Michael S. Caccese, Partner
Kirkpatrick & Lockhart Nicholson Graham LLP
75 State Street, Boston, MA 02109
(617) 261-3133
mcaccese@klng.com
www.klng.com
Overview
Definition
Rules and Guidelines
Performance Presentation
Portability
Article Reprints
Recordkeeping
SEC Examinations
Hedge Funds
Suggested Practices
2
Specific Guidance
Section206 (general antifraud provision of Advisers
Act)
Rule 206(4)-1 (SEC advertising rule)
No-Action Letters
Enforced through SEC inspections and enforcement
actions
Disclosure rules not calculation rules
3
Any written communication addressed to more than one
person that offers investment advisory services related to
securities
Includes communications designed to maintain existing
clients or solicit new clients
Includes electronic and broadcast advertisements
4
If the name of mutual fund included, then most likely is mutual
fund advertisement subject to mutual fund and NASD
advertisement requirement.
Oral communications
Customized RFP responses, letters or e-mails (not sent to more
than one person)
Account statements
May still violate Section 206 antifraud provision
5
Applicable to Registered and Unregistered Advisers
General Antifraud Rule
Unlawful to engage in any act, practice or course of
conduct which is fraudulent, deceptive or
manipulative.
6
Specific prohibitions applicable to Registered Advisers:
Testimonials
Third Party Reports
Partial Client Lists
Ratings
Past Recommendations
Charts/Formulas
Free Services
7
General Prohibitions:
Anti-Fraud Provision Depends On
Form
Content
Inferences
Client Sophistication
8
Guiding Principals:
Investment performance is false or misleading if:
it implies, or a reader would infer
something about the adviser s competence or about
future investment results
that would not be true had the advertisement included all
material facts
Comply with investment performance presentation
guidelines
Clover Capital series on No-Action Letters
9
Model & Actual Performance
Not disclosing the effect of material market or economic
conditions
Not presenting net-of-fees performance, except under certain
circumstances
Advisory fees
Other expenses that a client would have paid or actually paid
Failing to disclose whether and to what extent the results reflect
reinvestment of dividends and other earnings
10
Model & Actual Performance
Claiming the potential for profit without disclosing the
possibility for loss
Comparing results to an index without disclosing material
factors relevant to the comparison
Failing to disclose material conditions, objectives or
investment strategies used to obtain the performance
11
Model Performance
Failing to disclose:
The inherent limitations in model results
Material changes in the model versus actual performance
Differences between the model and adviser s actual
strategy
Adviser s client results were materially different from
model results
12
Actual Performance Results
Must include performance of all accounts managed to same
style or strategy unless disclose that the:
Results relate only to a select group of clients
Basis on which the selection was made, and
Effect of this practice on the results portrayed.
13
Exceptions to Net of Fees
Gross of fees performance
Performance presented NET of advisory and custodial
fees in one-on-one presentations
Must always be shown after transaction costs
14
One-on-One Presentations
Private Meeting
Ability to ask questions and negotiate advisory fees
Must disclose:
Advisory fees are described in the adviser s Form ADV
A representative example showing the effect advisory
fees, compounded over years, could have on the value of a
portfolio
15
Net Versus Gross of Fees Presentation
Model advisory fees
Side-by-side gross and net
Multi-manager accounts
Model-wrap fees
16
Article Reprints
Permitted, if comply with Advertisement Rules
Can t be false or misleading
Redact problematical statements
Use legends to
Correct inaccuracies
Update information
Fill in gaps (provide net performance if article
discusses only gross)
17
Recordkeeping
Client communications and distribution lists
Copies of all written communication
No record of who sent to if sent to more than 10 recipients
Advertisements and Recommendations
All advertisements sent to more than 10 recipients
Document basis of all recommendations
18
Recordkeeping
Records to support performance calculations
necessary to form the basis for or demonstrate the
calculation of the performance
Internal account statements and worksheets
Prepared contemporaneously
Third party records to substantiate claims
Retention periods
Necessary to support performance:
In articles
From prior firm
19
Recurring Problems:
Cherry picking composites
Comparing performance to inappropriate indices
Representing model or backtested performance as actual
Portability
Submission of misleading information to publications or
consultants
Inaccurate assets under management
False AIMR-PPS/GIPS claims
Presenting net-of-fees (especially on website)
20
Applicable to Hedge Funds and other Private Funds:
Unregistered advisers:
Holding out prohibition
Cannot advertise (even with client prescreening)
Registered advisers:
Can advertise but must pre-screen for qualification
Restriction on both offer and sale of Fund
21
Input Data
Calculation Methodology
Composite Construction
Disclosures
Presentation and Reporting
Detailed Policies and Procedures
Verification (recommended)
22
Under GIPS standards, a firm is defined as:
an autonomous investment firm, subsidiary, or division
held out to the public as a separate entity
23
Compliance can only be achieved on a
firm-wide basis, not product or composite.
