Alameda County Employees’ Retirement Association
Internal Audit Department
CASH MANAGEMENT AUDIT
OCTOBER 2012
INTERNAL AUDIT DEPARTMENT
REPORT PREPARED FOR:
THE ACERA BOARD OF RETIREMENT
TABLE OF CONTENTS
TABLE OF CONTENTS ..................................................................................................................................... 1
RISK LEVEL .................................................................................................................................................. 3
CONTROL EFFECTIVENESS ........................................................................................................................... 3
EXECUTIVE SUMMARY ................................................................................................................................... 4
AUDIT OBJECTIVE ........................................................................................................................................... 5
SCOPE AND AUDIT STRATEGY .................................................................................................................... 5
AUDIT LIMITATIONS ...................................................................................................................................... 6
INSTITUTE OF INTERNAL AUDITORS (IIA) AUDIT GUIDANCE AND STANDARDS ..................... 6
A. POLICIES AND PROCEDURES ............................................................................................................... 7
TEST 1: EXISTENCE OF A DOCUMENTED CASH MANAGEMENT POLICY .......................................................8
TEST 2: EXISTENCE OF DOCUMENTED DEPARTMENT LEVEL PROCEDURES .................................................9
TEST 3: ADEQUATE PERSONNEL ARE IN PLACE TO MANAGE THE CASH MANAGEMENT PROCEDURES ...12
B. CASH IS MANAGED EFFICIENTLY AND FULLY INVESTED ........................................................ 13
CASH ACCOUNT ........................................................................................................................................ 13
TEST 1: CASH DOES NOT EXCEED 5% OF THE PORTFOLIO ON A MARKET VALUE BASIS............................13
TEST 2: INVESTMENT DEPARTMENT INVESTS CASH EFFICIENTLY TO EARN HIGH RATES OF RETURN. .....14
TEST 3: ACTUAL CASH ALLOCATION IS ALIGNED TO THE TARGET CASH ALLOCATION ...............................15
TEST 4: ACERA USES CASH/CASH EQUIVALENTS AS AN EFFECTIVE RISK MITIGATION STRATEGY ............17
REBALANCING .......................................................................................................................................... 17
TEST 1: REBALANCING OCCURS IN ACCORDANCE WITH THE RECOMMENDED FREQUENCY .....................17
TEST 2: ACERA REBALANCES TIMELY WHEN KEY TRIGGER EVENTS OCCUR. ..............................................19
TEST 3: +/-1.8 STANDARD DEVIATION ADJUSTMENT FACTOR IS APPROPRIATE FOR ALL ASSET CLASSES 21
REAL ESTATE, PEARLS AND OTHER ILLIQUID ASSETS ................................................................................. 23
TEST 1: CASH IS EFFICIENTLY USED TO FUND ILLIQUID INVESTMENTS (REAL ESTATE AND PEARLS) .........23
TEST 2: DOCUMENTED STRATEGIC PLAN FOR ACQUISITION/DISPOSITION OF ACERA’S REAL ESTATE .....23
TEST 3: CASH FLOWS INCLUDING NOI, DISTRIBUTIONS, AND RETURN OF CAPITAL ARE MONITORED.....24
TEST 4: LEVERAGE IS LIMITED TO STATED REAL ESTATE PORTFOLIO GUIDELINES .....................................27
TEST 5: ACERA’S REAL ESTATE DIVIDEND REINVESTMENT STRATEGY IS EFFECTIVE ..................................28
TEST 6: CASHFLOWS FROM ALTERNATIVE INVESTMENTS ARE MONITORED .............................................29
BEST PRACTICES........................................................................................................................................ 30
TEST 1: ACERA EMPLOYS BEST PRACTICES FOR ASSET ALLOCATIONS .......................................................30
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TEST 2: CONTINGENCY PLAN FOR HOW A HYBRID PLAN/PLAN CHANGE COULD AFFECT CASH................30
TEST 3: EMPLOYS STRATEGIC CASH FORECASTING BEST PRACTICES ..........................................................31
TEST 4: BEST PRACTICE LANGUAGE INCORPORATED IN ACERA’S INVESTMENT POLICY ...........................32
TEST 5: IMPLEMENTS BEST PRACTICE PROCESSES AND PRACTICES IN THE OPERATIONS ........................33
C.
ACERA PREPARES AN ANNUAL CASH FORECAST ....................................................................... 34
TEST 1: ACERA PREPARES AN ANNUAL CASH FORECAST...........................................................................34
TEST 2: ACERA INCORPORATES LONG-TERM CHANGES IN THE CASH FORECASTING PROCESS................39
D. COMMUNICATION BETWEEN ACERA DEPARTMENTS INVOLVED IN THE CASH
MANAGEMENT PROCESS IS EFFECTIVE ......................................................................................... 44
TEST 1: INTERDEPARTMENTAL COMMUNICATION IS EFFECTIVE ...............................................................44
TEST 2: COMMUNICATION WITH THIRD PARTY BANKS IS EFFECTIVE ........................................................46
E.
ACERA AVOIDS UNPLANNED DISTRIBUTIONS DUE TO INACCURATE OR INCOMPLETE
MONTHLY FORECASTS ........................................................................................................................ 47
TEST 1: THE MONTHLY FORECASTING PROCESS IS ACCURATE ..................................................................47
TEST 2: GENERAL LEDGER CASH ACCOUNT RECONCILES TO THE BANK STATEMENTS ...............................49
TEST 3: CASH RECEIPTS RECONCILES WITH THE CASH RECEIPTS LOG .........................................................50
TEST 4: CASH FORECAST WORKBOOKS ARE APPROVED .............................................................................50
TEST 5: INVESTMENT CASH ANALYSIS WORKSHEETS ARE ACCURATE ........................................................51
F.
CASH MANAGEMENT INTERNAL CONTROLS ARE EFFECTIVE AND WORKING AS
DESIGNED ................................................................................................................................................ 52
TEST 1: BENEFITS ENHANCED REPORTING TOOL PROVIDES ACCURATE AND TIMELY INFORMATION ......52
TEST 2: INTERNAL CONTROLS FOR THE MONTHLY PAYROLL PROCESS ARE EFFECTIVE .............................54
TEST 3: INTERNAL CONTROLS FOR THE WEEKLY PAYROLL PROCESS ARE EFFECTIVE .................................57
TEST 4: INTERNAL CONTROLS FOR THE INVESTMENT CASH FLOW PROCESS ARE EFFECTIVE ....................59
CONTROLS NOT EXAMINED DUE TO IMMATERIALITY OR CONSIDERATION IN A SEPARATE AUDIT .........61
G. CONCLUSION ........................................................................................................................................... 63
Controls Summary
Risk Level
Effectiveness
Medium
Partially Effective
2
Cash Management Policies and Procedures are
Documented
Ensuring Funds are Fully Invested
High
Partially Effective
3
ACERA Prepares An Annual Cash Forecast
Medium
Partially Effective
4
Communication Between Departments is
Effective
ACERA Avoids Unplanned Distributions
Medium
Partially Effective
High
Effective
ACERA Cash Management Internal Controls are
Effective and Working as Designed
High
Partially Effective
1
5
6
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RISK LEVEL
High Risk Controls:
Controls associated with critical processes within an organization. Typically, they are
associated with overall monitoring controls or valued in key or numerous processes. They can
be controls that had significant findings in previous years. A high-risk control failing could result
in a material weakness. Material weakness includes material misstatements in the financial
statements, significant process errors and misuse of ACERA resources.
Medium Risk Controls:
Controls associated with important processes within an organization, where a deficiency in the
control could cause financial loss or breakdown in process, but in most cases do not lead to a
critical systemic failure. Typically, these controls had minimal or no findings in previous years,
but are integral to the process and necessary to test on a regular basis. A medium risk control
failing could result in a significant deficiency, and in some instances, a material weakness.
Significant deficiencies can include staff competency, lack of consistent business process and
poor utilization of ACERA resources.
