There is little doubt in my mind that if Bernie Madoff were to be given a copy of the proposed changes to the Guidance Statement on Performance Examinations he would pat himself on the back, and be quite proud that his nefarious actions have extended so far.

At the beginning of the document we find a few specific questions that the GIPS(R) (Global Investment Performance Standards) Executive Committee (EC) would like comments on, including:

Regarding performance examination procedures” we’re asked if “you believe it also needs to be indicated that:

a. it is  preferable that verifiers obtain appropriate documentation directly from independent third parties;
b. verifiers must make every reasonable effort to obtain appropriate documentation directly from independent external parties; or
c. verifiers must obtain appropriate documentation directly from independent external parties?”

Also, regarding the existence and ownership of client assets we’re asked if “it needs to be indicated that:

a. it is preferable that verifiers obtain appropriate documentation directly from independent external parties; or
b. verifiers must obtain appropriate documentation directly from independent external parties?”

Within the document itself we find on page 6: “Beginning- and end-of-performance measurement period portfolio positions are supported by sufficient documentation such as custody statements and custody reconciliations. The verifier must make every reasonable effort to obtain these documents directly from independent external parties (e.g., custodian, broker).”

The references to “independent external parties” trouble me, as it could possibly require the verifier to reach out to brokers and/or custodians to obtain documents, which in itself can be a challenge, and would likely add further complication and cost to the process. While I can understand why the EC would “float” such ideas, I would hope that they do not make it into the final document.

We’re aware of legal cases involving firms that had committed fraud and that had both claimed compliance with the Standards and had undergone verification. Questions arose whether or not it’s the job of the verifier to “detect fraud,” and while it’s fairly clear that it isn’t, some of us feel that there are cases when verifiers should be alert to possible problems. These changes would, in essence, put the onus on verifiers to do just that: detect fraud. Is this really the verifier’s role? I think not.

Our firm is on record as not supporting examinations as we don’t believe they add to the compliance process. We do conduct them for a few of our clients, but most recognize that they’re an expense that usually cannot be justified.

Please take the time to read the draft guidance and send your comments in (you have until August 31, 2011). You don’t have to read the entire document; by simply referring to the first few pages (that ask specific questions) you’ll understand the key items that the EC wishes to hear your comments on.