AUDIT AND FINANCE
INTRODUCTION
California Penal Code Section 925 requires the Grand Jury to "investigate and report on the operations, accounts, and records of the officers, departments, or functions of the county including districts in the county for which the officers of the county are serving in their ex -officio capacity as officers of the districts." The investigations may be conducted on some selective basis each year. California Government Code Section 25250 mandates the Board of Supervisors to audit, or cause to be audited, the financial accounts and records of the county. The county and the Grand Jury meet these requirements by contracting the service of an independent auditor and monitoring that auditor's work.
OBJECTIVE
To meet the statutory requirements of Penal Code Section 925: investigate and report on the operations, accounts, and records of the county.
APPROACH
In our approach, the Grand Jury :
- _ Attended audit status meetings held by the outside auditor _ Reviewed audit status reports and the Comprehensive Annual Financial Report (CAFR) for fiscal year ended June 30, 1996 _ Reviewed the CAFR for selected districts _ Reviewed reports delivered by the outside auditor _ Studied the audit contract _ Interviewed the outside auditors, the county Auditor-Controller
- _ Reviewed financial reports from selected Special Districts
OBSERVATIONS
Outside Auditor Contract
The County of Santa Barbara and the 1995-1996 Grand Jury contracted with KPMG Peat Marwick LLP for the fiscal year 1995-1996 annual audit of its financial accounts and records.1 The contract refers to the requirement of Section 925 of the Penal Code that directs the Grand Jury to investigate and report on operations, records, and accounts. The contract scope of services identified 18 specifications for the contractor work and 10 reports to be issued.2 The Grand Jury inspected the KPMG reports and services.
The outside auditor's contract provided for a second renewal option for the fiscal year 1996-1997.3 Based on the performance for fiscal year 1995-1996, the Grand Jury agreed with the County Administrator and County Auditor-Controller to extend the contract for the fiscal year 1996-1997 work. This contract extension includes an audit of the Comprehensive Annual Financial Report for the county's Retirement System. The Grand Jury is a party to the contract extension, but no line existed on the extension for the Grand Jury's signature.
Management Letter and County Response
KPMB has audited the general purpose financial statements of the County of Santa Barbara for the year ended June 30, 1996. During their audit, KPMG noted certain matters involving the internal control structures and other operational matters that are presented in their management letter.4 The Grand Jury received this letter on December 3, 1996. This letter also contains the responses of the affected departments within the county
In the review of prior years' Management Letters, the Grand Jury found that the subjects of Federal Grants, Claims Management and Fixed Assets were reported in the 1993-94 and 1995-96 Management Letters. They were reported again in this year's letter.
After interviews with the Auditor-Controller, this Grand Jury came to the same conclusions as the 1995-96 Grand Jury: that these subjects appear repetitively because they are not given the priority needed for resolution.
The Auditor-Controller has concurred with the independent auditor's recommendation that the fixed asset register be updated on a regular basis during the year. However, there is no commitment on the part of the Auditor-Controller to implement the recommendation in a timely manner.5
As recommended in the Management Letter, the County Administrator has recently sent memoranda to each department head addressing the suggested improvements to internal controls. These improvements are regarding grant reimbursement, on-site visits by outside auditors, timely reporting of asset dispositions, and segregation of duties. The memoranda specify department actions to be implemented, and include a chart to be used by departments to report on implementation of the recommendations.
Auditing of Federal Grants
It has come to the attention of the Grand Jury that when an outside auditor visits any department administering federal grants, there is no one present from the county's Auditor-Controller Department. A standard practice in industry is to have a company auditor present anytime an employee is giving information to an outside auditor. This practice is a safeguard to both the employee being interviewed and the company.
Audit of Automation Systems
The Auditor-Controller and the Treasurer use computer programs for the processing of warrants, direct deposits of receipts and other electronic transfer of funds. The present audit conducted by the outside auditor (KPMG) does not run independently generated test software for testing these transactions. Test programs generated by an independent auditor experienced in this field should be used to verify these financial transactions. This would assure that presently used financial computer programs are performing the desired functions confined within the approved financial rules.
Santa Barbara County Pension Plans
The Santa Barbara County Employees' Retirement System (SBCERS) is a defined benefit pension plan operating under the California County Employees Retirement Act of 1937. As of June 30, 1996 SBCERS consisted of 6011 members. At present, Pension Plan information is included in the Comprehensive Annual Financial Report (CAFR) issued by the Auditor-Controller for fiscal year ended June 30, 1996. On December 31,1995 the date of the most recent actuarial valuation, net assets (at cost) available for benefits were $586.7 million and the unfunded pension benefit obligation was $50.1 million.6 The Governmental Accounting Standards Board (GASB) has issued Statement No.25 & No. 27 establishing financial reporting standards for Pension Plans. The provisions of Statement No.25 are effective for periods beginning after June 15, 1996. The provisions of Statement No. 27 are effective for periods beginning after June 15, 1997.
GASB Statement No.25 "establishes financial reporting standards for defined benefit pension plans and for the notes to the financial statements of defined contribution plans of state and local governmental entities."7
GASB Statement No. 27 "establishes standards for the measurement, recognition, and display of pension expenditures/expense and related liabilities, assets, note disclosures, and, if applicable, required supplementary information in the financial reports of state and local governmental employers."8
The Grand Jury has been informed that the County Treasurer will issue a separate CAFR for the Santa Barbara County Pensions Plans in 1997 using the guidelines stated in GASB Statements No. 25 and No. 27. The Retirement CAFR will be audited by the independent auditor for fiscal year ending June 30, 1997.
