Fiduciary

Fid i Audit
A dit and
d
Benchmarking Options

Serving Employees of Illinois Community Colleges and Universities

What is a Fiduciary Audit ?

Q A fiduciary
duc a y audit
aud t has
as been
bee described
desc bed as:
– A systematic diagnostic study of a pension fund’s
organization, program and practices, by experts independent
of all the regular professionals.
– Main focus is usually the investment program, but can also
cover administrative functions, benefits administration and
Board operations.

Q Diff ffrom the

Differs h services
i provided
id d by
b the
h fund’s
f d’
regular investment consultant.
– Non-recurring
– Covers areas the Investment Consultant may not
– Process focus as much as substantive
 What is a Fiduciary Audit?

y Purpose is to Identify:
– Aspects of the fund’s operations or organization that pose
undue risk,
– Aspects that pose undue expense or inefficiency and,
– How its organization and procedures compare to industry “best
practices
practices”

What is a Fiduciary Audit?

y Fiduciary Audits are not a requirement of
any governing
i b body
d suchh as GFOA or
industry groups such as:
– Institute of Internal Auditors (IIA)
– National Council of Public Employee Retirement
Services (NCPERS)
– National Association of State Auditor Controllers &
Treasurer (NASACT)
– National Association of State Retirement
Administrators (NASRA)
– National Association of State Investment Officers
(NASIO)
 Why perform a Fiduciary
Audit?
• Most common reasons for fiduciaryy audits:
• Funds that are managed internally may want independent help
to identify issues that require upgrading and obtain a blueprint
for doing so
• Changes in status quo where new “players” want to know what
they’ve inherited or want a fresh look
• Change in upper management, e.g., Chief Investment Officer,
Executive Director
Director, etc
• Change in Board of Trustees
• May come from Board or outside oversight agency, e.g.,
legislative oversight committee or government auditor

Which Funds have Conducted Fiduciary

Audits?

y Some of these PERS funds are as follows (in alphabetic order):

– Alaska State Pension Investment Board (2003)
– District of Columbia Retirement Board (1994)
– Florida Sate Board of Administration (2000 - real estate program)
– Idaho Public Employees Retirement System (1995)
– Illinois State Teacher Retirement System (1998)
– Indiana State Teachers Retirement System (2001)
– Los Angeles County Employees Retirement Association (2008)
– Michigan Bureau of Investments (2001)
– Missouri State Employees Retirement System (2006)
– Nevada PERS (1995)
– Ohio PERS (2000-2001)
(2000 2001)
– Pennsylvania Public School ERS (2006)
– Pennsylvania State Employees Retirement System (2006)
– St. Louis Police Retirement System (2001)
– Texas Teacher Retirement System (1996 & 2001)
– Virginia Retirement System (1993)
– Washington State Investment Board (1997)
 Steps in a Fiduciary Audit

y Identify the scope of the audit and subjects to

review
y Collect information including Board meeting
minutes, investment policy and procedures,
strategic plans, external manager
performance, etc.
p
y Interview Board and staff
y Analyze the data and present
recommendations to the Board

Possible Subjects Evaluated

z Organizational Structures and Resources
-- Relationship of fund assets and operations to plan
sponsor
-- Nature and functions of Board and Committees
-- Staff duties
-- Consultant’s duties
-- Lines of authority

z Investment Policy
-- Suitability in terms of Board’s objectives and risk tolerance
-- Suitability in terms of financial and actuarial conditions
-- Clarity and completeness

z Asset Allocation
-- Methodology
-- Inputs/assumptions for risk/return analysis
-- Re-balancing process
 Possible Subjects Evaluated

z Investment Performance
-- Total portfolio performance
-- Performance
P f off iindividual
di id l components
t
-- Absolute performance
-- Risk-adjusted performance
-- Peer rankings