Low Risk Controls:
Controls associated with process optimization and non-critical processes. Typically, they
represent controls that did not have findings in the previous year's testing and have not
changed in how they operate or in the personnel performing the controls. Low risk controls are
inherent in the current control environment, but are unlikely to cause a material misstatement,
unless there is a failure of several low risk controls within the same process.
CONTROL EFFECTIVENESS
Effective:
The control is fully operating as designed.
Partially Effective:
The control is operating as designed with modification necessary due to a change in business
process, change in personnel, inadequate documentation, the control has not been fully
implemented, or the control requires additional enhancements to be effective. Often new
controls will fall in this category.
Improvement Opportunity:
The control is only marginally effective and should be redesigned or implemented. Typically,
these controls require review due to an ineffective design, which will prevent the control from
detecting control risk.
Ineffective:
The control is not operating as designed. This could lead to a significant risk to the
organization, if not remediated.
Remediated:
The control was previously ineffective, partially effective, or an improvement opportunity. A
remediation plan is in place to correct the deficiency. Note that reliance can be placed on the
remediated control, once retested by internal audit, which typically occurs in the following audit
cycle.
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EXECUTIVE SUMMARY
The Cash Management Audit is an operational audit. The purpose of the audit was to identify
internal control weaknesses in the cash management policies, procedures, practices, process
(Four P’s), and recommend strategies to improve cash flow. Further, cash management allows
the organization to differentiate between income recognition and cash receipts, as there can be
a significant difference between both components based on Generally Accepted Accounting
Principles (GAAP). This audit is a measurement and report of the effectiveness of the cash
management process. Since cash management is an organization-wide process, the impact of
having effective internal controls is crucial to meeting ACERA’s mission of providing ACERA
members and employers with flexible, cost-effective, participant-oriented benefits through
prudent investment management and superior member services. The organization must ensure
that it has adequate funds to meet daily operations, funding for investments and retiree payroll.
The Cash Management Audit focused on key operational activities including cash receipts,
cash disbursements, policies and procedures and forecasting. We also evaluated the
investment management process related to the cash investment strategy, capital calls,
acquisition and disposition planning, and rebalancing. Operational controls must also provide
reasonable assurance that assets are safeguarded against waste, loss, unauthorized use, or
misappropriation. While the need for internal controls may seem burdensome or restrictive,
their value should be obvious. However, the costs and benefits of proposed controls should be
carefully evaluated to ensure the costs do not normally exceed the benefits likely to be derived.
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AUDIT OBJECTIVE
The objective of this audit was to provide assurance to Senior Management and the Board of
Retirement, that the overall cash management process and departmental procedures are
adequately controlled, monitored, and in compliance with ACERA’s policies and industry best
practices.
The audit examined if the cash management process was working optimally to ensure invested
funds achieve high returns, yet maintained sufficient cash reserves to pay vested benefits,
provide for operational expenditures and enables outlays in long-term strategic initiatives. In
the process of defining the audit objective, we determined that we needed to establish a clear
mission statement as to what was most important to ACERA, especially when prioritizing
resources for remediation.
We concluded that the most important objective is ensuring that sufficient funds are available to
pay member benefits on a timely basis. Therefore, if observations were made where for
example, investment returns could be improved by minimizing cash on hand, but the risk of
non-payment of benefits significantly increased due to timing, we recommended the safer
option of no change.
SCOPE AND AUDIT STRATEGY
Efficient
department
practices and
processes in
place
Accurate
benefit
payments are
made timely
Investment
returns are
maximized
Documented
policies and
procedures
The scope of the Cash Management Audit primarily involved reviewing ACERA’s cash flow
process as it pertained to making benefit payments, managing ACERA’s operations and
optimizing cash flows. It also included a review of interdepartmental procedures, business
continuity planning for payment processing, managing liquidity, and communication between
the key stakeholders involved in the cash management process. Moreover, it included
evaluating how important strategic information was being transmitted to Senior Management
and the Chief Executive Officer to allow for timely decision-making. This audit also examined
the Fiscal Services and Investment Department’s cash forecasting process and the practices
and procedures in place to handle planned and unplanned liquidation of assets. The scope of
the period examined was from January 2011 to May 2012.
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AUDIT LIMITATIONS
Please note that the scope of this audit was limited to information at hand. The Internal Audit
Department did not perform the following:
Independently reconcile bank account information
Examine investment statements for accuracy
Perform a financial audit
Confirm the balance of general ledger accounts
For certain processes (i.e. monthly payroll, monthly forecast), we limited our
control assessment to only those controls that affected the cash management
process
We performed a limited review of the weekly payroll process, since it is similar to
the monthly payroll process.
Further, this audit did not include a validation of information provided by third parties, including
State Street, the investment managers, actuary or any investment consultant. Our audit relied
primarily on data provided by the ACERA Department and/or information obtained
independently through the audit.
Please also note that a review of the wire payment procedures and verification of proper
authorization will not be a part of the scope of this audit. The Wire Transfer Authorization Audit
was a separate audit performed in conjunction with the Cash Management Audit. The results
of that audit were reported separately.
INSTITUTE OF INTERNAL AUDITORS (IIA) AUDIT GUIDANCE AND STANDARDS
Internal auditing is conducted in diverse legal and cultural environments; within organizations
that vary in purpose, size, complexity, and structure; and by persons within or outside the
organization. While differences may affect the practice of internal auditing in each environment,
conformance with The IIA's International Standards for the Professional Practice of Internal
Auditing (Standards) is essential in meeting the responsibilities of internal auditors and the
internal audit activity.
If internal auditors or the internal audit activity is prohibited by law or regulation from
conformance with certain parts of the Standards, conformance with all other parts of the
Standards and appropriate disclosures are needed.
If the Standards are used in conjunction with standards issued by other authoritative bodies,
internal audit communications may also cite the use of other standards, as appropriate. In such
a case, if inconsistencies exist between the Standards and other standards, internal auditors
and the internal audit activity must conform to the Standards, and may conform with the other
standards if they are more restrictive. The Standards are principles-focused, mandatory
requirements consisting of:
(1) Statements of basic requirements for the professional practice of internal auditing and
for evaluating the effectiveness of performance, which are internationally applicable at
the organizational and individual levels.
(2) Interpretations, which clarify terms or concepts within the Statements. The Standards
employ terms that are specific. Specifically, the Standards use the word "must" to
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specify an unconditional requirement and the word "should" where conformance is
expected unless, when applying professional judgment, circumstances justify deviation.
(3) The structure of the Standards is divided between Attribute and Performance
Standards. Attribute Standards address the attributes of organizations and individuals
performing internal auditing. The Performance Standards describe the nature of internal
auditing and provide quality criteria against which the performance of these services
can be measured. The Attribute and Performance Standards are also provided to apply
to all internal audit services.
Assurance services involve the internal auditor's objective assessment of evidence to provide
an independent opinion or conclusions regarding an entity, operation, function, process,
system, or other subject matter. The nature and scope of the assurance engagement are
determined by the internal auditor. There are generally three parties involved in assurance
services:
(1) The person or group directly involved with the entity, operation, function, process,
system, or other subject matter - the process owner
(2) The person or group making the assessment - the internal auditor
(3) The person or group using the assessment - the user
Consulting services are advisory in nature, and are generally performed at the specific request
of an engagement client. The nature and scope of the consulting engagement are subject to
agreement with the engagement client. Finally, the Internal Audit Department personnel are
not trained or qualified to offer recommendations on legal, actuarial or investment matters.
Any questions on these issues should be directed to the appropriate ACERA Department
and/or qualified consultant. Hence, no part of the Internal Audit Report should be construed as
legal, actuarial, or investment advice.
A. POLICIES AND PROCEDURES
Risk Level - Medium
Audit Results - Partially Effective
CONTROL
RISK
OWNER
•The control will test if ACERA has established documented organizational
and departmental cash management policies and procedures.
•Cash management policies and procedures are not followed consistently,
leading to ineffective or inefficient management of cash.
