You are reading the 2026 curriculum (exams up to November 2026). Sitting in February 2027 or later? Go to the 2027 Ethical and Professional Standards guide.
Defining the firm and discretion, and independent verification
A firm should define itself as broadly as is meaningful, including all offices under the same brand. Portfolios whose documented client restrictions stop the firm from implementing its strategy are non-discretionary and stay out of composites. Verification is an optional, independent, firm-wide test of Global Investment Performance Standards (GIPS) policies and procedures.
Before this: GIPS key concepts and composites
On the exam
- Describe the fundamentals of compliance, including the recommendations of the GIPS standards with respect to the definition of the firm and the firm’s definition of discretion
- Describe the concept of independent verification
Describe the fundamentals of compliance (the firm and discretion) and describe independent verification. Expect 'is verification required?', 'who may verify?' and 'how should the firm be defined?'. The usual wrong answers make verification mandatory, let the compliance department do it, or say it certifies a composite.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What are the fundamentals of compliance?
Several core principles support the GIPS standards: define the firm properly, give GIPS Report s to all prospective clients (and certain pooled fund prospective investors), follow applicable laws and regulations, and never present false or misleading information. Two decisions come first when a firm becomes compliant: how it defines itself, and how it defines discretion.
Memorize
How should the firm be defined?
The definition of the firm is the foundation of firm-wide compliance. It draws the boundary from which total firm assets are measured. The standards recommend the broadest, most meaningful definition, covering all geographic offices operating under the same brand name, regardless of the legal name of each investment management company.
A narrow boundary invites abuse. A global manager that defined “the firm” as its London office only could leave out a weak Asian unit trading under the same brand. The recommendation closes that route.
Exam tip Brand decides the boundary, not the legal entity.
What counts as discretion?
Discretion rests on the firm’s ability to implement its strategy. If documented client-imposed restrictions interfere so much that the portfolio no longer represents the strategy, the firm may classify it as a non-discretionary portfolio . Non-discretionary portfolios must not be included in composites.
For example, a client bans all energy and financial stocks in a “global equity” account, so the portfolio can no longer hold the strategy’s main positions. The firm may classify it as non-discretionary and leave it out.
What does independent verification add?
Firms self-regulate their claim of compliance. They may then, voluntarily, hire an independent third party to perform verification . The verifier tests the firm on a firm-wide basis against the required verification procedures. The result is assurance on whether the firm’s policies and procedures for composite and pooled fund maintenance, and for calculating, presenting and distributing performance, have been designed in compliance with the GIPS standards and implemented across the firm.
Three limits are examined often:
- It is voluntary, not a precondition for claiming compliance.
- It must be independent. A firm cannot verify itself.
- It is firm-wide and does not ensure the accuracy of any specific performance report or composite.
The benefits are more credibility with existing and prospective clients, better internal processes and procedures, and a marketing advantage.
- Definition of the firm Memorize broadest, most meaningful
- All offices under the same brand any country or region
- Regardless of legal entity name brand decides, not the legal name
- Sets total firm assets the boundary for firm-wide compliance
-
- Discretion Memorize can the firm run the strategy?
- Discretionary goes in a composite if it fits
- Non-discretionary documented client restrictions; stays out
-
- Verification Memorize optional assurance on the claim
- Independent third party the firm cannot verify itself
- Firm-wide not a single composite or fund
- Policies and procedures designed and implemented correctly
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Where do the lines fall?
| Situation | Verdict |
|---|---|
| A global manager defines “the firm” as only its London office to exclude a weak Asian unit under the same brand | Inconsistent with the recommended broad definition |
| A client bans all energy and financial stocks in a “global equity” account, so it no longer reflects the strategy | Firm may classify it as non-discretionary and exclude it |
| A firm’s internal audit team “verifies” its GIPS compliance | Not verification, which must be independent |
| A verified firm advertises its Asia composite as “verified accurate” | Misleading: verification is firm-wide and does not certify a composite |
Try this 0 of 3
- Draw Kestrel Bay's boundary right first time
- Pass all four verification checks and the ad first time
- Get every case right first time
Case 1 of 4 Drawing the firm
Kestrel Bay Investments, a fictional manager, has offices in Toronto, Singapore and Sydney. Toronto is Kestrel Bay Investments Ltd; Singapore and Sydney belong to a second legal entity, Kestrel Bay Asia Pacific Pte. Ltd. All three offices market themselves under the Kestrel Bay name and run the same investment process. The same parent also owns Marrow Lane Advisers, a wealth manager sold under its own name with its own process. The Singapore office has had three weak years. Before claiming GIPS compliance, the Toronto team proposes defining the firm as the Toronto office only.