z Investment Performance Reporting

-- To Board
-- To all stakeholders
-- Adequacy of content and frequency

z Performance Benchmarks
-- Strategic level
-- Policy level

Possible Subjects Evaluated

z Due Diligence Procedures

-- Selecting external managers
-- Monitoring external and internal accounts, including
compliance with guidelines
-- Clarity and thoroughness, by asset class and strategy

z Cost and Fees

-- Reasonableness and consistency of asset management fees
-- Consultant fees
-- Accounts payable process
-- Transactions costs
 Possible Subjects Evaluated

z Legal Matters
-- Adequacy of legal resources, especially regarding
private/appraised assets
-- Conflicts of interest
-- Statutory fiduciary standards
-- Legal or statutory provisions that constraint performance
-- Policy and procedures for determining whether to join, or act
as legal plaintiff for, securities class action litigation
-- Ethics policies

Possible Subjects Evaluated

z Personnel Practices
-- Size of staff
-- Adequacy of compensation
-- Adequacy of training and personnel evaluation

z Investment Management Structure

-- Active vs. passive
-- Internal vs. external
-- Number of managers
-- Suitability in light of investment policy and asset
allocation

z Trust and Custody Arrangements

-- Costs and hidden fees
-- Cash management
-- Securities lending - risk, return, monitoring
 Possible Subjects Evaluated

z Investment Consultant’s Responsibilities

-- Fiduciaryy status
-- Scope of work
-- Conflicts of interest
-- Actual performance vs. contract

z Fiduciary Liability Insurance

-- Board and investment managers
-- Self-insurance vs. third-party coverage
-- C t/b fit
Cost/benefit

z Brokerage and Trading

-- Procedures for evaluating trade execution
-- Use of minority-owned firms
-- Directed brokerage/commission recapture/soft dollar
practices

Possible Subjects Evaluated

z Controversial Practices
-- Derivatives strategies
-- Appraised assets, e.g., real estate and private equity
-- Economically Targeted Investments (ETIs)

z Investment Accounting and Operations

-- Trade order entry management systems
-- Need for and functions of a “middle office”

Note: the actual extent of the audit will depend on the scope agreed
to between Internal Audit, Investments, Executive Management and
the Board.
 Who performs these audits?
y Accountingg Firms ((Bigg 4))
y Various Consulting Firms (in alphabetic order):
– Callan and Associates
– Cortex
– Ennis Knupp and Associates
– Fourth Street Financial
– Independent Fiduciary Services (IFS)
– Mercer Investment Consulting
– Segal Company
– Stratford Advisory Group
– Tillit Group

Benefits

y Independent
p assessment
y Validation for Board and staff
y Identification of Best Practice ideas
y Identification of developing trends and
technologies that could help improve
operations
i
y May find a potential problem before it
becomes a major problem
 Drawbacks

y Cost
y Time commitment
y Redundancy
y No knowledge transfer

Cost

y Dependent
D d t on the
th scope off th
the audit
dit
y Typical audit hours - 1,000 – 1,400
y Range - $400,000 to $800,000
y Average costs per informal survey -
$500 000
$500,000
 Staff Time Commitment
y The fiduciary audit can take 6 to 12 months to
co p ete
complete
y Staff must gather extensive amounts of data – 197
items required for recent LACERA audit
y Board usually participates in RFP and selection
process and must be available for interviews and
surveys
y Executive staff must be available for extensive
interviews and surveys
y Typical reports have more than 50
recommendations which can take years to
implement

Redundancy
y SURS is 100% externally managed. There
is a significant amount of oversight of the
investment managers:
– Investment Staff
– The Investment Consultant
– Significant Board oversight
– External and Internal Audits performed on
many investment areas
 No Knowledge Transfer

y Several PERS have stated they expected

to learn a lot from the fiduciary auditors,
but there is no knowledge transfer to
staff