•Fiscal Services/Legal/Investments
•Benefits/Administration/PRISM/Human Resources
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TEST 1: EXISTENCE OF A DOCUMENTED CASH MANAGEMENT POLICY
An organization-wide policy would be necessary to establish the priority for how cash is used,
the role of each department, agreement on the metrics of how cash efficiency is measured,
clear direction on the optimal amount of cash to have on hand at any point of time, and the
hierarchy of what expenditures need to be paid first. The objective of this test was to
determine if ACERA follows approved documented cash management policies and procedures.
This test was conducted to determine if ACERA has an overall cash management policy for the
organization and cash management procedures to support the policy. We surveyed the
departments to gather an understanding of what approved written policies and procedures
were in place for each department, and for the organization. The internal control survey
consisted of several detailed questions about completeness and sufficiency of the
organization’s cash management policies and procedures. We also tested for the existence of
a Cash Management Business Continuity Planning (BCP) policy and related procedures. In the
current process, the following departments played primary or secondary roles in the cash
management process:
Primary Departments involved in the Cash
Management Process
*Fiscal Services Department
Investments Department
*Note that the Accounting Department was
recently renamed as Fiscal Services
Secondary Departments involved in the
Cash Management Process
Project and Information Systems
Management Department (PRISM)
Administration Department
Benefits Department
Source: ACERA Internal Audit Department
As part of the audit, we surveyed other retirement systems to determine if others incorporate a
Cash Management Policy for their organization. If the respondent had a Cash Management
Policy, we also requested information on the critical areas they covered for both investments
and operations. The Internal Audit Department surveyed the Association of Public Pension
Fund Auditors (APPFA) and Marguerite Malloy of ACERA’s Legal Department, assisted us by
surveying the 1937 Act Retirement Systems. Although, the survey results showed only one
1937 Act Retirement System had a formal Cash Management Policy, nationally, 36% of a
sample of 11 respondents indicated that they had a formal Cash Management Policy.
Retirement System
Colorado Pension Employees Retirement Association
Contra Costa County Employees Retirement Association
Iowa Pension Employees Retirement Association
Maine Public Employees Retirement System
Missouri State Employees' Retirement System
San Diego County Employees Retirement Association
San Joaquin County Employees Retirement Association
South Carolina Retirement Systems
Tulare County Employees Retirement Association
Ventura County Employees Retirement Association
Wyoming Retirement System
Implemented a Cash Mgmt Policy
No
No
Yes
Yes
No
No
Yes
Yes
No
No
No
Source: Internal Audit APPFA Survey and Survey conducted by Marguerite Malloy of ACERA’s Legal Dept.
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Results:
No Cash Management Policy exists for ACERA. A policy would ensure proper protocols are in
place (i.e. authorization, segregation of duties, communication plan, logical and privileged
access) to manage daily cash flow. In addition, no approved documented procedures detailing
supervision over cash management in the event the organization exercised the BCP protocol
exists. Please also note that although ACERA does not have an approved BCP Policy in
place, we understand from the PRISM Manager that they are already looking into implementing
one.
Recommendation:
Recommendation
1. We recommend for ACERA to take a best practices
approach and develop a cash management policy. We
further recommend that the policy be implemented as an
operations policy, where ACERA Management would be
responsible for administration and monitoring the policy,
versus the Board of Retirement.
Business Owner
 All Departments
Based on Government Financial Officer Association (GFOA)
and IIA guidelines, cash management is deemed a critical
function for any organization.
2. We recommend that the Benefits Department and
Administration Department become primary departments
involved in the planning and monitoring activities related to
cash needs and uses.
 Administration
 Benefits
TEST 2: EXISTENCE OF DOCUMENTED DEPARTMENT LEVEL PROCEDURES
Absent an overall organizational Cash Management Policy, we surveyed the departments
involved with the cash management process to determine if established department level
policies, procedures, practices and processes existed, to confirm sufficient guidance was
available for ACERA to manage the cash management process successfully. We found the
ACERA’s General Investment Guidelines, Policies and Procedures (Investment Policy) did
contain language regarding the expected cash rate of return, cash as an eligible asset class,
overall investment strategy, a structured methodology on how cash should be utilized.
However, the investment policy did not cover the critical operational aspects of benefit
payments and administration of the fund, which typically is not the objective of an Investment
Policy.
We also tested if the individual departments formally documented their roles, a list of the
dedicated and back up personnel assigned to the task, and each staff’s responsibility in the
process. Further, we tested for completeness and sufficiency in the documented procedures
and examined if these procedures adequately described how departments communicate
across functional lines within a department, and if each department transacted effectively with
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other departments involved in the process. We also tested for the existence of BCP procedures
for each department’s cash management process.
As part the audit testing, we met with management and staff of the respective departments to
gather an understanding of their procedures. Subsequently, we performed walkthroughs to
observe how each department actually performed their cash management duties. We
specifically focused on inter-department and intra-department procedures to determine if
departments were working collaboratively, instead of in silos. Based on the walkthroughs, we
created detailed As-Is Process Flow Charts to confirm our understanding of the process, and
establish a baseline design including the associated internal controls.
Results:
We found most departments directly involved in the cash management process did have
documented procedures at the department level. Even though the procedures provided
guidance and directives for the management of cash at the department level, interdepartmental process documentation was generally absent.
Departments
involved in Cash
Management
Documented Cash
Management
Procedures Exist
Documented
Interdepartmental
Procedures Exist
Documented BCP Cash
Management
Procedures Exist
Administration
No
No
No
Fiscal Services
Yes
Yes
Partial
Investments
Yes
Partial
Partial
Benefits
Yes
Partial
Partial
Source: ACERA Internal Audit Cash Management Survey and Inquiry.
1. Administrative Department procedures were non-existent, indicating that long-range
forecasting was rarely, or not used to steer the organization. Please note that the new
CEO recognized the lack of documented process or procedures in the Administration
Department, and recommended the Cash Management Audit, as a strategic method to
build stronger documentation throughout the organization.
2. Fiscal Services had documented cash management procedures. The Fiscal Services
Department documented procedures primarily related to the monthly operational
forecast, including descriptions of the detailed roles and responsibilities, setup of the
cash forecast workbook, and sources and uses of cash. We also observed the
procedures described how Fiscal Services communicates and transact with other
departments involved in the cash management process. With major changes in the
department, many procedures were in draft mode, and efforts were being made to
update and complete the documentation. We did not find an overall BCP Policy existed
and BCP procedures were incomplete.
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10
3. The Investment Department had documented procedures for three primary processes,
which included daily rebalancing, rebalancing analysis procedures, and sources for
cash flow for the HI1A account. We observed that the procedures consisted of a list of
the steps to follow. The documented procedures did not include BCP procedures.
4. The Benefit Department’s cash management procedures were documented formally in
the approved ACERA template. The procedures were well detailed including
assignment of responsibility and backup responsibility. We did not observe formal BCP
procedures, although informal procedures exist, and tested regularly at the annual BCP
exercise.
Recommendations:
Recommendation
1. We recommend the use of the Operations Working Group
or the development of an ACERA Tiger Team1 to create
interdepartmental procedures that clearly define roles,
responsibilities and expectations between departments.
1
Tiger Team is a small interdepartmental tactical team tasked with
accomplishing a specific objective.
Business Owner
 Administration
 Human Resources
 Investments
 Benefits
 PRISM
 Fiscal Services
2. We recommend all organizational and departmental
procedures should be documented, reviewed for accuracy
and completeness, and updated on a regular basis.
 All Departments
3. Best practices dictate one process owner is primarily
responsible for ensuring the internal controls are operating
as designed. We recommend that the Fiscal
Officer/Assistant Accounting Manager hold this role and
have the responsibility of monitoring the organization’s cash
management process and coordinating with the different
departments involved with the process.
 Fiscal Services
4. We recommend that the organizational and departmental
policy and procedures should include BCP as part of the
documentation. We recommend that the PRISM
Department review new procedures and policies and work
with Management to incorporate the changes as a part of
ACERA’s annual BCP exercise and explore the
implementation of a BCP Policy.