Funding County Infrastructure
The county has a Cost Allocation Plan "to identify the total program costs of delivering County services to the citizens" of the county.9 Direct costs are those that can be seen, such as road maintenance, sheriff services, or planning. Indirect costs are those which are not readily seen, such as accounting, purchasing, building maintenance, utilities. The county's cost allocation plan is in accordance with federal guidelines provided in Office of Management
and Budget Circular A-87. Direct "line" costs are those departments or programs that provide direct services to the public. Indirect "staff" costs provide services to the organization, including postage, telephones, utilities. These indirect costs "use allowance (similar to depreciation schedules) costs for capital assets."10
The cost allocation plan can be used in several ways:
_ to determine costs applicable to grant programs for recovery of county costs;
_ in administering and providing support services to special districts, enterprise funds and internal service programs;
_ in establishing service fees for cost recovery (all indirect costs associated with fee-for-service activity).
In the cost allocation plan, there is a category entitled "STRUCTURE USE." The cost of that use is based on the age of the building. Part of each grant allows cost recovery for the use and maintenance of county structures in administering the grant program. In our study of the county audit, the Grand Jury found that the cost recovery from grants for "structure use " is put into the general fund, and not set aside for building replacement.
Grant Revenues
According to KPMG, Santa Barbara County received $87,357,154 in federal grants during FY 95-96.11 The county expends county money on grant programs, then is reimbursed from grant money. Requests for reimbursement are prepared on a quarterly basis, but could be submitted more often. The county "is entitled to the grant revenue once the expenditure is made."12 The county earned interest income from grant money due to time lags (two days) "between receipt of grant revenue and expenditure of grant funds."13
The amount of interest earned in the two-day time lag is less than the interest cost by delays in reimbursement of county expenditures on grant programs. The memorandum issued by the County Administrator directs departments to request more frequent grant reimbursement.
Financial Highlights Report
The Grand Jury has reviewed the current Financial Highlights document, as well as a previous issue. These reports, which have received commendations, appear to be very informative for non-financial specialists. These reports "highlight the significant financial and economic activity of Santa Barbara County."14 The Grand Jury reviewed annual reports for several
publicly held corporations in the United States. These annual reports tend to include financial highlights as well as quantitative statements of performance.
Special District Financial Reports
The Grand Jury selected special districts based on geographic location and diversity of functions. We requested and received financial statements and management letters for fiscal year ending June 30, 1996 from the Goleta Sanitary District15 and the Lompoc Hospital District.16
1. Goleta Sanitary District: The Certified Public Accountant, Michael O. Lyon, who
performed the audit of the financial statements of the District stated in his report that the financial statements of the District as of June 30, 1996 and 1995 and the results of its operations and cash flows for the years then ended is in conformity with generally accepted accounting procedures.17 During his audit, the auditor noted that there were "several matters that are opportunities for strengthening internal controls and operating efficiencies." These comments and suggestions were reviewed by the Grand Jury. On the matter raised concerning Segregation of Duties, the Grand Jury requested information on the actions that the District was taking to accomplish increased segregation of duties. The Grand Jury reviewed the District's reply and found the District's corrective actions were acceptable.18
2. Lompoc Hospital District: The report from the independent accountants (Coopers &
Lybrand) on the financial statements of the District states: "In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lompoc Hospital District as of June 30, 1996 and 1995, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles."19
In their report to management,20 the independent accountants submitted recommendations designed to help the District make improvements and achieve operational efficiencies in the internal control structure and its operation. The Grand Jury requested and received from the District their responses to the Management Report. The Grand Jury reviewed these responses and found them to be acceptable.21
FINDINGS AND RECOMMENDATIONS
FINDING 1: The Grand Jury is a party to the contract to hire an independent auditor, but there is no provision for the Grand Jury to sign the extension of the contract with KPMG.
- RECOMMENDATION 1: Provide for the Grand Jury's participation and signature in any future contract for an independent auditor and subsequent extensions.
1997-1998 Grand Jury
FINDING 2: The Auditor-Controller has not given priority in the past three years to updating the fixed asset register on a regular basis during the year.
- RECOMMENDATION 2: The Auditor-Controller should set a firm date to establish and implement a plan to update the fixed asset register on a regular basis during the year.
AFFECTED AGENCY: Auditor-Controller Response
FINDING 3: Internal Audit Division is not represented when departments administering grants are being audited by outside auditors.
- RECOMMENDATION 3: The County Administrator should establish, adopt and implement a policy that whenever an outside auditor is auditing any program within the county, a county auditor is present during the audit process and interviews with county personnel.
AFFECTED AGENCY: County Administrator Response
FINDING 4: The independent outside auditor (KPMG) does not thoroughly test and verify financial processing software.
- RECOMMENDATION 4: The Auditor-Controller and the Grand Jury should assure that the next contract with an independent auditor includes testing and verification of computer processed financial transactions by an expert in that field.
AFFECTED AGENCY: Auditor-Controller Response
1997-98 Grand Jury
FINDING 5: The county experiences delays in reimbursement of county funds spent on grant programs. The County Administrator has issued a directive to department heads to request frequent reimbursement from federal grants.
- RECOMMENDATION 5: The County Administrator should review the frequency of grant reimbursement requests to assure that there is minimal delay in receiving the funds.
AFFECTED AGENCY: County Administrator Response
FINDING 6: The county is a public enterprise whose revenues are approximately half a billion dollars per year ($500,000,000). Publicly held corporations of this size publish an annual report containing financial highlights and quantitative product summaries.
- RECOMMENDATION 6: The Auditor-Controller should publish an annual report to Santa Barbara county residents. This document should expand Financial Highlights to include all departments, with quantitative statements of services provided and comparisons to previous years.