List of IS and other Audits

y IS general controls – BKD 2007
y IS networkk penetration
i – IntelGuardians
I lG di 2006
y IS website vulnerability – IntelGuardians 2006
y IS security practices – Security Compliance Corp 2008
y IS website penetration – Cenzic 2008
y IS comprehensive CSG system – Geo Olive 1997
y IS general controls – Internal Audit every 2 years
y Check writing w/ claims – Internal Audit quarterly
y Check
h k writing
i i accounts payablebl – Internall Audit
di semi-annual
i l
y Disability claim process – LewisCo 2005
y Actuarial audit – Watson Wyatt 2000
 SURS List of Information Systems, check writing and other audits

Name of Audit Date/Cycle Audit firm Scope Cost Report issued? Time spent Comments

Info Systems Fall 2007 BKD  ‐ OAG General controls that apply to entire computer operation. Unknown Yes 1 month No material findings

General Controls Every 5 yrs Areas reviewed:  administration, computer operations, Listing of less significant issues
physical security, continuous service, security admin,
application system development, change control,
systems software, security software, telecommunications.

Info Systems Nov 2006 IntelGuardians Purpose ‐ test for standard weaknesses in network. $8,000 Yes 1 week Very few issues noted

Network Penetration Ad hoc Scanned for vulnerabilities using automated scans on all
Test external IP addresses used by SURS.  
Testing completed remotely.

Info Systems Nov 2006 IntelGuardians To inspect and test for vulnerabilities in member website. $12,000 Yes 3 weeks Several issues noted

Vulnerability testing Ad hoc The customized review was completed remotely using test  Recommendations implemented
member website ID's supplied by SURS.

Info Systems July 2008 Security  High level assessment of key roles & responsibilities per $24,000 Draft 2 weeks Currently reviewing draft report

Security practices Ad hoc Compliance  position, policies, education & awareness. Some recommendations 
Corporation expected

Info Systems Aug 2008 Cenzic Testing of new member website prior to implementation. $14,000 Draft 2 weeks A few high & medium severity

Penetration member Ad hoc Conduct tests of member website using intrusive and non findings being corrected
website intrusive methods.  Infrastructure (hardware & operating
system software) also tested to ensure no flaws in 
configuration.

Info Systems May 1997 Geo S. Olive Comprehensive testing of the new CSG system which  $50,000 Yes 4 months SURS implemented most of 

Comprehensive CSG Ad hoc includes member accounting, claims calculation and check recommendations
system audit writing functions.  Reviewed application controls (input,
processing & output) for each sub system.  Reviewed 
functionality to design specifications & conversion 
processing of all sub‐systems.  Also performed info systems 
general controls review.  Many of the test programs 
adopted by IA in routine IS general controls and claims
audits.

Info Systems June 2008 Internal Audit General controls that apply to entire computer operation. N/A Yes 2 months A few recommendations noted

General Controls Every 2 yrs Areas reviewed:  Segregation of duties, physical security,  in June 08 report
logical security access, application change controls, 
program promotion processing.
 SURS List of Information Systems, check writing and other audits

Name of Audit Date/Cycle Audit firm Scope Cost Report issued? Time spent Comments

Check writing system Quarterly Internal Audit Quarterly audits of SURS check writing "Pay Benefits" N/A Yes Varies Check writing findings if any 

w/ claims audits system conducted with audits of claims.  Audits examine included in reports
procedures and controls of check writing systems and 
payments of new benefits.  Looks at all aspects of system
including EFT payments, insurance withholding & all
deductions, 1099R and AAI processing.

Accounts Payable Semi ‐ Internal Audit Semi annual audit of administrative expenses paid using  N/A Yes 2 weeks Any findings included in travel &

Check writing process annual Timberline accounts payable system.  Once a year,  admin expense reports
additional analytical testing completed on entire 
population using ACL audit software.  Tests include search
for duplicate payments, phony invoices, phony vendors, 
missing checks, late and early payments.