 PRISM
 Legal
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11
TEST 3: ADEQUATE PERSONNEL ARE IN PLACE TO MANAGE THE CASH
MANAGEMENT PROCEDURES
As part of our testing, we inquired about the level of training and strength of staff involved with
managing cash management activities in key functions, to determine if adequate personnel are
in place.
Results:
Although the primary staff assigned to perform specific cash management tasks is competent
and skilled, we found that several key cash management positions lacked adequate backup in
the event of an unforeseen illness or termination of employment.
Recommendations:
Recommendation
1. We recommend that Benefit Accounting Unit staff have
adequately trained backup. The Benefit Accounting Unit is
responsible for critical functions within the cash management
process. Although, they have made a strong effort to
document the role and responsibilities, the process is
complex, involving several procedures and requires a greater
understanding of proprietary software (i.e. Pension Gold,
BERT). Currently, only few staff have been trained as
backup.
2. We recommend that Fiscal Services Staff involved with
preparing the cash forecast have adequately trained backup.
Retirement Accountant II/Retirement Accountant III are in
charge of performing several critical tasks (i.e. preparing the
cash forecast, transferring funds to meet payroll). We are
concerned that adequate trained backup is not available to
perform all necessary tasks.
Business Owner
 Fiscal Services
We have been informed by the
Asst. Accounting Manager that
the remediation to have
adequately trained backups is
already in the process of
remediation.
 Fiscal Services
We have been informed by the
Asst. Accounting Manager that
the remediation to have
adequately trained backups is
already in the process of
remediation.
3. We recommend that Assistant Accounting Managers involved
with preparing the cash forecast have adequately trained
backup. Accounting Assistant Managers competently
manage and coordinate several functions within the Fiscal
Services Department. With the recent departure of the CFO,
we do not feel there is adequate trained backup. The hiring of
a Fiscal Services Officer may remediate this finding.
 Fiscal Services
4. We recommend additional backup signors be trained and
authorized for large payments in the event the key signors are
unavailable. The authority of these backup signors can be
limited to events of last resort or special circumstances.
 Administration
 Fiscal Services
 Investment
5. We recommend that more of the daily tactical level functions
of the CIO be handed off to an Investment Officer or Senior
Investment Officer, to enable the CIO to continue to be the
visionary on strategic cash management issues.
 Investment
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12
B. CASH IS MANAGED EFFICIENTLY AND FULLY INVESTED
Risk Level - High
Audit Results - Partially Effective
•This control will test if ACERA meets their financial obligations and surplus
cash is invested in a timely manner to avoid cash being held in low interest or
CONTROL non-interest bearing accounts.
RISK
•ACERA fails to meet their financial obligation to fund vested benefits,
manage payment of operational costs, and provide for investment funding
due to their inability to manage cash effectively. Alternatively, ACERA
maintains surplus cash that is not being invested to maximize returns in
accordance with investment guidelines, policies and procedures.
•Fiscal Services/Investments
OWNER
CASH ACCOUNT
TEST 1: CASH DOES NOT EXCEED 5% OF THE PORTFOLIO ON A MARKET VALUE
BASIS
Investment Policy states that all Managers shall endeavor to be fully- invested in stocks at all
times unless they have received specific authorization to the contrary from the Board of
Retirement. Cash holdings, as defined in this Policy, shall generally not exceed 5% of the
portfolio on a market value basis.
Results:
Pass
Year
2007
2008
2009
2010
2011
Cash (In thousands)
$580
$2,525
$730
$4,053
$2,915
Portfolio Assets (In thousands) $5,556,359 $3,795,136 $4,669,185 $5,214,646 $5,064,136
Cash as % of Portfolio Assets
0.01%
0.07%
0.02%
0.08%
0.06%
Fully Invested
Yes
Yes
Yes
Yes
Yes
Source: ACERA CAFRS (2007-2011)
We tested if the ending balance for the cash asset class exceeded the market value of total
portfolio assets in the period 2007-2011, and found no instances where the cash balance
exceeded 5% of the portfolio balance. Please note our testing was limited to verifiable
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13
information from the CAFR. The test is limited in that it does not take into account if the cash
exceeded the portfolio at any time during the year. Therefore, we inquired of McCalla, and he
confirmed that in his experience, he is not aware of a situation where ACERA cash allocation
exceeded 5% of the total portfolio during any of the years he served as our rebalancing
consultant.
Recommendation:
None
TEST 2: INVESTMENT DEPARTMENT INVESTS CASH EFFICIENTLY TO EARN HIGH
RATES OF RETURN.
We met with the Investment Department and Patrick Thomas, Strategic Investment Solutions,
Inc. (SIS), to gather an understanding of how the cash asset class is used in the portfolio.
Thomas mentioned that cash is not a strategic asset and therefore minimized in the portfolio.
He mentioned that ACERA strives to have zero allocation towards cash/cash equivalents.
When cash is necessary, we learned that the primary investment accounts used to convert to
cash are the Baird and Mellon Investment Accounts, where Baird represents a U.S. Bond
Fund, and Mellon, an institutional S&P 500 Index Equity Fund. These accounts are used
because they are liquid, and have low liquidation transaction costs associated with
withdrawals. According to SIS, close to 90% of the portfolio is liquid, so the account(s) used to
fund alternative and/or real estate investments would ultimately depend on which asset classes
need to be rebalanced at the time, and may include accounts other than Baird and/or Mellon.
Results:
Pass
SIS commented that ACERA has one of the most liquid portfolios, so there is little risk of
liquidity risk in converting investments to cash. We confirmed through testing that the
Investment Department monitors cash on a daily basis. Unallocated cash is monitored and
managed through State Street Bank (ACERA’s custodial bank). State Street Bank notifies
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14
ACERA via email about the cash account balance twice daily. The Investment Department
prepares a rebalancing analysis and a cash analysis daily to monitor the cash account balance.
Recommendations:
Recommendation
1. We recommend the term “fully invested” be clearly defined in
the Investment Policy. Other departments that are involved with
the cash management process were unclear of the definition
(i.e. how much uninvested cash on hand is acceptable). SIS
recommended adding one sentence specifying, “cash is not a
strategic asset,” to offer clarification in the Investment Policy
language referring to what is meant by ACERA being “fully
invested.”
Business Owner
 Investment
2. Although we strive to maintain minimum balances in the
Cash/Checking Accounts, we recommend that ACERA
research if higher yielding short-term accounts are available,
other than the current Stagecoach Investment Sweep Account.
The Annual Fund Yield on the Stagecoach Investment Sweep
Account is .010%.
 Fiscal Services
3. We agree with the CEO’s recent recommendation to move
emergency cash from a secure offsite facility to our bank. The
cash was previously held in a secure location to help ACERA
function in the event of a natural disaster. Most of ACERA’s
payments are electronic in nature, so having access to physical
cash would not be very beneficial to the organization, and
caused an additional security concern.
 Administration
4. Similar to the Actuarial Audit performed by EFI on Segal, we
recommend that the Investment Department (possibly work with
SIS/Townsend) to select third party investment specialists to
review the more illiquid portfolios (PEARLS and Real Estate),
and provide a second opinion on whether we are appropriately
invested to meet ACERA’s investment objective.
 Investment
This was remediated
by CEO in August
2012. The issue is
resolved.
TEST 3: ACTUAL CASH ALLOCATION IS ALIGNED TO THE TARGET CASH ALLOCATION
We tested ACERA’s 2011 actual cash allocation to the targeted cash allocation, and
determined that ACERA was managing the cash allocation as recommended by the SIS. We
were unable to define an established benchmark for the range of acceptable error, so we
surveyed other funds to determine the how ACERA would compare to their peers.
Results:
It is evident from the testing that ACERA closely monitors cash to minimize it in the portfolio, as
recommended by SIS. The results also indicate that ACERA’s Investment Department
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15
manages cash well and ranks high in comparison to their peers among other 1937 Act
Retirement Systems.