AFFECTED AGENCY: Auditor-Controller Response
AFFECTED AGENCIES California Penal Code Section 933(c) requires that comments to Grand Jury Findings and Recommendations be made in writing to the presiding judge of the superior court within 60 days by all affected agencies except governing bodies, which are allowed 90 days. In accordance with Section 933.05, the responding person or entity shall indicate the following:
1. The respondent agrees with the finding.
2. The respondent disagrees wholly or partially with the finding, in which case the respondent shall specify the portion this is disputed and include an explanation.
3. The recommendation has been implemented, with a summary of the implemented action.
4. The recommendation has not been implemented, but will be in the future, with a time frame.
5. The recommendation requires further analysis, with an explanation and a time frame. This time frame shall not exceed six months from the date of publication of the grand jury report.
6. The recommendation will not be implemented because it is not warranted or is not reasonable, with an explanation.
The Grand Jury requests that all responses be submitted on a 3 inch computer disk along with the printed response.
1 Agreement to Audit Certain County Financial Statements made among the County of Santa Barbara, California, the Grand Jury of the County of Santa Barbara for 1996-97 and the joint venture of KPMG Peat Marwick LPL and Nasif, Hicks, Harris & Co. 2 Ibid., pages 3-8 3 Extension of Contract (See Exhibit 1) 4 See Exhibit 2, pages 1-17 5 Ibid., page 9 6 CAFR Pension Trust fund, page 8 7 GASB Statement 25 - Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, Nov. 1994 8 GASB Statement 27- Accounting for Pensions by State and Local Government Employers, Nov. 1994 9 Cost Allocation Plan For use in the Fiscal Year 1996-1997, page i 10 Ibid. 11 Single Audit Reports, pages 2-5 12 See Exhibit 1, KPMG Management Letter, page 5-6 13 Single Audit Reports, page 18 14 Financial Highlights, Published by the County Auditor-Controller, Robert W. Geis, CPA,
page 1, July 31, 1996 15 Goleta Sanitary District, Financial Statements, June 30, 1996 16 Lompoc Hospital District, Financial Statements, June 30, 1996 & 1997 17 See Exhibit 3 18 See Exhibit 4 19 See Exhibit 5 20 Coopers & Lybrand, June 30, 1996 21 See Exhibit 6
http://www.sbcgj.org/2000/l_audit.htm
AUDIT AND FINANCE
INTRODUCTION
The Santa Barbara Civil Grand Jury (GJ) is mandated under California Penal Code Section 925 to "…investigate and report on the operations, accounts, and records of the officers, departments, or functions of the County…". It was decided some 35 years ago to retain an independent outside auditing firm to audit the County's financial statements. To avoid duplication of effort, the GJ joined with the Auditor Controller (AC) and the County Administrator (CA) to retain the same independent auditor. The Grand Jury Audit and Finance Report will consist of two sections:
Section I.
The independent audit of the County's general purpose financial statements, including comments and recommendations of the current auditors, KPMG Peat Marwick LLC.
Section II.
Santa Barbara County Employees' Retirement System.
SECTION I
OBJECTIVE/PROCEDURE
To fulfill the statutory requirements of California Penal Code 925, the Grand Jury reviewed all pertinent activities of the Auditor Controller, staff, consultants and primary interfaces such as the County Administrator and staff. It also reviewed KPMG's management letter dated July 31, 1999. BACKGROUND/OBSERVATIONS
In 1994 Peat Marwick (KPMG) was selected, on a competitive basis, as independent auditor to conduct the audit for 1994-1995. The County's fiscal year runs from July 1 to June 30 of the succeeding year. Although there have been arguments regarding periodic changes of auditing contractors, the excellent performance of KPMG has enabled them to obtain contract renewals up to the present time. The 1997-1998 Grand Jury perceived a conflict of interest and did not join the County in signing the three-year contract. Other Grand Juries will have the option to do so in the future. As part of each audit, the independent auditor in its management letter, makes findings and recommendations for improvement in the County operations. The management letter and the County's responses are a matter of public record. The following findings and recommendations were found in the latest management letter, accompanied by the County's responses.
Management Concerns
In its annual management letter, KPMG registered concern in six areas and made recommendations that would improve the County's internal control or result in other operating efficiencies. The areas of concern are:
- Disaster Recovery Plan
- Federal Grants
- Changes in the Government Reporting Model
- Fixed Assets
- General Litigation Designation
- Related Party Documentation
During the audit, KPMG found no formal countywide disaster recovery plan in place to ensure the physical protection of computer operating system programs, data files and documentation. The auditors recommended instituting and monitoring such a plan. The County, through General Services, coordinated with each department and all departments have complied, including instituting contingency plans for the year 2000. Furthermore, as part of its annual Information Technology assessments, the County will review and update, if necessary, all department disaster plans.
Federal Grants
There is no formal countywide grant application process or grant maintenance function, making it difficult to identify and track federally funded grants or identify new Federal or State grant opportunities. The County needs to appoint a "grants coordinator" who can service these needs and assist the County in identifying grants available that best support its service strategy. The County's Auditor-Controller currently has a project underway to assess the needs in this area and to undertake enhancement of its automated systems to collect grant information and monitor grant activity.
Changes in the Government Reporting Model
The Governemental Accounting Standards Board (GASB) issued a revolutionary new reporting model in June 1999, which dramatically changes the presentation of the governments' external financial statements. This will substantially affect the County's financial data accumulation and financial statement presentation processes. For instance, under the new standard, the County must report infrastructure assets acquired within the last twenty five years at historical cost. Implementation for the County will be completed in the year ending June 30, 2002.
In response, the County studied the impact of GASB Statement No. 34 on its systems and processes, and in January, 2000 the Auditor's office formed a GASB 34 Implementation Project Team under the direction of the Chief Deputy Controller, to study and develop strategies to implement the changes.
