Explanation

Under the Global Investment Performance Standards (GIPS), a firm's definition of discretion establishes criteria to determine which portfolios must be included in a composite. This is a fundamental requirement for GIPS compliance.

Key Points:

1. Definition of Discretion: According to GIPS standards, firms must define discretion to establish criteria for determining which portfolios must be included in a composite.
2. Purpose: The definition of discretion helps ensure that composites are representative of the firm's investment strategy and that all discretionary portfolios are included.
3. Option Analysis:
   • Option A (Incorrect): Investment strategy implementation is determined by the firm's investment mandate, not by the definition of discretion.
   • Option B (Correct): The definition of discretion establishes criteria for determining which portfolios must be included in a composite.
   • Option C (Incorrect): GIPS standards prohibit excluding accounts from composites based on performance criteria (this would be considered "cherry-picking").

GIPS Requirements:

• Firms must include all actual, fee-paying, discretionary portfolios in at least one composite.
• The definition of discretion must be applied consistently over time.
• Non-discretionary portfolios may be excluded from composites.

This question tests understanding of GIPS requirements for composite construction and the role of discretion in determining composite inclusion.