Required disclosure to state how a firm
defines itself.
24
All discretionary portfolios included
in at least one composite.
Flexibility to define discretionary
and nondiscretionary.
Definition should be well
documented and applied consistently.
25
What is a composite?
Aggregation of portfolios that
represent an investment style,
strategy or objective.
All fee-paying discretionary
portfolios must be included in at
least one composite.
26
Conforming and Consistent Calculations
Inclusion of Cash Allocation
Weighting by Account Size (Asset Weighting)
Presentation of Annual Returns
Ten-Year Performance Record (GIPS 5 years)
Offer composite definition upon request
27
Lost accounts included
Portfolio manager s departure and prior
results
Simulated performance excluded
28
Valuations:
Based on market value (not cost or book)
Monthly
By January 1, 2010, revalue on date of any large
external cash flow
Use month-end valuations or disclose
Calculate composite returns by asset-weighting
individual portfolio returns at least quarterly
29
Number of portfolios
Total assets
Percentage of manager s total assets
Handling of balanced results
Gross of net of fees
Inclusion of fee schedule
Disclosure of leverage
Settlement date versus trade date accounting
30
Minimum Asset Level: must report changes, if any
Bundled fees
percentage of composite assets that are bundled fee
portfolios
various types of fees included in bundled fee
Gross-of-fee returns: fees deducted in addition to
direct trading expenses
Net-of-fee returns: fees deducted in addition to
advisory fee and direct trading expenses
31
Use of subadviser(s) and periods of use
Subadviser fees (recommended)
Composite description
Firm redefinitions: date and reason for change
Composite redefinitions: date and nature of change
32
Disclose if, prior to 1/1/2010, calendar month-end portfolio
valuations or valuations on last business day of month are not
use
Dispersion method
Policies for calculating and reporting returns available upon
request
All significant firm events (e.g., departures, mergers)
33
A ten year performance record (or since firm
inception, 5 years for GIPS)
Annual returns for all years
Appropriate benchmark
Measure of composite dispersion
# of portfolios and % of assets represented in
the composite
34
Firm Definition
Must define the firm as an investment firm, subsidiary or
division held out to existing to potential clients as a distinct
business entity
Policies and Procedures
Must document written policies and procedures to maintain
compliance with GIPS
Compliance Statement
[Firm Name] has prepared and presented this report in
compliance with the Global Investment Performance Standards
(GIPS®).
35
Compliant Presentations
Must make every reasonable effort to provide a compliant
presentation to all prospective clients if not received within
previous 12 months
Interpretations
Must comply with all interpretations published by the CFA
Institute on its website and in the GIPS Handbook
Composite Definitions
Must provide full composite definitions upon request
36
All advertisements that include a claim of compliance with the
GIPS Advertising Guidelines must include:
A description of the FIRM.
How an interested party can obtain a presentation that
complies with the requirements of GIPS standards and/or a
list and description of all firm composites.
The GIPS Advertising Guidelines compliance statement:
[Insert name of firm] claims compliance with the Global
Investment Performance Standards (GIPS®).
37
All advertisements that include a claim of compliance
and present performance results must also include (from
a presentation that adheres to the requirements of the
GIPS standards):
A description of the strategy of the composite being
advertised
Whether performance is shown gross and/or net of
investment management fees.
The currency used to express returns
38
Period-to-date composite performance results in addition to
either:
1-, 3-, and 5-year cumulative annualized composite
returns with the end-of period date clearly identified (or
annualized period since composite inception if inception
is greater than 1 and less than 5 years). Periods of less
than 1 year are not permitted to be annualized; or
5 years of annual composite returns with the end-ofperiod date clearly identified (or since composite
inception if inception is less than 5 years).
