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News August 22, 2005 Issue

CFA Institute Issues Final Wrap Guidance

If your firm manages wrap accounts and wants to continue claiming GIPS or AIMR-PPS (soon to be GIPS) compliance, get ready to roll out a new division: "[Your Firmís Name] Managed Accounts" (or whatever your firmís marketing people come up with).

That, at least, is one projected scenario resulting from the CFA Instituteís new wrap guidance, issued August 15. According to Chris Cosentino, director of communications for the Money Management Institute, advisers that do wrap business and want to remain GIPS-compliant will likely find that carving out their wrap business as a separate, non-GIPS- compliant division is the only way they can continue claiming GIPS compliance for their non-wrap accounts.

"Most managers are going to end up with wrap businesses that are not GIPS compliant," he predicted.

The CFA Instituteís final wrap guidance requires GIPS-compliant advisers that manage wrap accounts to include the wrap accounts in their firm composites. Hereís the sticky wicket: the GIPS recordkeeping standards require that advisers have access to data necessary to substantiate account-level performance for accounts in the firmís composite.

Of course, thatís not a problem when an adviser manages regular private accounts on its own platform. For those accounts, the adviser is fully aware of whatís going on in the account. However, when an adviser manages a wrap account, it does not have that same eagle eye look at the data because the account resides on the sponsorís platform. As a result, a wrap manager typically doesnít know when a wrap client adds or withdraws cash or when the wrap fee is deducted from the account (or, for that matter, how much the wrap fee is). Not to mention devilish details such as the original purchase dates of securities transferred into the wrap account from the clientís other accounts.

Under the new guidance, if a manager wants to keep its wrap business GIPS-compliant, it effectively has two options to address the recordkeeping issue: setting up a shadow accounting system or relying on the program sponsor to provide information, in either case no later than January 1, 2006.

Neither option is ideal.

Shadow accounting is viewed as costly and cumbersome. While it is being used by some advisers, they may find that their current systems do not capture the level of detail required by GIPS.

Relying on the sponsor for data also is viewed as impractical. Relying on sponsor information "is one of the biggest hurdles" to an adviserís making its wrap business GIPS compliant, explained Cosentino. "Thereís a limit on what the manager can do," he said. "You can ask for [the information] and you can check it against what you know of the customer, but thatís about it."

Nonetheless, the final wrap guidance attempted to provide more flexibility for managers to rely on sponsors for information by clarifying that a manager need not contractually obligate the sponsor to provide access to the underlying records (something that the CFA Instituteís November 2004 proposed wrap guidance seemed to indicate). The final guidance simply states that a GIPS-compliant manager "must take the necessary steps to satisfy that the information provided by the wrap fee/SMA sponsor can be relied on to meet the [GIPS requirements]."

Kirkpatrick & Lockhart partner Michael Caccese was pleased with that language, particularly in light of the CFA Instituteís position that a sponsor can report wrap account information to the manager on an aggregate level, as if all the wrap accounts on the sponsorís platform were a fund. As long as the adviser takes steps to ensure the sponsor-provided aggregate number is reliable, said Caccese, it can rely on it and claim GIPS compliance for its wrap accounts. For example, the manager can compare the performance of the sponsor-reported aggregate number to the managerís other accounts or a peer group, to check for consistency. Caccese indicated that he was optimistic about adviserís reliance on sponsor-provided aggregate information.

Alternatively, advisers can throw up their hands at the prospect of making their wrap accounts GIPS-compliant and redefine their "firm" to carve out their wrap business into a non-GIPS compliant division. Cosentino predicted that most advisers faced with the new guidance will opt to rebrand their wrap business so as to carve their wrap business out of their "firm." The final wrap guidance, echoing the GIPS standards, states that a firm can be defined on the basis of the way it is held out to the public. (Of note: the CFA Institute declined to allow firms to be defined on the basis of the products it offered, as the MMI had requested.)

The upshot: If a firm is willing to go through the rebranding exercise, it can then treat its wrap division as a non-GIPS-compliant firm. Concerns about shadow accounting and reliance on the wrap sponsor for recordkeeping fall away.

Alecia Licata, CFA Institute director of investment performance standards, warned that advisers that do a substantial amount of wrap business may want to think twice before rebranding their wrap divisions: by carving their wrap business out of their firm definition, the adviser will not be able to count the wrap assets towards the firmís total AUM for their GIPS composite.

Cosentino, however, didnít think that this was going to be a concern for most firms. "Even if wrap is 20 percent of their business, [the adviser] is still going to hit all the minimums" on the institutional side, he said.

Caccese also pointed out that the final wrap guidance applies prospectively, from January 1, 2006. For periods prior to January 1, 2006, firms that claim GIPS compliance can report performance that is substantiated by records that are not GIPS-compliant.