Please see the test results as follows:
1937 Act
2011 Plan
Cash
Cash
Difference
Retirement
Assets
Allocation Allocation
System
Target
Actual
Alameda
$5,053,211,000
0.0%
0.1%
-0.1%
Contra Costa
$4,968,836,000
0.5%
0.6%
-0.1%
Fresno
$3,074,617,000
0.0%
1.1%
-1.1%
Imperial
$552,207,000
N/A
4.9%
N/A
Kern
$3,059,364,000
2.1%
3.0%
-0.9%
Los Angeles
$39,452,011,000
3.0%
3.0%
0.0%
Marin
$1,388,331,000
0.0%
0.1%
-0.1%
Mendocino
$354,754,000
0.0%
0.3%
-0.3%
Merced
$497,192,000
0.0%
1.2%
-1.2%
Orange
$9,404,819,000
0.0%
2.4%
-2.4%
Sacramento
$6,324,819,000
0.0%
5.5%
-5.5%
San Bernardino $6,373,633,000
2.0%
0.5%
1.5%
San Diego
$6,376,113,000
N/A
4.5%
N/A
San Joaquin
$1,851,211,665
0.0%
4.7%
-4.7%
San Mateo
$2,271,145,860
0.0%
0.2%
-0.2%
Santa Barbara
$2,151,960,567
2.0%
1.0%
1.0%
Sonoma
$1,826,833,000
1.0%
2.3%
-1.3%
Stanislaus
$1,419,000,000
0.0%
2.8%
-2.8%
Tulare
$991,840,473
0.0%
0.0%
0.0%
Ventura
$3,097,001,268
1.0%
0.3%
0.7%
Source: 1937 Act County CAFRS (2011)
Recommendations:
None
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16
TEST 4: ACERA USES CASH/CASH EQUIVALENTS AS AN EFFECTIVE RISK MITIGATION
STRATEGY
With certain retirement plans, cash is sometimes used to buffer against variability in cash flows
that are attributable to a particular risk associated with either a recognized asset or liability or a
highly probable transaction.
Results:
According to SIS, cash/cash equivalents are not used as part of the ACERA hedging strategy.
Unlike endowments and other similar entities, where the majority of assets can be illiquid,
ACERA is around 90% liquid and does not require a separate cash reserve.
Recommendation:
None
REBALANCING
TEST 1: REBALANCING OCCURS IN ACCORDANCE WITH THE RECOMMENDED
FREQUENCY
We inquired with Doug McCalla, ACERA’s rebalancing consultant, if ACERA is rebalancing at
an optimal frequency (daily, monthly, quarterly, etc) to maximize the portfolio return. McCalla
recommended that the frequency of rebalancing should be driven by the actual market
performances of the various asset categories in the portfolio rather than by arbitrarily selected
calendar based periods. He mentioned that Markets do not schedule their episodic swings in
performance to coincide with end of month or end of quarter periods. Rather, he mentions that
research has shown that defining the rebalancing control bands around each liquid allocation in
the portfolio in terms of standard deviation measurements of the volatility of each allocation is
the more cost efficient and value added approach to rebalancing.
McCalla stated, “that given the history of the covariance of the market performance of the
benchmarks used in the ACERA asset allocation strategy, the +/- 1.8 standard deviation
control band is expected to result in rebalancing on average once every twelve months, with
the shortest period between rebalances being 2 months and the longest period being 35
months. These differences in periods are entirely in response to investment market trends and
events that create the opportunity to “buy low” or “sell high” at the asset allocation level,
through more efficient rebalancing.”
We also surveyed other public retirement systems to determine the typical time interval used to
rebalance, method of rebalancing, and whether the process used by other retirement systems
was purely mechanical. We found the answers varied significantly between the retirement
systems indicating several different methodologies are acceptable in practice. We are
providing this data as information only for the Investment Department’s review, and not opining
on the suitability of any of the methods represented.
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17
Retirement
System
Period used
for
rebalancing
Rebalancing Method
ACERA
Event-Based Daily
Rebalancing
Performed.
+/- 1.80 standard deviation factors of each
allocations expected volatility, relative to other
allocations in the asset mix. This represents 92.8%
of all expected outcomes assuming a normal
distribution.
SDCERA
Event-Based
+/- 3-35% range from target allocation based on
asset class.
MOSERS
Monthly
Determined by beta adjusting the exposure of all
investments that are compared to an investable
policy benchmark. Investments compared to noninvestable benchmarks (T Bills + 4%, S&P 500 + 3%
and NCREIF Timberland) shall not be beta adjusted.
SWIB
Monthly
NYSTRS
Quarterly
Equities or fixed income is found to be outside of its
established target range by 4% of public market
assets as of the end of a month.
Investment policy specifies a target allocation for
each investment category, and +/- 5% for a range
Maine Public
Employees
Retirement
System
State of
Wyoming
Monthly
Annually
Uses +/- 5% range from the target allocation. Since
Infrastructure, Real Estate, Private Equity, and
Opportunistic Strategies are illiquid, rebalancing is
not practical or possible.
Utilize an overlay program that rebalances at a 3%
threshold.
Is rebalancing
method purely
mechanical or is
there staff and
consultant input
Primarily
mechanical, but
open to
Investment Staff
and consultant
input regarding
pending cash
flows.
Investment staff
and consultant
input.
Investment staff
and consultant
input.
Investment staff
and consultant
input.
Investment staff
and consultant
input.
Purely mechanical
Investment staff
and consultant
input.
Source: Internal Audit Department Survey of APPFA Internal Auditors
Results:
In our discussions with the Investment Department, we verified they follow McCalla’s
recommendation of event-based rebalancing versus performing it on a certain time interval (i.e.
monthly). The Investment Staff populates an MS Excel based tool provided by McCalla to
perform the rebalancing activity. ACERA investment staff will typically seek McCalla’s advice
on rebalances exceeding $1 Million.
Recommendations:
None
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18
TEST 2: ACERA REBALANCES TIMELY WHEN KEY TRIGGER EVENTS OCCUR.
The Investment Department educated us on the pros and cons of using a set frequency of
rebalancing vs. rebalancing that responds to market conditions. The Investment Department
confirmed that ACERA’s approach has been to respond to rebalancing signals based on
changes in market conditions. This has worked well to both minimize transaction costs and
maintains the target class percentages within specified tolerance bands. The Investment
Department described the types of triggering events (operational such as meeting payroll,
funding new accounts and market driven events such as a major market spike) that they have
encountered over time and their frequencies of occurrence and the variability of rebalancing
events; sometimes a few in a year; other times many in a year.
We also received input from McCalla, where he stated, “that short to intermediate term
extremes in market performance of asset classes are the key triggers that cause ACERA to
rebalance. Examples of market driven events that would cause ACERA to rebalance would be
either sustained steady growth or decline in an asset class (e.g. the small cap growth stock
“Tech Bubble” of 1999-2000), or an extremely rapid episodic increase or decrease in an asset
class (e.g. the U.S. equity market declines of October 1987 and 1997).”
We also inquired if the rebalancing process should be purely mechanical, to avoid staff bias
and attempts to time the market. McCalla responded, “yes, but subject to staffs input regarding
pending cash flows in the portfolio.” He mentioned, “that research has shown that attempts to
time the markets on an ad-hoc basis are ill advised and cannot be consistently or reliably
replicated. As such, institutional investors such as ACERA approach the investment of assets
with a long-term orientation that is governed by a well thought out asset allocation strategy.
The asset allocation strategy attempts to achieve the actuarial rate of expected return over
longer periods with the least amount of risk or volatility in overall portfolio value. Nevertheless,
there will be periods of time when individual asset categories in the portfolio significantly outperform or under-perform their long-term return expectations. When that occurs, research has
shown that having a systematic, repeatable, well thought out rebalancing decision rule to
control the extent of each allocation’s drift away from its desired size in the portfolio, provides
the opportunity to control overall portfolio risk and add long-term value by “buying low” and/or
“selling high”.”
