were always responsible to assess independence, this proposed Guidance Statement now requires all verifiers to formally document their policies and procedures for addressing independence. The proposed Guidance Statement also encourages verification clients to follow suit and document policies and procedures that address verifier independence.
Your Opinion Matters
The proposed Guidance Statement on Verifier Independence will be open for public comment until October 26, 2017. We encourage all firms, including both verification firms and verification clients, to weigh in on the guidance statement as all will be subject to the provisions on verifier independence. The draft of the guidance statement can be found at: https://www.gipsstandards.org/standards/Documents/Guidance/exposure_draft_public_comment_verifier_independence.pdf.
We would be pleased to provide further information related to this subject. For more information, contact Thomas A. Peters, Director, Audit & Accounting at tpeters@kmco.com or Joshua E. Kramer, Senior Accountant, Audit & Accounting at jkramer@kmco.com.
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The GIPS Technical Committee is seeking comments on a newly-proposed Guidance Statement on Risk and how it relates to the presentation of risk, both quantitatively and qualitatively within the compliant presentation. The Guidance Statement will address when and where risk-related information is appropriate, recommended, and required to be included in compliant presentations.
Presentation of the Three-Year Annualized Ex-Post Standard Deviation
GIPS standard 5.A.2 requires firms to present the three-year annualized ex-post standard deviation, using monthly returns, for the composite and the benchmark. If the firm determines that the three-year ex-post is irrelevant or inappropriate for a given strategy, reasoning supporting this conclusion must be disclosed (GIPS Standard 4.A.34). Firms electing not to present the three-year annualized ex-post are required to present an additional three-year ex-post risk measure that is available and appropriate.
Firms already presenting the three-year annualized ex-post are not required to change anything to their compliant presentations. The proposed Guidance Statement will eliminate a firm’s ability to elect to not present the three-year annualized standard deviation. Under the new guidance, all firms will be required to present the three-year annualized ex-post standard deviation as well as disclose whether the risk measure was calculated using gross or net returns. GIPS standard 5.A.2 does not currently address disclosure of using gross versus net returns in the calculations. Firms will still be encouraged to present additional ex-post risk measures, and will be required to describe the risk measure and its relevance to the strategy.
Adequacy of Risk Description within Composite Definitions
While GIPS Standard 4.A.3 related to defining composites does not explicitly require firms to disclose qualitative information about risk, firms must include any significant features about an investment strategy to help prospective investors make informed decisions.
Prior to the proposed Guidance Statement on Risk, there was little guidance within the standards on how firms should address risk within composite descriptions. The newly-proposed Guidance Statement will require firms to assess the impact and significance of risk as it relates to a composite’s investment mandate, objective, and strategy. Firms will need to assess strategy features including, but not limited to, investment concentration, correlation of returns, changes in liquidity, exposure to counterparty creditworthiness risk, and the ability to employ significant leverage in portfolio. The nature and significance of risk features within a composite will drive the complexity of the risk description disclosure within the composite definition.
Your Opinion Matters
Like all new GIPS pronouncements, the proposed Guidance Statement on Risk will be open for public comment until September 26, 2017. We encourage all firms to weigh in on the guidance statement as all will be subject to the provisions on risk and the adequacy of risk disclosures. The draft of the guidance statement can be found here: https://www.gipsstandards.org/standards/Documents/Guidance/exposure_draft_public_comment_risk.pdf.
We would be pleased to provide further information related to this subject. For more information, contact Thomas A. Peters, Director, Audit & Accounting at tpeters@kmco.com or Joshua E. Kramer, Senior Accountant, Audit & Accounting at jkramer@kmco.com.
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The GIPS Technical Committee is seeking comments on a newly proposed Guidance Statement. The purpose of the Guidance Statement is to address applying the GIPS Standards® to broadly-distributed pooled funds, as the existing standards do not directly address these funds.
Broadly distributed pooled funds (BDPFs) are funds which are unitized and broadly distributed, typically where there is no or minimal contact between the investment advisor of the pooled fund and the prospective pooled fund investors. Mutual funds are a good example of BDPFs, while private equity partnerships typically are not considered BDPFs.