Fixed Assets
In past years, fixed assets relating to construction in process, land and buildings, were updated only once a year, and fixed assets relating to equipment were recorded once a month. In fiscal year 1999, the County began the process of reconciling detail fixed assets records. The auditors recommended that the County implement the new fixed asset policy and procedures as soon as possible, and provide training for individual departments. Furthermore, a countywide physical fixed assets inventory should be updated and performed at regular intervals with more frequent inventories for certain classes of fixed assets such as computer equipment. Detailed listings of all fixed assets should be provided to Department heads. Once an inventory has been conducted, it should be sent back to the Auditor Controller.
General Litigation
The auditors have recommended to the County that they develop a plan for calculating litigation costs on a quarterly or semi-annual basis. The County prepared a mid-year update for the Board of Supervisors in February, 2000. Furthermore, a system is under development to calculate the litigation liability on a quarterly basis.
Related Party Documentation
Certain County employees are required to file Form 700 Statements of Economic Interests annually as required by the Fair Political Practices Commission. During the audit it was noted that these forms were not always available. The County Clerk Recorder Assessor's office now includes a transmittal sheet that summarizes the individuals required in each department.
COMMENDATION
The Grand Jury wishes to commend the Auditor Controller, his staff and their able consultants, KPMG Peat Marwick, LLC, for their use and oversight of the standard budgeting process and controls that have performed well for the last three years. Section II
SANTA BARBARA COUNTY EMPLOYEES’ RETIREMENT SYSTEM
INTRODUCTION
The Grand Jury (GJ) conducted a comprehensive review of the policies and procedures that govern the management, administration, investment advisory, consulting advisory, fiduciary compliance, and due diligence oversight of the Santa Barbara County Employees’ Retirement System (SBCERS) investment portfolio. The purpose of this study is to ensure that the Santa Barbara County Board of Retirement is performing its fiduciary obligation to provide prudent investment oversight of the SBCERS investment portfolio on behalf of the current and future plan participants.BACKGROUND
The GJ conducted extensive research to verify all relevant legal obligations of the Board of Retirement are duly performed by the Board of Retirement as provided in Section 17 Article XVI of the California Constitution and in Sections 31580 et.seq. of the Government Code (Article 5 of the 1937 County Retirement Act). The focus of the investigation was to verify the sections of California law which stipulate that “the assets of a public pension or retirement system (SBCERS) are trust funds and shall be held for the exclusive purposes of providing benefits to participants … and their beneficiaries and defraying reasonable expenses of administering the system. ”[1] Furthermore, “The members of the retirement board of a public pension or retirement system shall discharge their duties with respect to the system with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.”[2] Similarly, the GJ sought to verify the Board of Retirement’s fiduciary obligation “to provide for actuarial services in order to assure the competency of the assets of the (SBCERS).”[3]PROCEDURE
In order to perform this investigation, the GJ compiled and reviewed all custodial and performance measurement reports, investment summaries, actuarial reports, Board of Retirement internal allocation summaries, as well as performance reports from similar public retirement systems.In addition, the Grand Jury conducted personal interviews:
- Pension Consulting Alliance (PCA):
- Santa Barbara County Board of Retirement
OBSERVATIONS
Management of the SBCERS investment portfolio is an extremely complex process. In order for the Board of Retirement to successfully perform its fiduciary obligations to the plan participants, they must rely on numerous consultants and advisors. In addition, they must coordinate and review extensive actuarial, investment, and analytical information which is often quite technical and requires specific skills to interpret, correlate, and evaluate. As of December 31, 1999, SBCERS assets were approximately $1.23 billion. The Grand Jury believes with this amount of assets, more emphasis needs to be placed upon understanding the risks inherent to institutional investing and making informed, qualified investment decisions. Although the Board of Retirement sends new board members to an introductory one-week investment educational class, the GJ thinks these classes are insufficient to prepare individuals - some with little financial expertise - for the responsibility of providing competent, qualified, or knowledgeable investment oversight for the SBCERS investment portfolio. The ability to comprehend sophisticated investment tools, strategies, and methods (i.e. portfolio modeling, risk assessment, asset allocation, correlation, efficient frontier analysis, etc.) are paramount to successful performance of the Board’s fiduciary obligation.The current custodian (State Street) also provides portfolio analytical services. Although this is not unusual, the GJ found the information difficult to understand in conjunction with another consultant (Pension Consulting Alliance) that provides the investment/economic review. It appears to the Grand Jury that combining the analytical services would enhance the investment oversight. If the portfolio analytical services were combined with the investment advisory services, the performance measurement reviews would be presented together with the investment/economic reviews. Furthermore, consolidating these two services would provide the Board of Retirement with a single, cohesive, and comprehensive portfolio review.
Government Code Section 31520.2[4] states that when a retirement fund exceeds $800 million, which this fund exceeded in 1997, the Board of Supervisors may create a separate Investment Board. Creating an Investment Board would provide the expertise the GJ feels is necessary with this growing asset. According to the code, the Board of Investments consists of nine members including four members appointed by the County Board of Supervisors. The four members appointed by the Supervisors shall not be connected with County government in any capacity and shall also have had “significant experience in institutional investing.”[5] The GJ concurs with the code regarding the importance of creating a board that includes members with "significant experience in institutional investing.”
It was brought to the GJ’s attention that the duties of the Board of Retirement appeared to be in conflict. The Board not only oversees retirement investments but it must also determine who shall receive disability benefits. Creation of a separate Board of Investments would remove any appearance of a conflict of interest between decisions regarding individual retirement/disability claims (Liabilities – Board of Retirement), and providing for current and future SBCERS plan participants (Assets – Board of Investments).