Step 1 of 7 Is this the recommended definition?
Is "Toronto only" the definition of the firm the GIPS standards recommend?
Read the case, then answer each step. 4 cases.
Go deeper Why a narrow firm definition can hide poor results
Composites and total firm assets both start from the firm boundary. If a manager may leave out an office, a product team or a region under the same brand, the weakest records can disappear before any composite is built, and the claim of compliance would cover only the flattering part. That is why the recommendation looks at the brand, not at legal structure.
Go deeper Verification versus a performance examination
Verification covers the firm’s policies and procedures as a whole. A performance examination is a separate, optional engagement that looks at one specific composite or pooled fund. Do not confuse them: the Level I curriculum describes only verification, and states that it does not ensure the accuracy of any specific report.
Memorize this
MemorizeFirm, discretion and verification
| Topic | What to know cold |
|---|---|
| Core principles | Define the firm properly; give GIPS Reports to all prospective clients; follow laws; no false or misleading information |
| Definition of the firm | Broadest, most meaningful definition: all offices under the same brand name, whatever the legal entity names |
| Why it matters | Foundation of firm-wide compliance and of total firm assets |
| Discretion | Based on the firm's ability to implement its strategy. Documented client restrictions that stop it make a portfolio non-discretionary |
| Non-discretionary | Must not be in any composite |
| Verification | Voluntary, by an independent third party, firm-wide |
| What it tests | Policies and procedures for composite and pooled fund maintenance and for calculating, presenting and distributing performance: designed in compliance and implemented |
| What it does not do | Does not ensure the accuracy of any specific report or composite |
Memory hook Draw the circle wide, drop the handcuffed accounts, then let an outsider test the whole system, not one report.
Know it cold Verification is optional, independent and firm-wide. It never certifies a single composite.
- Definition of the firm Memorize broadest, most meaningful
- All offices under the same brand any country or region
- Regardless of legal entity name brand decides, not the legal name
- Sets total firm assets the boundary for firm-wide compliance
-
- Discretion Memorize can the firm run the strategy?
- Discretionary goes in a composite if it fits
- Non-discretionary documented client restrictions; stays out
-
- Verification Memorize optional assurance on the claim
- Independent third party the firm cannot verify itself
- Firm-wide not a single composite or fund
- Policies and procedures designed and implemented correctly
-
How it is asked
-
Verification statement
Which statement about GIPS verification is most accurate?
Firm-wide, by an independent third party. Trap: "required first" or "certifies a composite".
-
Restricted account
A client restriction stops the manager following the small-cap strategy in that account.
Non-discretionary, excluded from composites. Trap: "include it anyway".
-
Defining the firm
The GIPS standards recommend the firm be defined as...
Broadest, most meaningful, all offices under the same brand. Trap: "smallest legal entity".
-
Who may verify?
The firm's compliance department reviews its own GIPS compliance.
Not verification. It must be an independent third party.
Exam traps
- Saying verification is required before a firm can claim compliance. It is voluntary.
- Letting the firm's own compliance department or internal audit verify. Verification must be independent.
- Believing verification confirms a specific composite's returns. It is firm-wide and does not ensure the accuracy of any report.
- Defining the firm narrowly (one office, one legal entity) to leave out weak units under the same brand.
- Including a non-discretionary account in a composite because it 'follows the strategy most of the time'.
Checkpoint
3 exam-style questions. About 90 seconds each.
1Which statement about GIPS verification is most accurate?
2A client imposes documented restrictions that prevent a manager from following its small-cap growth strategy in the client's account. Under GIPS, the firm most appropriately:
3The GIPS standards recommend that the firm be defined as:
Key takeaways
- Define the firm as broadly as is meaningful: all offices under the same brand, whatever the legal entity names.
- Documented client restrictions that stop the firm implementing its strategy make a portfolio non-discretionary, and it is excluded from composites.
- Verification is voluntary, independent and firm-wide. It tests policies and procedures, not the accuracy of a single report.
Questions about this lesson?
Where this comes back
- Ethics Application Ethical and Professional Standards
- Alternative Investment Performance and Returns Alternative Investments
Questions candidates ask
Is GIPS verification mandatory?
No. A firm that claims compliance may voluntarily hire an independent third party to verify it. Verification adds confidence in the claim, but a firm is not required to have it before claiming compliance.
How should a firm be defined under GIPS?
The standards recommend the broadest, most meaningful definition, covering all geographic offices operating under the same brand name, regardless of the legal names of the individual investment management companies.
What makes a portfolio non-discretionary?
Documented client-imposed restrictions that interfere with the intended strategy so much that the portfolio no longer represents it. The firm may then treat the portfolio as non-discretionary, and it must be kept out of composites.
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