39
The benchmark total return for the same periods for
which the composite return is presented and a
description of that benchmark. If no benchmark is
presented, the advertisement must disclose why no
benchmark is presented.
The description of the use and extent of leverage
and derivatives, if used as an active part of the
investment strategy of the composite. Where they
do not have a material effect on returns, no
disclosure is required.
40
When presenting noncompliant performance information
for periods prior to 1 January 2000 in an advertisement,
firms must disclose the periods and which specific
information is not compliant as well as provide the
reasons the information is not in compliance with the
GIPS standards.
Firms are encouraged to present supplemental
information provided the supplemental information is
clearly labeled as such and shown with equal or lesser
prominence than the information required under the
guidelines.
41
An independent third-party has reviewed your performancemeasurement processes and procedures and opined that:
the investment firm has complied with all the composite
construction requirements of the Standards on a firmwide
basis; and
the firm s processes and procedures are designed to calculate
and present performance results in compliance with the
Standards.
Not currently required!
42
Restatement is common
Composite construction
Discretionary vs. Non-Discretionary assets
Timing of accounts in and out of the
composite
Portability
Changes to marketing materials
Disclosure omissions
Increased awareness of the Standards
43
Pros
Claim of compliance
Necessary to compete in institutional market
Demonstrates high ethical standard
Cons
If you claim, you must be
Increased regulatory scrutiny
It s a lot of work
44
Pros
Instant credibility
Someone looking over your shoulder
Someone to keep you informed of changes
Relaxed regulatory scrutiny
Cons
Cost
Staff time
45
Un-linked
Same persons responsible for performance at prior firm
responsible at new firm
Accounts managed the same
Accounts selected not cherry picked
Appropriate disclosure
Supporting records
46
Linked
All Unlinked Conditions Met
Solely Responsible for Performance at Both Firms
(same investment decision makers)
GIPS - Virtually All Clients Move to New Firm if Firm
Merger
GIPS - Disclosure Performance Is Linked
47
How to avoid false claims of compliance:
Educate marketing on appropriate presentation usage.
Understand the limitations of verification.
Take GIPS compliance seriously
Comply with all guidance statements.
The Devil is in the Guidance Statements
48
Verification Limitations:
Not a statement of presentation compliance.
Policies and procedures reasonably designed to
confirm compliance.
Calculations are accurate.
Firm must do own compliance.
49
Applicable to Hedge Funds and other Private Funds:
Internet Advertisement:
Pre-screening for qualification
Adviser ultimately responsible
Subscription fee no longer required
50
Hedge and Other Private Funds
Performance not typically presented in O.M.
Less Liability
Performance is audited
Credibility
Performance not GIPS compliant
Not a market necessity
51
GIPS and Hedge Funds
Cost, size, lack of market demand
Many Hedge Funds managed by:
Unregistered Advisers GIPS Compliant
claim potentially violates holding out
prohibition
Small Advisers
Limited staff
Cost and time prohibitive
Prime broker calculates performance
52
GIPS and Hedge Funds
Many AIMR-PPS compliant Advisers define the
AIMR Firm to exclude Private Fund/alternative
investments as separate division:
No market necessity
Difficulty in complying
Monthly valuation fair value no estimates
Performance fee calculation difficult
Little AIMR Guidance or help
53
GIPS and Hedge Funds
Separate Division
Holding out as separate division
Letterhead
Web Site posted
Separate Investment Team
Asset under management limitation
Prohibition of usage of GIPS compliant firm
performance
54
GIPS and Hedge Funds
Part of GIPS Defined Firm
Do not name fund in list of composites
Restrict composite performance availability to
qualified persons only
Caution in following GIPS internet performance rules
55
New Private Fund:
Creating marketing record
Market Record
Substantially similar managed funds
Disclose assumptions
Supporting record
One-three Years usage
No linkage
56
Existing Private Fund:
Due Diligence of performance calculation methodology of
underlying Funds
Need comfort in valuations
Require performance audit
Estimated performance concerns
Clearly disclose estimate and limitation
Promptly update
Wait for year-end audit because of 5% holdback
57
PAST PERFORMANCE IS NOT
INDICATIVE OF FUTURE RESULTS
58