Messrs. Tschampion and Spaulding are esteemed and capable professionals, whose contributions to the industry are greatly appreciated. The first six points below address comments that are common to both their letters. The last two points are specific to Mr. Spaulding's letter.
1) The Spaulding survey says more than 90% claim compliance, so what does Surz mean by "the honor system is not working"?
On page 12 of the Nov. 28, 1994, issue of Pensions & Investments, David Spaulding wrote to the editor: "Some firms sincerely think they're in compliance but aren't. Some firms, I suspect, know that they are not in compliance but claim compliance anyway .*.*. In most cases, Level 1 verification is adequate because it addresses the compliance issues, while Level 2 is more of an audit of the actual numbers."
In his current letter on my commentary, Dave reaffirms "verifiers, on average, believe only 57% of the firms that claim compliance are actually in compliance." My feeling is 57% is optimistically high.
2) The majority of firms claiming compliance have been verified.
On page 15 of the Nov. 29, 1993, issue of P&I, I wrote to the editor "makeshift verifications have been sufficing to meet these sponsors' demands.... and actually serve to confuse the investing public as well as increase the likelihood the standards will fail .*.*. the real 'meat' is at Level 1." I believe one objective of AIMR's Verification Subcommittee is to remedy this problem, but it's much too early to tell if it has succeeded.
3) Industry participation on the Verification Subcommittee.
AICPA members of the subcommittee have publicly stated accountants will not be permitted to perform Level 1 verifications.
4) Mr. Tschampion writes: "Further, any composite specific verification must also include a Level 1 verification including procedures regarding the completeness of the composites, not just a representation from the firm on its composite construction."
Mr. Spaulding writes: "Modified Level 2 includes aspects of Level 1, and it's the verifier's responsibility to ensure these requirements are met."
Sample language suggested by the Verification Subcommittee for composite specific verification opinion letters reads as follows: "Firm XYZ has represented to Verifier X in writing: (i) that Firm XYZ complies with the AIMR Standards on a firmwide basis; and (ii) that a list of all firm composites is available and the required disclosures for each composite has been made. Verifier X is not responsible for the accuracy of the list of firm composites and has relied solely upon information provided by Firm XYZ for its claim of firmwide compliance with the AIMR Standards."
5) Sanctions for lying. A recent survey showed 600 out of 800 products reportedly in compliance. The survey also showed the nature of the composite used to report compliance. Approximately 200 of the 600 "compliant" composites were flagrantly not in compliance. I informed AIMR of this fact, and was told AIMR members would need to file official complaints against the offenders before any action could be taken.
6) The aspiration. I fully support the aspiration. That's why I wrote the commentary.
7) Accountants and modified Level 2 are what the industry wants, according to Mr. Spaulding. Dave's letter is so confusing on this point I'm not sure how to respond. On the one hand, he states "Whenever I can, I recommend firms undergo Level 1 (verification)," which accountants no longer can provide, after previously stating "there will be no verification without the accountants." All I can make of this is Mr. Spaulding recommends firms undergo Level 1 verification by accountants who refuse to do it. Also, why does he recommend Level 1 when the industry wants a modified Level 2? Perhaps it's the industry that's confused. Whose decisions are these anyway? They ought to be the investor's, but so far they are not.
8) Mr. Spaulding writes consultants are supporting the standards. I agree. It's terrific! I hope they take full advantage of the information as I outline in what follows. Although neither writer mentions it, no one has told prospective investors what they should do to benefit from the standards. In my opinion, the most important steps an investor and his consultants can take are as follows:
Require Level 1 verified compliance.
Request performance for all composites relevant to the search, including "garbage can" composites.
Be very critical if the composite submitted for the search is the best performing.
I sincerely hope these comments foster support for the standards, and that I am not viewed as a trouble maker.
Ronald J. Surz is president of Performance Presentation Consulting Alliance, Wheaton, Ill.