What Led to the Proposed Guidance Statement
GIPS Standard 0.A.9 requires firms to make every reasonable effort to provide a compliant presentation to all prospective clients. This requirement, combined with the lack of direct guidance on how to handle BDPFs and the fact that many countries have different offering rules, led to this proposed guidance statement.
Complicating Factors
While it would seem easy to simply require firms to provide compliant presentations to all prospective BDPF clients, it’s not actually so easy or logical. In many cases, investment managers don’t have contact with BDPF clients (or prospective clients), as they are distributed by other institutions. Sometimes all the investment manager sees is an omnibus account.
Other potentially confusing factors:
What the Guidance Statement is Proposing
The proposed Guidance Statement takes a minimalist approach, in that it requires the following items to be included in the offering document:
What the Proposed Guidance Statement Does Not Require
The proposed Guidance Statement does not require including the GIPS claim of compliance nor disclosure of sales charges/loads, but notes that these are recommended.
Interestingly, the proposed Guidance Statement states that offering to provide investors with a GIPS compliant presentation is neither required nor recommended. Instead, Provision 0.A.9 would be deemed satisfied if the firm followed the list of required disclosures and calculation rules noted above.
Your Opinion Matters
Like all new GIPS pronouncements, the public is given an opportunity to weigh in with comments. If you firm manages mutual funds or similar funds that would fall under these new rules, we encourage you to provide feedback. The comment period is open until April 29, 2016. The draft of the guidance statement can be found here.
We will be happy to provide further information relating to this subject. For more information, contact Tom Peters, Director, Audit & Accounting at tpeters@kmco.com.
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In December 2015, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. The proposal is an element of the FASB’s broader disclosure framework project. This project is expected to promote the use of discretion by entities when assessing disclosure requirements, with the hope of improving the level of effectiveness of the financial statement footnotes.
The proposed update is still in the review period, and therefore open for public comment. Comments are due February 29, 2016.
Topic 820 provides a single purpose framework for measuring fair value, while requiring specific fair value measurements and/or disclosures. The FASB has proposed revising and removing specific fair value measurement disclosures for all entities, and adding new disclosures for public entities, not-for-profit entities, and employee benefit plans.
The goal of this proposal is to increase the efficiency of the disclosure requirements for all entities, and to further eliminate the number of disclosures for private companies. Some of the key changes are as follows:
If the proposed update is accepted, entities would have several modifications and eliminations to their disclosures, either due to inconsistencies or no longer being applicable. We recommend that firms research this topic in order to determine the effects it might have on their financial statements. Firms should consider whether this proposed amendment will result in more direct and useful information about fair value measurements.
We will be happy to provide further information relating to this subject. For more information, contact Meghan DiDonato, Senior, Audit & Accounting at mdidonato@kmco.com.
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Several years ago, the interim inspection program of auditors of broker-dealers was implemented due to new authority given to the Public Company Accounting Oversight Board (PCAOB) over auditors of SEC-registered broker-dealers by the Dodd Frank Wall Street Reform and Consumer Protection Act.
This summer, the PCAOB released its fourth inspection report. It continues to identify deficiencies in broker-dealer audits, despite publicizing four years of inspection findings covering over 275 audits.
The fourth interim inspection included 66 firms and covered elements of 106 audits. In its report, the PCAOB indicated that is has identified deficiencies in portions of 92 of the 106 audit engagements inspected. The most frequent deficiencies identified were around independence, revenue recognition, reliance on records/reports, fair value accounting estimates, financial presentation and disclosure, and the customer protection rule.
It is important to note that while these deficiencies were identified by the PCAOB, it does not mean that the financial statements and/or supporting schedules of the broker-dealer were materially misstated or that the broker-dealer violated SEC rules 15c3-1 and or 15c3-3. Rather, audit deficiencies described by the PCAOB are failures by firms to perform, or perform sufficiently, certain required audit procedures.
The following includes some of the key points identified in the PCAOB’s report.
Independence
Independence remains a primary concern of the PCAOB. One in four of the audits inspected had an independence finding, many of which related to the auditors’ assistance with the preparation of the audit clients’ financial statements.