Disability claim May 2005 LewisCo Group Operational audit of disability claims processing.   $24,000 Yes 4 weeks Staff has implemented some 

process Ad hoc Reviewed existing processes, staffing model, rehabilitation recommendations
protocols, clinical resources, performance standards, 
quality controls.  Also reviewed sample claims for 
effectiveness of claim risk management in several areas.

Actuarial audit Sept  2000 Watson Wyatt Comprehensive actuarial audit of current actuary.    $30,000 Yes 4 weeks No material findings

Most of audit was to check the accuracy & processing by
the current actuary.  Some of review steps address 
fiduciary risk concerns.  Audit also evaluated the data that
SURS submits to actuary.
 Benchmarking
COST Cost Effectiveness Measurement (CEM)

Who is CEM Benchmarking

Inc.?
• CEM stands for Cost Effectiveness Measurement, which
stands for the philosophy “measure what matters because
what gets measured, gets managed”.

• Company was founded in Toronto, Canada in 1992.

• CEM is an independent provider of objective and actionable

benchmarking information for pension investment and
administration operations – worldwide.
 Pension Investment
CEM’s pperformance database includes funds from around the
world:

y 141 US funds participate with aggregate assets of $2.4

trillion USD.
y 100 Canadian funds participate with aggregate assets of
$836 billion USD.
y 26 European funds participate with aggregate assets of 1.20
trillion USD.
y 12 Australian and New Zealand funds participate with
aggregate assets of $141 billion USD.

Pension Investment
A Comprehensive Investment benchmarking service:

A
Annual
l Total
T l Performance
P f Review.
R i
– multi year review of cost, value added, and risk.
– Analysis is presented to Trustees and Investment Committee.

Used as a cost Management Tool.

– Costs matter and can be managed.
– Reports can be used as a negotiation tool.

Value provided from research and insights into best

practices and trends.
– Learn what leading international funds are doing and what drives results
 Pension Investment
Cost comparisons are to Custom Peer Group
Primary criteria for peer groups is fund size, because size impacts costs

Sample Custom Peer Group for Example Fund

Peer group example for a Public Fund with 3.71 billion USDA mix of
Corporate and Public funds with a $3.69 billion average

Abbot Laboratories MERS of Michigan

Ameren Corporation Missouri Local Government ERS
City of Milwaukee ERS Motorola, Inc
NCR Corporation
Denver Public Schools RS
Nestle USA, Inc.
District of Columbia Board
North Dakota State Investment Board
Dominion Resources Pension Trust for Operating Engineers
Georgia-Pacific Corporation Sandia Corporation
Houston Police Officers Pension Siemens Corporation
Indiana State Teachers’ RS Ventura Country ERA

Pension Investment
CEM collects investment costs by major asset classes and 4 different
implementation styles as well as costs of investment oversight and
administration.

Only asset management and oversight costs are

included.

Direct investment costs are collected for all major asset

classes and 4 different implementation styles.

Oversight, Custodial & Other includes all costs

associated with the oversight and administration of the
investment operation.
 Pension Investment
Cost performance is assessed by calculating a benchmark cost, or by
estimating what cost would be, using asset mix and peer median costs.

Provide explanation of cost by analyzing the impact of implementation

Style choices and all line-item costs.

Quantify cost impact of Implementation Style decisions.

Examine costs relative to peers for all line item costs.

Analysis focuses on two key decisions: asset mix policy and

implementation.

Show how asset mix policy has impacted performance.

Examine where implementation value added comes from and how it

compares to other funds.

Pension Investment
Sample Report
 Pension Investment
Sample Report

Pension Investment
Summary of Services
A custom
t selected
l t d Peer
P Group
G bbased
d upon unique
i SURS
characteristics.

A customized report that compares SURS results to it’s peers and to

CEM’s U.S. Fund Universe.