FINDINGS AND RECOMMENDATIONS
Finding 1: The portfolio analytics and investment advisory reports are currently provided by separate entities.Recommendation 1: Consolidate the portfolio analytics and investment advisory review so one consultant can produce a single, comprehensive investment review.
Finding 2a: The Retirement Fund has exceeded $800 million and the BOS has not created a separate Board of Investment.
Finding 2b: The BOR not only oversees retirement investments, but must also determine who shall receive disability benefits, giving the appearance of a conflict of interest.
Finding 2c: The current structure of the BOR does not guarantee that Board members possess the financial expertise necessary to adequately supervise the investment portfolio.
Recommendation 2: The 1999-2000 GJ recommends that the BOS invoke Government Code Section 31520.2 to establish a Board of Investment for Santa Barbara County Employees Retirement System.
Finding 3: Currently the BOR receives one week of investment training.
Recommendation 3: If the Board of Retirement continues to manage the retirement investments, more extensive orientation and ongoing investment training is essential.
AFFECTED AGENCIES
Santa Barbara County Board of Supervisors:Finding 2a, 2b, 2c
Recommendation 2
Santa Barbara County Board of Retirement:
Findings 1, 3
Recommendations 1, 3.
BIBLIOGRAPHY
State Street Analytics, Custodian and Performance Measurement AnalyticsComparison, State Street Universe Report
Measurement, Performance Evaluation
Analysis, Portfolio Analytics
End of Year Custodial Report, 1999
Pension Consulting Alliance, Pension Investment Advisor
Quarterly Performance Reports (2nd, 3rd, 4th Quarter 1999)
Santa Barbara County Recommended Benchmark Changes, September 1999
Consultant Agreement dated February 1, 1991
Consultant Biographies
Board of Retirement
Investment Goals, Policies, and Procedures, September 1999
Comprehensive Annual Financial Report as of June 30, 1998
Actuarial and Investment Workshop Book, September 1999
Santa Barbara County Retirement System Asset Allocation Review
Internal Report
Buck Consultants, Actuarial Consultants
Report on the Actuarial Valuation as of December 31, 1998
California Public Employees Retirement System
Investment Performance Analysis, June 30, 1999
APPENDIX
Article XVI, Section 17 of the California Constitution:“The State shall not in any manner loan its credit, nor shall it subscribe to, or be interested in the stock of any company, association, or corporation, except that the State and each political subdivision, district, municipality, and public agency thereof is hereby authorized to acquire and hold shares of the capital stock of any mutual water company or corporation when the stock is so acquired or held for the purpose of furnishing a supply of water for public, municipal or governmental purposes; and the holding of the stock shall entitle the holder thereof to all of the rights, powers and privileges, and shall subject the holder to the obligations and liabilities conferred or imposed by law upon other holders of stock in the mutual water company or corporation in which the stock is so.
“Notwithstanding any other provisions of law or this Constitution to the contrary, the retirement board of a public pension or retirement system shall have plenary authority and fiduciary responsibility for investment of moneys and administration of the system, subject to all of the following:
(a) The retirement board of a public pension or retirement system shall have the sole and exclusive fiduciary responsibility over the assets of the public pension or retirement system. The retirement board shall also have sole and exclusive responsibility to administer the system in a manner that will assure prompt delivery of benefits and related services to the participants and their beneficiaries. The assets of a public pension or retirement system are trust funds and shall be held for the exclusive purposes of providing benefits to participants in the pension or retirement system and their beneficiaries and defraying reasonable expenses of administering the system.
(b) The members of the retirement board of a public pension or retirement system shall discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system. A retirement board’s duty to it participants and their beneficiaries shall take precedence over any other duty.
(c) The members of the retirement board of a public pension or retirement system shall discharge their duties with respect to the system with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.
(d) The members of the retirement board of a public pension or retirement system shall diversify the investments of the system so as to minimize the risk of loss and to maximize the rate of return, unless under the circumstances it is clearly not prudent to do so.
(e) The retirement board of a public pension or retirement system, consistent with the exclusive fiduciary responsibilities vested in it, shall have the sole and exclusive power to provide for actuarial services in order to assure the competency of the assets of the public pension or retirement system.
(f) With regard to the retirement board of a public pension or retirement system which includes in its composition elected employee members, the number, terms, and method of selection or removal of members of the retirement board which were required by law or otherwise in effect on July 1, 1991, shall not be changed, amended, or modified by the Legislature unless the change, amendment, or modification enacted by the Legislature is ratified by a majority vote of the electors of the jurisdiction in which the participants of the system are or were, prior to retirement, employed.
(g) The Legislature may by statute continue to prohibit certain investments by a retirement board where it is in the public interest to do so, and provided that the prohibition satisfies the standards of fiduciary care and loyalty required of a retirement board pursuant to this section.
(h) As used in this section, the term “retirement board” shall mean the board of administration, board of trustees, board of directors, or other governing body or board of a public employees’ pension or retirement system; provided, however, that the term “retirement board” shall not be interpreted to mean or include a governing body or board created after July 1, 1991 which does not administer pension or retirement benefits, or the elected legislative body of a jurisdiction which employs participants in a public employees’ pension or retirement system.”
Government Code 31595:
“The board has exclusive control of the investment of the employees retirement fund. The assets of a public pension or retirement system are trust funds and shall be held for the exclusive purposes of providing benefits to participants in the pension or retirement system and their beneficiaries and defraying reasonable expenses of administering the system. Except as otherwise expressly restricted by the California Constitution and by law, the board may, in its discretion, invest, or delegate the authority to invest, the assets of the fund through the purchase, holding, or sale of any form or type of investment, financial instrument, or financial transaction when prudent in the informed opinion of the board. The board and its officers and employees shall discharge their duties with respect to the system:
(a) Solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system.
