By Brian C. Breidenbach
Public pension plans have been making incorrect claims on the performance presentation standards in their comprehensive annual financial reports. Consultants for at least the last seven years have guided plans into making such assertions. Plan trustees and their auditors have fumbled their fiduciary duties and have certified these claims.
These certifications are contrary to performance reporting requirements of the CFA Institute, which issues the global investment performance standards, and of its predecessor, the Association for Investment Management and Research, which issued performance presentation standards. Plan trustees, consultants and auditors who certify such claims in public pension fund annual reports are misleading participants and taxpayers and anyone else concerned with the plans.
As the CFA Institute points out in guidance it provides in the form of a Q&A on its website:
"Question: Many consultants, plan sponsors and software vendors claim compliance with the AIMR Performance Presentation Standards. Is this appropriate and are they able to make the claim?
"Answer: No. Plan sponsors and software vendors can not make the claim of compliance because they do not present performance results on actual assets under their management, unless the consultant, plan sponsor or software vendor actually manage the assets to which the compliance with the AIMR-PPS standards is directed."
The answer is a cut-and-dry no. The conclusion is simple for pension plans claming compliance with GIPS or AMIR-PPS — either their consultant:
clacks basic knowledge of investment performance standards despite holding itself out as an expert, or
cis deliberately misusing GIPS (AIMR-PPS) as a marketing tool to placate trustees about their performance results.
While some public plans could conceivably claim compliance for a portion that they manage internally, they cannot claim compliance for an entire pension plan that has more than one external manager.
Investment consultants and certified public accounting firms conducting plan audits would be wise to correct their misstatements given the increasing demands of fiduciary responsibility. Making a GIPS (AIMR-PPS) claim opens plan trustees up to increased fiduciary liability.
CPAs risk liability from Statement of Position 01-4, issued in 2001 by the American Institute of Certified Public Accountants. Under the rule, CPAs are required to review the entire content of the public plan annual report and verify any claims of GIPS (AIMR-PPS) compliance are accurate. Obviously, CPA firms have failed to do this and should be cited and or disciplined according to their peer review process.
The CFA Institute, while providing guidance on its website, does not have much enforcement power. It has limited power over CFA charterholders and CFA Institute members, but because a large number of consultants are not CFA Institute members, its reach is even more limited.
A survey of websites of large public plans found rampant misuse or incorrect reference of stating GIPS (AIMR-PPS) compliance, with most appearing to be guided by a consultant.
Even after the then AIMR sent a letter in 1998 to Ed Hatchett, then state auditor of Kentucky, regarding the Kentucky Retirement Systems, the plan has continued to claim reporting under the AIMR PPS standard. The system has made such a claim every year from 1998 through 2004 in its annual report.
The AIMR letter of July 2, 1998, to the state auditor stated, "Any use of the marks AIMR or AIMR-PPS except as specifically provided in the above legend is prohibited. If results are not in full compliance, statements referring to the calculation methodology used in a presentation as being ‘in accordance (or compliance) with AIMR-PPS standards' are prohibited by the standards."
Even so, the Kentucky systems annual financial report continues to state in similar wording each year, as it so did in 1998: "Performance figures were calculated using a time-weighted rate of return in accordance with AIMR's Performance Presentation Standards," a claim that is an incorrect usage of AIMR-PPS.
In 1998, Kentucky Retirement System officials gave the following response to the state auditor: "… (consultant name) asserts that PPS is applicable" asserting that their consultant knows more about AIMR standards than AIMR does.
The Ohio Public Employees Retirement System, like some other plans, may claim its statements are factually correct and, as it states in its annual report for the years 2002 and 2003, "results are presented in a manner consistent with the Performance Presentation Standards of the Association of Investment Management and Research." But this type of statement is prohibited by CFAI.
Statements like those of the Ohio PERS might be less egregious than that of the Kentucky system because they do not overtly claim compliance, but they are still wrong.
The California State Teachers' Retirement System in its 2004 annual report claims, "Investment performance is calculated using a time-weighted rate of return based on the market rate of return in accordance with Association of Investment Management and Research." Besides the more technical wording violation, its claim for total fund returns that mix individual manager returns is not allowed under the CFA guidelines.
The Tennessee Consolidated Retirement System's annual report for the year ended June 30, 2004, contains a letter from its consultant, dated Oct. 14, 2004, noting: "(Consultant) prepares the quarterly performance reports in full compliance with AIMR standards." This statement begs the question of which standards is the Tennessee system in compliance with, and shows a total lack of knowledge because the CFA Institute has both ethical and performance standards.
One consultant's website sells a return calculator to pension plans insinuating that the plans can then compute and claim compliance. The consultant claims the program allows plans to "quickly and easily compute quarterly or monthly AIMR-compliant time-weighted returns."
I found apparent violations at 103 of the 155 public funds' comprehensive annual financial reports I sampled. Because there are more than 155 large public plans, it is likely there are many more violating these standards, because many of them use the same consultants.
Few consulting firms were left unscathed in our sample. The shortlist includes many of the large investment consulting firms.
Public plans have a reasonable expectation that consultants should understand investment performance standards and the ethical disclosure requirements defined by the CFA Institute. While many consultants try to shirk any fiduciary liability from poor performance or excessive fees they should at least be responsible for compliant disclosures.
Additionally CPA firms conducting plan audits have been asleep at the wheel. Even though the accounting profession has addressed AIMR-PPS in SOP 01-4, it seems that auditors of public pension plans are not aware of this rule. Any professional holding himself or herself out to be a pension expert should know the standard before pronouncing compliance, and especially be aware that standards don't apply in the case of plans. Unlike consulting firms, CPA firms have a peer review process that has teeth. CPA firms should take corrective actions or face the disciplinary actions.
Even if the measure of performance is accurate, public funds and their consultants and auditors can't dress it up as compliant with performance presentation standards when it isn't and never can be.
Brian C. Breidenbach is managing principal of Breidenbach Capital Consulting LLC, Louisville, Ky.; the company website is www.4bcap.com