As a refresher on independence, auditors cannot be in a position to audit their own work. As a result, auditors are prohibited from, among other items, maintaining or preparing the audit clients’ accounting records, preparing or originating source documentation underlying the financial statements, or preparing financial statements that are filed with the SEC or that form the basis of financial statements that are filed with the SEC.
Broker-dealers should be preparing their own financial statements, including disclosures, and maintaining all documentation required to support the financial statements.
Revenue Recognition
At least one deficiency was found in 76 of the 106 audits selected for inspection. Of these, at least half had multiple deficiencies related to testing of revenue recognition. For example, some firms did not test material classes of revenue transactions or did not perform sampling procedures correctly to test revenue transactions. It was also noted that some firms did not perform sufficient procedures to test the relevant assertions for revenue.
Broker-dealers should review their own policies and procedures surrounding revenue recognition, as this will be an area their auditors will focus on during the audit.
Reliance on Records and Reports
More than 55 percent of the audits that were selected for inspection had a deficiency related to establishing a basis for reliance on records and reports. Inspections staff observed that firms did not perform sufficient procedures on information produced by service organizations that were used to perform substantive audit procedures or test of controls.
For example, in some instances the PCAOB indicated that the auditor obtained a clearing broker statement, and the auditors’ procedures were limited to agreeing the clearing broker statement to the cash receipts or general ledger of the audit client. Auditors should be establishing some basis to conclude that they can rely on the clearing broker report. Broker-dealers should expect their auditors to request additional information to collaborate the data in the clearing brokers’ reports.
Broker-dealers can also expect their auditors to request an SSAE-16 report from the clearing broker or other third party service providers. Broker-dealers should also obtain a copy of these reports and ensure they have implemented and documented the user controls noted in the SSAE-16 report.
Fair Value Accounting Estimates
Deficiencies were found in nearly half of the inspections related to valuations. For fair value accounting estimates, broker-dealers should expect their auditors to test how management’s estimates are formulated and the inputs being used, as well as the controls surrounding the inputs for the estimate and any information that could have an impact on the estimate up through the date of the auditor’s report.
Financial Presentation and Disclosures
In nearly 45 percent of the audits that were examined, there was a deficiency related to financial statement presentation and disclosures. Broker-dealers should review their policies and procedures for ensuring all required disclosures are complete and accurate. These procedures should include the completion of a disclosure checklist and a review by someone other than the preparer of the financial statements. This review should focus on the reader’s ability to understand the financial statement disclosures without additional explanation from the broker-dealer’s personnel.
The Customer Protection Rule
When a broker or dealer claims an exemption under the Customer Protection Rule, auditors are required to ascertain whether the conditions of the exemption were complied with as of the examination date and whether anything came to the auditor’s attention to indicate that the broker-dealer was not in compliance during the period since the last examination. Broker-dealers should reconsider how their compliance with their exemption from Rule 15c3-3 is monitored and be prepared to discuss these matters with their auditors. They should also be prepared to demonstrate how their compliance with the exemption is monitored, and to detail any exceptions that occurred during the year.
PCAOB Staff Inspection Brief
In addition to the results of the interim inspection program, the PCAOB staff also released a Staff Inspection Brief during 2015 which identified key areas of PCAOB inspection focus. Many of the items are recurring, including revenue recognition, service organization reports utilized as audit evidence, auditor independence, and auditing supplemental information, including the broker-dealers’ computation of Net Capital under SEC Rule 15c3-1 and the Compliance or Exemption Reports under SEC Rule 15c3-3.
As part of the planning process for your upcoming audit, look at the PCAOB inspection results and the focus of upcoming inspections, and review your policies and procedures in those areas. This review will help you to discuss these matters with your auditor, and to understand your auditor’s increased focus and testing on these areas.
In 2016, the PCAOB plans to increase its inspections to 75 firms covering portions of approximately 115 audits. It continues to work toward developing a rule proposal to be issued during 2016 that would establish a permanent inspection program.
The PCAOB Interim Inspection Report is available here.
The PCAOB Staff Inspection Brief is available here.
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 Frank L. Varanavage, Manager, Audit & Accounting at fvaranavage@kmco.com.
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