We also requested McCalla’s advice on what types of staff and consultant input are necessary
in the rebalancing process. He stated, “the volatility based rebalancing process performs an
additional optimization on the historic covariance structure of the asset allocation strategy and
manager structure adopted by the ACERA Board. The asset allocation strategy is based on the
asset allocation analysis of ACERA’s primary investment consultant (SIS). Analysts use
various assumptions for the future expected returns and volatilities (expressed in standard
deviation measures of the various benchmarks used in the long-term investment strategic
analysis. The inputs used for the rebalancing analysis from SIS are the expected volatilities of
the various benchmarks used in the asset allocation analysis and the optimal asset weights
generated by the consultant, and reviewed and adopted by the Board. Additionally, SIS
provides historical monthly performance data for the various benchmarks used in the manager
structure of the asset allocation strategy. Input from staff consists of the timing and size of
pending cash flows associated with paying monthly benefits or funding changes in the asset
allocation strategy.”
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19
Results:
Our testing indicated an investment analyst monitors and updates the rebalancing
spreadsheets daily. In addition, the Investment Officers review and sign off the rebalancing
spreadsheets daily, and CIO also randomly checks the spreadsheets. The daily activity is
monitored to ensure events signaling a rebalancing adjustment, are monitored by the
Investment Department for five business days to confirm the signal is real and more permanent
in nature. When we inquired about the reasons for waiting five business days, the Investment
Staff mentioned it allows necessary time to confirm the rebalancing signal. If an adjustment is
necessary, the excess in an over allocated account is moved to an underweighted account.
We confirmed that rebalancing occurred within the specified timeframe and found this control
effective. We tested the rebalancing worksheet and confirmed rebalancing occurred within 5
business days, as specified by the Investment Department protocol.
Sample #
Sample Dates
1
September 12, 2012
2
September 13, 2012
3
September 14, 2012
4
September 15, 2012
5
September 16, 2012
6
March 26, 2012
7
March 27, 2012
8
March 28, 2012
9
March 29, 2012
10
March 30, 2012
Rebalanced within 5 Business
Days Rule
Pass
Pass
Recommendation:
Recommendation
1. The “five business day” rule is not documented in the
rebalancing procedures or Investment Policy. We recommend
that the Investment Department document the reasons for why
rebalancing typically occurs five days after receiving a
rebalancing signal. We further understand that the rule can
vary depending on circumstances in the market. We
recommend documenting what circumstances would cause the
Investment Department to adjust the timeline before or after
five business days.
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20
Business Owner
 Investment
TEST 3: +/-1.8 STANDARD DEVIATION ADJUSTMENT FACTOR IS APPROPRIATE FOR
ALL ASSET CLASSES
Presently, the Investment Department and its consultants examine each asset class for
volatility by calculating the standard deviation for each asset class. This standard deviation is
then multiplied by an adjustment factor to come up with a threshold band for each asset
class. There is risk from a cash flow perspective, which involves both performance of the fund
and increased transaction costs. Increased transaction costs would unnecessarily be incurred
if we rebalance too often on a volatile asset class that we expect to exceed the threshold band,
but it comes back within the acceptable range quickly.
In the future, as we increase our allocation into the PEARLS portfolio, which is presently at
about 6% of total assets, we can expect the amount of total liquid assets subject to rebalancing
will decrease slightly. The new asset allocation study approved at the September 20, 2012,
board meeting, has increased the total commitment to the PEARLS portion of the portfolio from
10% to 15%. This increased allocation will lower the percentage amount of investable assets
subject to rebalancing, and the drawdown of commitments into the PEARLS investments may
have a long-term effect on the adjustment factor.
The Schedule IA in the Investment Policy (Revised 2008) states “for the purpose of enhancing
the risk-adjusted return of the asset allocation structure, the relative deviation of any liquid subasset class away from the target weight (or liquidity-adjusted target weight), shall be no more
than plus or minus 1.8 standard deviation factors of each allocation’s expected volatility.” The
Investment Department explained that the idea of using the same adjustment factor across all
classes treats every class equally in the sense that each will have an equal probability to
breech the tolerance bands despite their different volatilities. The Investment Department
added that McCalla had recommended that +/- 1.8 standard deviation adjustment factors was
most efficient.
We confirmed with McCalla that the rebalancing rules are evaluated based on standard
deviation measures of benchmark volatility, on percentages of total portfolio size and on
calendar interval time periods. These rebalancing decision rules are compared and evaluated
with respect to how much return per unit of risk the ACERA portfolio would have produced, net
of transaction costs. These rules are also evaluated with respect to how frequently or
infrequently the rebalancing decision rule would have been triggered given the covariance
history of the markets. McCalla stated, “that the last analysis indicated that the +/- 1.8 standard
deviation (s.d.) band rule could be expected to provide better risk adjusted portfolio
performance than other decision metrics. The +/-1.8 Standard Deviation factor is then applied
to the expected volatility of each of the publically traded allocations in the portfolio to derive an
allowed tracking band around the policy target size of each benchmark’s allocation.”
Using automated spreadsheet monitoring tools, staff can review on a daily basis the market
values of the publically traded allocations via prior day market closing valuations provided by
the custodial bank’s on-line reporting systems. When an allocation’s size in the portfolio trends
to a point that falls outside of the allowed tracking band, staff initiates the process to rebalance
and return the allocation close to its policy target size. This can involve “selling high” an
allocation that is above target by notifying the appropriate asset manager(s) to liquidate
enough of their holdings, so that funds can be transferred from the account(s) to return the
allocation back to its policy target size in the portfolio. The transferred funds are then
reallocated to those managers most proportionally below their target allocation. If the
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21
rebalancing correction is to “buy low” an allocation that is below target, staff identifies those
managers’ whose allocations are proportionately most above target and instructs them to
liquidate sufficient securities so that cash can be transferred to the manager(s), whose
allocation was below the allowable rebalancing range and returns it close to its policy target
size.
According to McCalla, “A +/-1.8 Standard Deviation adjustment factor around a small cap
growth stock allocation whose expected annual volatility is 24% has the same probability of
triggering rebalancing as that of a +/- 1.8 Standard Deviation control band around a bond
allocation whose expected annual volatility is only 6%. Increasing or decreasing the size of the
Standard Deviation band will affect the expected frequency with which rebalancing may occur
and will influence the effectiveness of the rebalancing process. Very tight rebalancing control
bands will result in more frequent rebalancing and higher transaction costs but produce less
risk adjusted return over time. Very wide rebalancing control bands may result in greater risk
adjusted return but very infrequent achievement of that benefit as it may take a decade or more
for market events to cause rebalancing with very wide bands. Less frequent rebalancing also
creates greater policy risk in terms of the rebalancing process being abandoned due to a lack
of observing its benefits during the tenure of the policy setters.”
Results:
We inquired of McCalla, about whether our hypothesis was valid, and whether we should
recommend to the Investment Department to reexamine this section in the policy. McCalla
stated that it does not make sense to increase or decrease the standard deviation adjustment
factor based on the volatility of the asset class because the standard deviation statistical
measure is a normalized measurement. Using identical standard deviation volatility ranges
around each benchmark in the portfolio results in all allocations having an equal probability of
benefiting from the opportunity to “sell high” or “buy low”, regardless of the inherent volatility or
dollar size of each allocation in the portfolio.
Please note we confirmed that the Investment Department meets regularly with McCalla to
adjust the standard deviation factor based on changes in asset allocation (i.e. increase to the
PEARLS allocation). The Investment Department provided evidence that the Investment Policy
was amended to reflect the new adjustment factor as follows:
Year
2000
2004
2005
2006
2007
2008
Standard Deviation Factor
2.10
1.70
1.85
1.80
1.80
1.80
Recommendation:
None
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22
REAL ESTATE, PEARLS AND OTHER ILLIQUID ASSETS
TEST 1: CASH IS EFFICIENTLY USED TO FUND ILLIQUID INVESTMENTS (REAL
ESTATE AND PEARLS)
We inquired of SIS whether cash was efficiently used to fund illiquid assets, where ACERA
would not incur a higher liquidity risk.