Guarantee confidentiality of data and results

Personal on
on-site
site presentation of results

Performance insights from the CEM Research Program

COST $20,000
 Pension Administration
Over 60 Systems participate
United States Pennsylvania SRS Australia
Arizona SRS Pennsylvania Public Schools Australia Post
CalPERS O
Orange C
Countyt ERS CitiStreet/SunSuper
CalSTRS Oregon Public Employees ComSuper
City of Dallas ERS San Diego City ERS Pillar Administration
Colorado PERA San Diego County ERA QSuper
Delaware PERS South Carolina RS RBF – Tasmania
Idaho PERS South Dakota RS South Australia SA
Illinois Municipal State of Michigan Victoria - GSO
Indiana State Teachers’ Texas Municipal UniSuper
Iowa Public Employees’ Texas ERS Europe
Kansas Public Employees’ Texas Teachers ABP
Kern County ERA Utah SRS Blue Sky Group
Los Angeles County ERA Virginia
g Retirement System
y Bpf Metalektro
Louisiana Teachers’ Washington State DRS Cordares
Missouri State Employees Canada Horeca & Catering
Nevada PERS Alberta Pension Administration Interpolis
New Hampshire RS British Columbia Pension Corp. MN Services/ BPMT
New York City Teachers’ Canada Post PGGM
New York State and Local Defence Canada PNO Media
North Carolina RS Local Authorities of Alberta PPM - Sweden
Ohio Public Employees’ Ontario Teachers‘ Shell Pensioenfonds
Ohio State Teachers’ OpTrust
PWGS Canada
RCMP

Pension Administration

Why benchmark pension administration?

1. Strategic governance information.

2. Monitoring and improving service.
3. Insights into best practices.
4. Helps set priorities by demonstrating tradeoffs.
5. Networkingg with ppeers.
 Pension Administration
Strategic governance information

Addresses key performance issues.

– Are costs reasonable?
– Are service levels reasonable?
– What is being done different from other systems?
– What/where can there be improvements?

CEM benchmarking provides answers to these

questions using clearly defined, objective metrics.

Pension Administration

Monitoring and Improving Service

y Analysis is used to define service

standards.
y Performance is compared to the
performance of others.
 Pension Administration
Insights into best practices

• Annual
Ann al best practice review.
re ie
• Identifies examples of best practices that can be
copied, and poor practices to avoid.
• CEM evaluates
• Websites
– Pension Estimates
– Member Statements
– Satisfaction Surveys
– Disability Brochures
– Collections and Data Maintenance Process

Pension Administration
Helps set priorities by demonstrating tradeoffs
• Higher member service
ser ice means higher costs.
costs

• Achieving good service means investing in

people and systems to make it happen.

• Understanding tradeoffs leads to better decisions

and the ability to assess whether you are getting
good value for the cost.
 Pension Administration

y Systems attribute total costs to 13 core Benefit Administration

Activities.
y Total cost per member compared to peers.
y Demonstrates where budgets are spent.
y Analyze 5 factors that impact costs.
y Compare to peers on the 5 major cost drivers.
y Benchmark cost is predicted using transaction types and volumes.
y Quantify complexity challenges and assess how they compare to
peers.

Pension Administration
Sample Report
 Pension Administration
Sample Report

Pension Administration
Summary of Services
y Comprehensive Benchmarking Report.
y Assistance with data collection, to ensure data consistency and
comparability.
y A best practice review of a key element of communication
material or a business process.
y Full benefit of participation through a personal, on-site
presentation of results.
y Global Client Conference.
y Access to Peer Network which can save valuable research
time.
y All-inclusive cost $35,000.
 Staff Time Commitment

• Data collection begins January of each year.

• Benchmarking report available May.
• Best practice report available December.

• Executive staff must be available to complete extensive

surveys.

• Executive staff time commitment is estimated to be

approximately 20 hours per person.

• CEM site visit to review system results.

Benefits

y Independent assessment.

y Validation for Board and staff.

y Identification of Best Practice ideas.

y Identification of developing trends and

technologies that could help improve operations.

y Not as costly as a Fiduciary Audit.