GIPS Standards Verification Services, Part II: Case Analysis

For more on ethics in investment management, CFA Institute Research and Policy Center has launched an informational content hub to mark Global Ethics Day 2023.

On Global Ethics Day, Wednesday, 18 October, we presented an Ethics in Practice case based on a recent SEC enforcement action that also touched on the Global Investment Performance Standards (GIPS®), the globally adopted standards for calculating and presenting investment performance in an ethical and transparent manner. We asked readers to analyze the case facts and identify which of the newly adopted CFA Institute Standards of Professional Conduct, due to go into effect 1 January 2024, were at issue. Below are our answers and analysis.

For more on these updated standards, CFA Institute will present a webinar, “Changes to the CFA Institute Code of Ethics and Standards of Professional Conduct,” on Tuesday, 24 October, from 12 pm to 1 pm EDT, that will describe the changes to the Standards of Professional Conduct in detail.

For those who missed the 27th Annual GIPS Standards Conference earlier this week in Chicago but would like to access conference-related content, you can register for the digital event experience, which will be available on Monday, 30 October.

Case Analysis

Competence

New Standard I(E) Competence states:

“[CFA Institute] Members and [CFA] Candidates must act with and maintain the competence necessary to fulfill their professional responsibilities.”

The standard reinforces and emphasizes the need for investment professionals to continuously maintain or improve the competence required of their professional position. To be competent means having sufficient knowledge, skills, and abilities suitable for a professional to work in his or her specific role with success. This standard promotes a high standard of professional service for clients and employers.

In this case, Satterwhite violated Standard I(E). When he started LSC, his role shifted from a senior investment professional overseeing the work of a junior team and third-party verifiers to actually doing the verification work for other firms. His professional responsibilities changed, requiring new and different knowledge, skills, and abilities. In his role as verifier, Satterwhite was not sufficiently knowledgeable about the GIPS standards or how to apply them to certain investments, including overlay strategies, and did not have the competence necessary to perform a GIPS standards verification for VanZandt.

Disclosing the Nature of Services and Costs to the Client of Those Services

New Standard V(B.1) states:

“[CFA institute] Members and [CFA] Candidates must . . . [d]isclose to clients and prospective clients the nature of the services provided, along with information about the costs to the client associated with those services.”

A clear understanding of the services that investment professionals can provide is a foundational element to the client relationship. Providing clients with information about the nature of the services they can expect from investment professionals and the financial impact they can expect from those services is critical to protecting client interests and enabling fully informed investment decisions. To set appropriate expectations, clients must understand what services the member or candidate will provide and, importantly, what services are not being provided. Investment professionals cannot rely on the sophistication of clients and their supposed understanding of the nature and details of the investment process as a reason for not providing the information required by this standard.

Satterwhite violated Standard V(B.1) by not adequately informing VanZandt about the nature of the services and their cost. Satterwhite committed to Van Zandt that he would provide a “verification of all assets managed by the firm.” Satterwhite conducted the verification using a sampling technique, which is consistent with the requirements of the GIPS standards, and did not conduct a complete assessment of the entirety of the firm’s performance. This was not effectively disclosed to or understood by Odom, who later became furious at the apparent misrepresentation. Further, Satterwhite indicated that the work could be done for a fee based on 150 hours of work. When it became apparent that the cost to the client would increase dramatically, Satterwhite failed to provide appropriate disclosure of the increase in cost in a timely manner, as he did not disclose that new cost to the client until after the work was completed.

Avoid or Disclose Conflicts of Interest

New Standard VI(A) Avoid or Disclose Conflicts states:

“[CFA Institute] Members and [CFA] Candidates must avoid or make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity and interfere with respective duties to their client, prospective clients, and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.”

Best practice is to avoid actual conflicts or the appearance of conflicts of interest. While avoiding conflicts all together is preferred, often in the investment industry a conflict, or the perception of a conflict, cannot be avoided. When it is not reasonable for members to avoid a conflict, clear and complete disclosure of the conflict is required. Full disclosure of a conflict provides clients and prospective clients with the information needed to evaluate the objectivity of the advice they receive.  

Satterwhite violated Standard VI(A) by failing to avoid or disclose to VanZandt that MCA promised to provide support to Satterwhite’s wife’s nonprofit if he successfully persuades LSC clients to use MCA software, providing Satterwhite an indirect benefit. Standard VI(A) requires Satterwhite to disclose the conflict of interest when he recommended that the firm purchase MCA investment performance software. In this case, the conflict is simple to avoid. Best practice would be for Satterwhite to avoid this conflict by not having an agreement with MCA to contribute money to the nonprofit in exchange for recommending the software. At a minimum, Satterwhite must disclose the arrangement to his client so VanZandt can fully evaluate the motivations behind the recommendation of the MCA software purchase. 

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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