(b) With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.
(c) Shall diversify the investments of the system so as to minimize the risk of loss and to maximize the rate of return, unless under the circumstances it is clearly prudent not to do so.
Government Code 31520.2:
“In any county in which the assets of the retirement system exceed eight hundred million dollars ($800,000,000), the board of supervisors may, by resolution, establish a board of investments. The board shall consist of nine members, one of whom shall be the county treasurer. The second and third members shall be the general members of the association elected by the general membership of the association for a three-year term and, on the effective date of the amendment to this section during the 1970 Regular Session, shall also be members of the board of retirement. The fourth member shall be a safety member elected by the safety membership of the association for a three-year term and, on the effective date of the amendment to this section during the 1970 Regular Session, shall also be a member of the board of retirement. The eighth member shall be a retired member of the association elected by the retired membership of the association for a three-year term and, on the effective date of the amendment to this section during the 1976 Regular Session, shall also be a member of the board of retirement. The fifth, sixth, seventh, and ninth members shall be qualified electors of the county who are not connected with county government in any capacity, and shall be appointed by the board of supervisors. They shall also have had significant experience in institutional investing, either as investment officer of a bank, or trust company; or as investment officer of an insurance company, or in an active, or advisory, capacity as to investments of institutional or endowment funds. The first person chosen as a fifth, sixth, or seventh member, shall serve for three years, the second person chosen shall serve a four-year term, and the third person chosen shall serve a two-year term. The ninth member shall be appointed for the balance of term ending December 31, 1978. Thereafter, all terms of all appointed members shall be three years. The general members, the safety member, and the retired member shall serve on the board of investment until their current term as members of the board of retirement expires.
The board of investment shall be responsible for all investments of the retirement system.”
REFERENCE
AGENDA
SANTA BARBARA COUNTY BOARD OF RETIREMENT MEETING
WITH THE SANTA BARBARA COUNTY GRAND JURY
AUDIT AND FINANCE COMMITTEE
The purpose of this meeting is verify and report on the Board of Retirement’s compliance regarding investment oversight and the performance of fiduciary obligations to the County beneficiaries. Specifically, Article XVI Section 17 (c),(d), and (e) of the California Constitution, as well as Article 5 of the Government Code, Section 31595 (a), (b), and (c), define the fiduciary obligations of the Board of Retirement as follows: WITH THE SANTA BARBARA COUNTY GRAND JURY
AUDIT AND FINANCE COMMITTEE
“Article XVI Section 17:
(c) The members of the retirement board of a public pension or retirement system discharge their duties with respect to the system with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.
(d) The members of the retirement board of a public pension or retirement system shall diversify the investments of the system so as to minimize the risk of loss and to maximize the rate of return, unless under the circumstances it is clearly not prudent to do so.
(e) The retirement board of a public pension or retirement system, consistent with the exclusive fiduciary responsibilities vested in it, shall have the sole and exclusive power to provide for actuarial services in order to assure the competency of the assets of the public pension or retirement system.”
“Article 5 of the Government Code, Section 31595 (a), (b), and (c):
The board and its officers and employees shall discharge their duties with respect to the system:
(a) Solely in the interest of, and for the exclusive purposes of providing benefitsto, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system.
(b) With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these
matters would use in the conduct of an enterprise of a like character and with like aims.
(c) Shall diversify the investments of the system so as to minimize the risk of loss
And to maximize the rate of return, unless under the circumstances it is clearly prudent not to do so.”
The Audit and Finance Committee of the Santa Barbara Grand Jury would like the Board of Retirement to demonstrate, in detail, compliance with each of the preceding requirements. Please provide any relevant documentation and/or sources of documentation.
In addition, Government Code Section 31520.2 is the enabling Legislation for creating a Board of Investments which “shall be responsible for all investments of the retirement system.” The only prerequisite is that the retirement fund must exceed $800 million dollars. Does the Board of Retirement feel it would be prudent to create a separate Board of Investment at this time?
http://www.sbcgj.org/97-98/TCOUNTYRETIREMENTSYSYTEM1998.html
1997-1998 SANTA BARBARA COUNTY GRAND JURY
COUNTY RETIREMENT SYSTEM 1998
Released June 8, 1998
BACKGROUND
The 1996-97 Grand Jury initiated an investigation of the Board of Retirement (Board) after it received complaints from county employees regarding policies and practices of the Santa Barbara County Employees Retirement System, specifically with regard to procedures relating to applications for disability retirement. When the Grand Jury attempted to question members of the Board regarding these complaints, the Board sued the Grand Jury in Superior Court, challenging the Grand Jury's authority to investigate Board decisions. The issue was settled by the Appellate Court affirming the Superior Court decision in favor of the Grand Jury in October 1997. (Exhibit 1)
The 1997-98 Grand Jury then proceeded with its own investigation, including the review and analysis of materials gathered by the previous Grand Jury, the 1937 Retirement Act and the Santa Barbara County Retirement System bylaws. The Grand Jury also interviewed Retirement Office personnel and Board members, applicants for disability retirement, present and former employees, as well as retirees and their counsel.
The 1997-98 Jury focused its investigation on fund investment practices and the disability retirement application process. We examined the following:
- Fiduciary duties with regard to both Board investment responsibilities of the fund and the payment of retirement and disability benefits
- Length of time to process a disability claim
- Role of Retirement Office
- Effects of the new return to work policy on the retirement system
- Use of private law firms in the process
- Comparison of Santa Barbara County Employees Retirement System with others in the state.