Results:
SIS stated this is the case. The primary accounts used to fund most investments are the Baird
and Mellon Investment Accounts. Both accounts are used since they typically are the most
liquid, and have low liquidation/transaction costs associated with withdrawals.
Recommendations:
None
TEST 2: DOCUMENTED STRATEGIC PLAN FOR ACQUISITION/DISPOSITION OF
ACERA’S REAL ESTATE
We inquired with the Townsend Group (Townsend) to determine if they provide the Investment
Department with a documented strategic plan, which includes an acquisition and disposition
projection to assist in cash flow and lump sum forecasts.
Results:
Townsend stated that in conjunction with the annual review of the ACERA Five-Year Business
Plan & Investment Plan, The Townsend Group updates capital projections. The capital
projections are collected and provided to ACERA at the Fund level, for a future five-year
period.
Townsend finds that predicting cash flow beyond five years is often inaccurate. The
information provided to Townsend by the underlying fund managers, also takes into account
future contribution, distribution and withdrawals. The next annual review is scheduled for
October 2012, so Townsend is in process of updating the capital projection template, and will
provide it to ACERA upon completion.
Recommendation:
None
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23
TEST 3: CASH FLOWS INCLUDING NOI, DISTRIBUTIONS, AND RETURN OF CAPITAL
ARE MONITORED
There is a key distinction between how Net Operating Income (NOI) is recognized versus cash
receipts, and this variance needs to be identified and tracked. Therefore, we inquired with
Townsend on whether they keep the Investment Department informed of expected cash flows
and changes and offer key real estate metrics to help ACERA plan ahead for large distributions
and liquidations. Townsend mentioned that they do provide this information to ACERA.
An example of a Monthly Cash Flow Statements is provided below:
Source: Townsend Group (Provided by the ACERA Investment Department)
Results:
Page
24
We confirmed the Investment Department receives quarterly reports on the real estate
portfolio, as well as copies of the Townsend Pipeline, which identifies all the funds approved for
client purchase by Townsend’s Investment Committee.
To confirm our understanding of the liquidation plan for the real estate portfolio, the Internal
Audit Department asked Townsend to complete the following template to help us estimate the
date and amount of the liquidation from the real estate portfolio, as follows:
Real Estate Portfolio
Vintage Funded Amount Current Market Expected
Expected
Expected
Full (F) or Partial (P)
Year
Value
Annual Return Annual Return Liquidation Date Liquidation**
of Income
of Capital
(Distributions)
Core Portfolio
ACERA Oakland Building Porfolio
Blackrock Granite Property Fund
JP Morgan Strategic Property Fund
PRISA
RREEF America REIT II
RREEF America Separate Account
Total Core Portfolio
2003
2007
2008
2007
2006
2003
48,098,813
50,000,000
51,668,864
51,556,340
30,000,000
217,124,361
448,448,378
42,826,138
25,060,087
44,793,821
35,812,141
20,592,290
56,075,359
225,159,836
$1,654,386.16
$0.00
$255,207.52 $20,583,783.79
$0.00
$399,905.03
$1,376,923.98
$0.00
$0.00 $20,592,290.00
$458,257.55 $28,037,679.50
N/A
2013
OECF
OECF
2012
2006
N/A
F
OECF
OECF
F
F
Value Added Portfolio
AEW Value Investors Fund II
CIM Urban REIT
CIM Urban REIT II
Heitman Value Partners II
JP Morgan Alternative Property Fund
PRISA II
Total Value Added Portfolio
2007
2007
2012
2008
2006
2004
21,812,461
25,148,421
0
22,751,989
20,000,000
43,935,452
133,648,323
16,349,456
26,728,744
0
19,630,953
9,672,794
34,204,768
106,586,715
$3,456,221.00
$960,024.00
$259,000.00
$241,427.97
$1,211,803.68
$1,151,192.36
2016
2017
2023
2017
2014
OECF
F
F
F
F
F
OECF
582,096,701
331,746,551
Total Portfolio
$0.00
$0.00
0
$0.00
$4,836,397.00
$0.00
Source: Information provided by Townsend Group to the Internal Audit Department.
*OECF designates the Open-Ended Commingled Funds.
The Investment Department will use the Townsend information going forward, as they build
their annual cash flow projections. This information is collected on a quarterly basis in the cash
flow section of each quarterly performance measurement report provided to ACERA. In
addition, this information is provided in the base data files provided to the custodian bank.
We also confirmed that Townsend collects and reviews information on the 475 14th Street
Building (HQ) and discusses developments regarding the building either over the phone, in onsite planning meetings and/or discussions sessions with staff. We confirmed that there is a
regular flow of information between staff and Townsend. In the last discussion, Townsend
provided a general overview of their thoughts about employment, occupancy and rental growth
rates.
According to Townsend, the separate account assets, with the exception of the 475 14th Street
Oakland building, are expected to liquidate by 2Q2013. Given the 2013 liquidation date, there
Page
25
is effectively no “long-term” projection for these assets. Per the annual business plan, RREEF
expects to sell each of these core assets at values above the current NAV of the properties.
Townsend collects quarterly cash flow reporting at both the aggregate separate account level
and for each of the underlying separate account assets held in the ACERA portfolio. This
information is contained in the cash flow section of the quarterly performance measurement
reports provided to ACERA.
The 2012 RREEF Cash Flow Projection is below:
Source: RREEF (Provided by the ACERA Investment Department)
Townsend provided an update on the three remaining assets in the account, as follows:
1. RREEF put Park Lake Apartments on the market. They expect a sale by Q42013 on this property, if not sooner.
2. Preston Ridge has reached 91% occupancy and RREEF is in discussion with
potential tenants to expand occupancy to 95%. RREEF will likely engage
brokers for an opinion of value on that asset within the next 30 days and expect
a sale of the asset before Q1-2013.
3. There is an ongoing capital project at Winridge Apartments (balcony rehab) that
will be completed over time. This capital issue will be discussed with brokers to
determine the likelihood of selling Winridge over the coming quarters.
4. With respect to the Oakland building, ACERA should expect the asset to be
written down in Q2-2012 to reflect the new Chevron vacancy.
Recommendation:
None
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26
TEST 4: LEVERAGE IS LIMITED TO STATED REAL ESTATE PORTFOLIO GUIDELINES
Liquidity risk is the ability to access cash when we need it, and if we borrow money, ensuring
that our loan cannot be called at a time when we need the money. The Investment Department
explained the Loan-to-Value (LTV) levels permitted in the Strategic Plan for Core is 50% and
Value Added is 65%. The overall percentage allowed in the portfolio is 35%. They noted that
cross collateralization is not permitted. They also noted that some properties are currently
unlevered (e.g., HQ). We asked if it would make sense to add leverage to HQ or to lift the
leverage limits higher given that interest rates are currently low. The Investment Department
answered that such strategy could help the over-all return in these market conditions, but
conditions can change rapidly. Currently, no proposal has been made to make such changes.
According to Townsend, leverage is calculated at the fund level for each of ACERA’s
investment positions and aggregated at both the composite and total plan level. The Loan-toValue Ratio (LTV) reflects all leverage, including mortgage payables, subscription facilities,
lines of credit and all other forms of leverage not specific to an individual asset. It is calculated
as total debt divided by total assets. These figures are shown on the cash flow page of the
quarterly performance measurement reports provided to ACERA. Townsend stated that
reporting leverage according to this framework is industry-standard and best practice.
Results:
2009
2010
3/31/2011
3/31/2012
39.6%
31.4%
35.1%
31.1%
We reviewed the 2011 Investment Plan on the ACERA Real Estate Portfolio, and noted the
leverage was close to or exceeded the Real Estate Investment Policy Limit of 35% at the
Portfolio Level. We understand in 2008/2009, we experienced an unexpected decline in real
estate values, causing the LTV to increase.
