Falworth Asset Management is a USD 22 billion investment manager preparing to claim compliance with the GIPS standards for the first time. The firm operates two units. Falworth Institutional manages equity and fixed-income strategies for pension plans and foundations; it is marketed to clients and prospects under its own name as a distinct business entity, retains autonomy over its investment decision-making process, and maintains separate marketing materials and a separate client-facing website. Falworth Private Client, a retail wealth advisory unit, shares only centralized human resources and information technology functions with Falworth Institutional.
At a planning meeting, chief operating officer Renate Wolf states: 'We will define the firm, for GIPS purposes, as Falworth Institutional only.' The head of equities, Piotr Milos, adds: 'To reduce the initial workload, we should claim GIPS compliance for the equity composites only and extend the claim to the fixed-income composites in a later year.'
Separately, Falworth has agreed to acquire Marlowe Credit Partners, a high-yield credit boutique with a nine-year track record. Under the agreement, all four of Marlowe's portfolio managers, who together make all investment decisions for the strategy, will join Falworth Institutional and will continue to run the strategy using the same research process and the same proprietary credit models they used at Marlowe. Marlowe's complete performance books and records, including the account-level data supporting the nine-year track record, will transfer to Falworth at closing. Wolf wants to know whether Marlowe's historical performance may be linked to Falworth's history when the strategy is presented to prospective clients.
Announcing the acquisition to staff, chief executive officer Gordon Tsai says: 'Once we hire a verification firm, verification will certify that the returns of our high-yield composite are accurate, which will reassure prospective clients.'
Wolf asks Katrin Soler, the firm's performance officer, to prepare a memo evaluating Wolf's and Milos's statements against the fundamentals of GIPS compliance, determining whether the Marlowe track record may be used at Falworth, and correcting anything inaccurate in Tsai's description of verification.
For Wolf's statement, you correctly identified that defining the firm as Falworth Institutional is consistent with GIPS standards and provided strong justification by applying the 'distinct business entity' criterion to the vignette facts. For Milos's statement, you correctly concluded that it is not consistent with GIPS. However, your justification for this conclusion was flawed, as it implied that a phased approach to compliance could be acceptable if equity composites were complete, which contradicts the firm-wide nature of GIPS compliance. This contradiction cost points. Score: 2 / 4 points.
i. Wolf's statement is consistent with the fundamentals of GIPS compliance. For GIPS purposes, the firm must be defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity. Falworth Institutional meets this test: it is marketed to clients and prospects under its own name as a distinct business entity, retains autonomy over its investment decision-making process, and maintains separate marketing materials and a separate client-facing website, sharing only centralized human resources and information technology with the retail unit. Defining the GIPS firm as Falworth Institutional only is therefore acceptable, provided the definition captures the entire business entity as it is held out to the market.
ii. Milos's statement is not consistent with the fundamentals of GIPS compliance. Compliance with the GIPS standards is a firm-wide undertaking: a firm cannot claim compliance for selected composites, products, or asset classes while excluding others. To claim compliance, Falworth must meet all applicable requirements on a firm-wide basis, including bringing all actual, fee-paying, discretionary segregated accounts of the defined firm into at least one composite. Claiming compliance for the equity composites only, and extending the claim to the fixed-income composites in a later year, would make the claim of compliance false.
You correctly determined that Marlowe's track record may be linked to Falworth's history and provided two of the three necessary conditions for performance portability, correctly applying them to the vignette facts. You identified that substantially all decision-makers moved and that the decision-making process remained intact. However, you omitted the third condition, which requires the new firm to have records that document and support the reported performance. Score: 3 / 4 points.
Marlowe's nine-year track record may be linked to Falworth's historical performance, because the acquisition satisfies all of the conditions for portability.
First, substantially all of the investment decision-makers must be employed by the new firm: all four of Marlowe's portfolio managers, who together make all investment decisions for the strategy, will join Falworth Institutional. Second, the decision-making process must remain substantially intact and independent within the new firm: the managers will continue to run the strategy using the same research process and the same proprietary credit models they used at Marlowe. Third, the new firm must have records that document and support the reported performance: Marlowe's complete performance books and records, including the account-level data supporting the nine-year track record, will transfer to Falworth at closing. Because all three conditions are met on the facts, the Marlowe performance may be linked to Falworth's history when the strategy is presented to prospective clients.
You correctly stated that GIPS verification is performed on a firm-wide basis by an independent third party and cannot be obtained for a single composite. However, you incorrectly affirmed Tsai's statement that verification gives prospective clients assurance about the composite's returns; verification does not certify the accuracy of specific composite performance. You also did not explain what verification actually tests (firm-wide compliance with composite construction and policies/procedures design) nor did you identify the performance examination as the correct engagement for composite-specific assurance. Score: 1 / 4 points.
i. Verification applies to the entire firm, not to individual composites, and is performed by an independent third party. The verifier tests whether Falworth has complied with the composite construction requirements of the GIPS standards on a firm-wide basis and whether the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Tsai therefore cannot obtain verification of the high-yield composite alone: the engagement necessarily covers the whole defined firm.
ii. Verification does not certify the accuracy of any specific composite's performance. Tsai's statement that verification 'will certify that the returns of our high-yield composite are accurate' overstates the assurance provided: verification addresses firm-wide processes and the design of policies and procedures, not the accuracy of any particular composite's reported returns. If Falworth wants composite-specific assurance on the high-yield strategy, it would need to engage the verifier for a separate performance examination of that composite, which is distinct from, and in addition to, verification.
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