- Constitutional rights of members to due process of law in processing disability applications
Fiduciary Responsibility
The County Employees Retirement Law of 1937 (’37 Act) states, "This trust fund is solely for the benefit of the members and retired members of the system and their survivors and beneficiaries." The bylaws of the Santa Barbara County Employee Retirement System were developed from the requirements and subsequent amendments set forth in the ’37 Act. Present law requires that the Board retain funds from the investment of county and employee contributions to the retirement fund sufficient to cover anticipated pay out to retirees entitled to a monthly check.
Board bylaws provide structure for local administration of the system and guidance to Board members in carrying out their responsibilities. Several Retirement Board members commented that the dual responsibility of protecting the retirement fund as well as granting valid disability retirement claims may give the appearance that the system is biased in favor of protecting the fund and that applicants do not face a "level playing field."
The ’37 Act places the burden of proof upon the applicant to show by a preponderance of evidence that he or she is permanently disabled and, where applicable, the disability was service connected.
Length of the disability retirement application process
Role of the Retirement Office
The Retirement Office is responsible for daily operations, informing employees how to proceed with general retirement applications, service and non-service connected disability retirement claims, and preparing recommendations for Board action. Retirement office investigators gather sufficient background and medical data so that the retirement office, in consultation with County Counsel, can make an informed recommendation to grant a disability retirement, or deny it. The investigator prepares a confidential summary memorandum explaining medical information for Board members to review before they consider the retirement office recommendation.
Comparisons between counties
FINDINGS
- The ’37 Act states that when the assets of the retirement system exceed $800 million, the Board of Supervisors may establish a Board of Investments which shall be responsible for all investments of the retirement system. Membership on the investment board shall consist of nine (9) members consisting of the county treasurer; two general employees of the system elected to the Retirement Board; a safety member who is also a member of the Retirement Board, as is the eighth member who shall be a retired member,. The fifth, sixth, seventh and ninth members shall be qualified electors of the county appointed by the Board of Supervisors, having significant experience in institutional investments. Such persons are apparently not required to be retirement Board members.
- The assets of the retirement system currently exceed $800 million. It is reported to be in excess of $1 billion.
- Board of Supervisors has not established a Board of Investments to be responsible for all investments of the retirement system.
- The April 8, 1998, edition of the Los Angeles Times reported that a first ever audit by an outside actuarial auditing firm found substantial calculation errors in the Los Angeles County Employees Retirement Association calculations resulting in $1.2 billion in unforeseen liabilities to the retirement fund.
- Treasurer/Tax Collector has responded to Grand Jury inquiry as to whether an audit of retirement Board actuarial calculation has ever been conducted by an outside actuarial auditing firm, stating that such an audit has been conducted twice in the past 15 years.
- Substantially all applicants who have prevailed in obtaining retirement benefits due to service-connected disability have found it necessary to retain legal counsel at their own expense to represent them in adversarial proceedings before the Board and/or hearing officers.
- Applicants’ legal counsel are normally compensated on a contingency basis, i.e., no payment unless member is successful in obtaining disability retirement benefits. The legal fees typically are based on a predetermined percentage of benefits received by the applicant.
- The Board pays legal fees incurred by an applicant only if the case has been successfully appealed to Superior Court, and if the court, in its discretion, orders the Board to pay legal fees. The Board does not pay legal fees if a member’s application for disability benefits is approved without a review and order by Superior Court.
- If the Board does not pay applicant’s legal fees, the applicant’s attorney can obtain a lien against the applicant’s retirement benefits to satisfy fees incurred in prosecuting the application.
- The Board exclusively selects hearing officers without input from applicants.
- The Board’s method of selecting hearing officers violates applicant’s constitutional guarantee of due process of law. (Exhibit 2)
- The United States Supreme Court has defined the scope of the right to due process of law in hearings which involve a vested right such as pension benefits. It includes the right to decision by a fair process, administered by a neutral and disinterested decision maker. (Exhibit 2)
- California civil service and public employment law repeatedly recognizes the right to a neutral and impartial hearing officer as a component of due process. (Exhibit 2)
- The Board exclusively selects a panel of hearing officers (attorneys) from members of the State Bar, none of whom have their office addresses in Santa Barbara County.
- There are many members of the State Bar residing in Santa Barbara County who are qualified to serve as hearing officers.
- Hearing officers/referees are compensated for their work and serve at will, subject to being removed from the panel, or simply by not receiving any further cases for hearings. Continued membership on the panel of approved referees depends upon the satisfaction of the Board, Retirement Administrator and their counsel. This results in a perception that the implication of a continuing personal financial interest by the hearing officer might be instrumental in that hearing officer confirming the Board’s rejection of member’s application for disability retirement benefits. (Exhibit 2)
- The Board selects medical examiners in substantially the same manner as it selects hearing officers. This exposes applicants to the same procedures that they are confronted with before the hearing officers, who are exclusively selected by the Board, and who may have a bias due to personal financial interest in being selected and compensated by the Board.
- On July 15, 1997, the Board entered into Attorney Service Agreements with at least two private Santa Barbara law firms, pursuant to a provision of Government Code Section 31529.9 which authorizes the Board to contract with attorneys in private practice for legal services.
- Santa Barbara County is one of only four counties in the state to which Section 31529.9 applies. Since entering into service agreements with the private law firms, the Board has refused to retain the services of County Counsel for any purposes relevant to disability applications. This leaves the choice of hearing officers and Board retained medical examiners to be exclusively the result of referral and selection by the Retirement Administrator and the Board’s contracted private law firm/counsel.
- Board has contracted with private law firms for legal services that are compensated at substantially higher hourly rates, paid by the system, than the rate at which the Board would incur fees by contracting with County Counsel.
- While authorized by law, the Board’s use of private law firms, rather than utilizing County Counsel, has resulted in substantially greater legal fees being incurred at the expense of the system.
- Legal services that are within the scope of duties, and in the past have been performed for the Board by County Counsel, have in all matters pertaining to disability applications been contracted instead to the private law firms.
- The bylaws state that hearing and Board decisions are the result of administrative procedures, not adversarial litigious confrontations. The published areas of practice of the private law firms retained by the Board include civil litigation, lender liability, employment litigation and insurance defense. They are litigation advocates for the Board, not unbiased, disinterested administrative counsel.
- The Board’s utilization of private law firms with a continuing personal financial interest in advocating decisions that favor the Board’s rejection of the member’s disability application can be perceived as a basis of bias in favor of the Board. This creates adverse pressure to the detriment of the applicant.
- The Board has not complied, for various reasons, with the time sequences imposed by the bylaws to be ready for a hearing within 150 days of the disability application being filed.
- Additional investigator/staff would improve the ability to meet the time schedule of hearing within 150 days of the application being filed.
- Procedures to be followed by members filing disability applications are explained for the first time by the Retirement Investigator, an employee of the Retirement Office, rather than by a written procedure manual distributed to members, as is the practice in other counties.
- Applicants’ dependence on procedure information explained to them verbally by a Retirement Investigator results in confusion, delays, and stress for applicants.
- The Retirement Office issues an administrative recommendation (memorandum) recommending rejection or acceptance of a member’s retirement application without input from County Counsel. This is contrary to by-law 502 (a) requiring consultation with County Counsel. According to Exhibit 2 (page 5), apparently, the Board has always adopted the Retirement Office’s advice.
- When the Board first denies a member’s application for disability retirement benefits (based on the memorandum from the Retirement Investigator and the recommendation of the Retirement Office), the application is referred to a hearing. The Board’s exclusively appointed hearing officer conducts the hearing and the Board’s privately retained litigators represent the Board, in opposition to the member’s application.
- The Board may appoint one of its members or any member of the State Bar to act as a hearing officer.
- No members of the Board are serving as hearing officers. The Board has exclusively used compensated California licensed attorneys to serve as hearing officers/referees.
- Data regarding service and non-service connected disabilities granted annually was not easily available for Santa Barbara County because the Retirement Office failed to send requested information to Sacramento for inclusion in the Annual Report of the Financial Transactions Concerning Public Retirement Systems of the Counties of California. The Retirement Office has pledged to begin sending appropriate information to Sacramento for inclusion in the Annual Report.
RECOMMENDATIONS
- A Board of Investments should be established to oversee invested funds. [Finding 1, 2 and 3]
- Periodic in-depth actuarial audit of the retirement fund should be performed by an outside auditor. [Findings 4 and 5]
- Disability retirement applicant’s attorney fees should be paid by the retirement system when a decision is made in the applicant's favor. [Findings 6, 7, 8 and 9]
- Use of mutually approved medical examiners and referees should be required during the hearing phase of the application process. [Findings 10, 11, 12, 13, 14, 15, 16, 17, 18, and 19]
- Board should hire private law firms only when County Counsel has a "conflict of interest." [Findings 20, 21, 22, 23 and 24]
- Retirement office should hire more investigators/staff to improve their ability to be ready for a hearing within 150 days of filing a disability application. [Findings 25 and 26]
- A pamphlet outlining the Retirement System and application procedures should be published and provided to employees regarding regular and disability retirement. [Findings 27, 28, 29 and 30]
- Members of the Board should serve as referees on one or two cases per year rather than using a non-Board referee. This would assure that Board members themselves more clearly understand what is required of everyone during the hearing process. [Finding 31 and 32]
- Retirement Office should file with the state data for Annual Reports regarding the number of disability retirements granted each year.
Santa Barbara County Employees Retirement System Board
[all Findings and all Recommendations]
Santa Barbara County Board of Supervisors
[Findings 1, 3, 4, 15, 19, 20, 22, 24, 31 and Recommendations 1, 2, 3, 4, 5, 7]
A – Findings [Section 933.05 (a)]
1) That you agree with the finding.
2) That you disagree wholly or partially with the finding, in which case the response shall specify the portion of the finding that is disputed and shall include an explanation of the reasons for the disagreement.
1) The recommendation has been implemented, with a summary of the implemented action.
2) The recommendation has not yet been implemented, but will be implemented in the future, with a timeframe for implementation
3) The recommendation requires further analysis. If a person or entity reports in this manner, the law requires a detailed explanation of the analysis or study and timeframe not to exceed six (6) months. In this event, the analysis or study must be submitted to the officer, director or governing body of the agency being investigated.
4) The recommendation will not be implemented because it is not warranted or is not reasonable, with an explanation therefor.
If a finding or recommendation of the Grand Jury addresses budgetary or personnel matters of a county department headed by an elected officer, both the department head and the Board of supervisors shall respond if requested by the Grand Jury, but the response of the Board of supervisors shall address only those budgetary or personnel matters over which it has some decision making authority. The response of the elected department head shall address all aspects of the findings or recommendations affecting his or her department.
1 - Public Agency. The governing body of any public agency must respond within ninety (90) days.
2 - Elective Officer or Agency Head. All elected officers or heads of agencies and departments are required to respond within sixty (60) days.
3 - In any city and county, the mayor shall also comment on the findings and recommendations.
The written response is to go to the Presiding Judge of the Superior Court. In addition the written response and a 3 1/2 inch computer disc with the response (preferably done in Word) is to be forwarded to the Grand Jury.
Attachments A, B and C
Exhibits 1 and 2
ATTACHMENTS AND EXHIBITS ARE IN THE PUBLISHED 1997-98 FINAL REPORT.