The Townsend Quarterly Report did review the leverage in the real estate portfolio. However,
we did not observe an active strategic plan to manage the excess leverage, which may be due
to the liquidation plan in place.
According to Townsend, with respect to the ACERA Policy, the language in the Strategic Plan
was revised post-correction to state the following:
The Association has approved leverage limits in order to maximize returns to the total
portfolio with minimum risk. The Board has approved a maximum of thirty-five percent
(35%) leverage for the total portfolio. In addition, targets are established for each
investment style based on the risk/return profile of the underlying investments. At no time
shall the origination of leverage exceed the established limits on a loan-to-value basis. In
the event that either the portfolio level and/or style level leverage constraint is breached
due to a contraction in market values, the Association’s Staff and Consultant will notify the
Board and make a recommendation for action or exception.
Townsend continues to recommend this type of language to its clients and therefore, believes it
represents a fair form of measurement going forward.
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Recommendation:
Recommendation
1. ACERA should continue to monitor leverage for each real
estate investment fund and the effects on the overall real estate
portfolio. In addition, establish a long-term plan to ensure
leverage is utilized effectively within the policy limits. Managing
leverage can be an effective way to manage cash flow and risk
in the real estate portfolio.
Business Owner
 Investment
TEST 5: ACERA’S REAL ESTATE DIVIDEND REINVESTMENT STRATEGY IS EFFECTIVE
The Investment Department decides if they will receive dividend cash flows at the time of
contracting. Such decisions are made on a case-by-case basis. Based on Townsend’s Real
Estate Performance Measurement Report - Q1 2012, we noticed certain real estate assets had
a funded amount that exceeded the approved commitment amount. The Investment
Department stated that the difference represented the funded amount plus management fees,
but did not include the dividends reinvested back into the investment. The Investment
Department further informed us that going forward, they have requested that Townsend include
an additional column reporting the dividends reinvested.
We inquired with Townsend as to why dividends are automatically reinvested back into the real
estate portfolio versus reinvesting back into the overall investment portfolio based on the
established asset allocation. Townsend stated, “Cash flow management is a decision made on
a plan-by-plan basis, not by Townsend. If ACERA does not need the cash from real estate to
fund benefits or other short-term liabilities of the total plan, their preference would be to reinvest dividends and grow the size of the real estate positions unless there is a compelling
reason that suggests otherwise. This is simply a function of how ACERA elects to receive its
dividends.”
According to Townsend, “the dividend reinvestment plan (“DRIP”) option is addressed by
Townsend in the legal review of each fund and as such, decisions to either reinvest capital or
distribute capital are made by ACERA at the time of commitment. “ Townsend advises its
clients to answer the following questions before making a selection with respect to distributions
vs. DRIP:
a. How are cash distributions from real estate investments used? Is cash used to pay
short-term obligations or other ongoing expenses? Alternatively, are distributions
redeployed in to new investment options?
b. If cash is used to pay short-term obligations or ongoing expenses, how much is
required on a quarterly basis?
c. If distributions taken in the form of cash are deployed in to new investment options,
will ACERA achieve a higher relative return than real estate for similar levels of risk?
d. Is it ACERA’s intention to grow or maintain an allocation to real estate over time? If
so, in which sectors? DRIP programs provide an easy way to grow exposure over
time. For ACERA, these segments include Core OECFs.
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Results:
Although we understand the Investment Department may perform informal evaluations of
dividend reinvestment options, we did not observe a comprehensive analysis performed by the
Investment Department to determine whether reinvesting dividends back into the real estate
portfolio was the most effective option.
Recommendations:
Recommendation
1. Although decisions to reinvest dividends are made at the
time of commitment, reinvesting in non-real estate options may
be a consideration. We request the Investment Department to
evaluate if it would make sense to have a decision rule (similar
to the DRIP Plan) to decide which investment option to choose
based on established criteria. Further, the decision to reinvest
dividends should be considered at different times over the hold
period of the investment (especially in long-term asset classes
like real estate) versus only at the time of commitment.
Business Owner
 Investment
TEST 6: CASHFLOWS FROM ALTERNATIVE INVESTMENTS ARE MONITORED
Alternative investment managers may add more risk-adjusted value than traditional managers
may; however, the retirement system must account for possibly higher fees and reduced
liquidity. While most retirement systems focus on the returns that alternative investments can
provide, they fail to understand that cash management becomes more complicated when
investing in them. It requires a dedicated effort to evaluate and monitor counterparties and
credit risk from an operational and total portfolio perspective.
We inquired of the Investment Department if they forecast the cash flow for PEARLS
investments. The Investment Department responded that they have started forecasting and
tracking the cash flow from PEARLS and real estate Investments as requested by the CEO
early this year.
Results:
We confirmed the Investment Department prepares a spreadsheet forecasting cash flows,
capital calls and distributions for PEARLS and real estate investments, which is updated on an
annual basis.
Recommendations:
None
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BEST PRACTICES
TEST 1: ACERA EMPLOYS BEST PRACTICES FOR ASSET ALLOCATIONS
We inquired of McCalla, whether ACERA was employing best practices for asset allocations.
McCalla stated, “the residual cash holdings of the ACERA equity managers range from $50 to
$100 million on a daily basis. If the equity risk premium between stocks and cash is 6%,
overlaying the equity managers’ residual cash holdings with equity futures contracts could, over
long-term periods, produce an additional $3 to $6 million in additional annualized return.
Therefore, he would recommend that ACERA explore the pros and cons of hiring a derivative
overlay manager to assist in equitizing the residual cash holdings of the stock managers.”
Results:
According to the Investment Department, SIS stated that ACERA’s portfolio is considered a
best practice portfolio. Some retirement systems may employ strategies to equitize cash (i.e.
purchase futures in an amount equal to the cash held). SIS stated that this is not a strategy
that is necessarily beneficial to ACERA. The goal is to minimize any cash in the portfolio, and
allow professional fund managers to ensure funds are invested at all times.
Recommendation:
None
TEST 2: CONTINGENCY PLAN FOR HOW A HYBRID PLAN/PLAN CHANGE COULD
AFFECT CASH
We inquired with SIS about ACERA’s readiness in the event ACERA was required to undergo
a plan change and add a hybrid plan. SIS stated, “Even in the worst case scenario, the
funding of a new hybrid (Defined Benefit & Defined Contribution) plan would not affect the
initial strategic posturing and investment recommendation for the plan.” Per SIS, “There would
be minimal plan impact in the first 5-10 years. Over the longer term, the asset allocations may
change.”
Results:
Pension Reform is already a strategic initiative in ACERA’s Five-Year Business Plan under
Executive Sponsor, Robert Gaumer, Chief Counsel for ACERA. We believe this level of
oversight will ensure ACERA is monitoring potential changes to the current retirement plan
structure.
Recommendation:
None
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TEST 3: EMPLOYS STRATEGIC CASH FORECASTING BEST PRACTICES
Industry standards require that all relevant financial information, be presented in a structured
manner, and in a form that is easy to understand. Financial information should be
understandable to readers who have a reasonable knowledge of the organization’s activities.
The forecasting process is time consuming and complex. The organization relies heavily on
Microsoft Excel for its financial tool. Forecast periods should accurately reflect the cash
transactions of the organization. ACERA’s Budget and Five-Year Business Plan should drive
the prioritization of expenditures. Forecast software can be used to maintain historical data
and provide an enhanced ability to forecast future liquidity needs.
Forecasts should be made conservatively. The level of precision required in a forecast or
tolerance for variance should be determined at the organizational level and not on an ad hoc
basis. Forecasts should be updated on a regular basis. The frequency of such updates will be
determined by the organization. Daily monitoring and recording of actual revenues and
expenditures by major categories can greatly enhance the organization’s ability to prepare
timely updates to the cash flow forecast.
Benchmarks and best industry practices are sources of information that assist management in
establishing objective, relevant and meaningful criteria. Internal auditors evaluate the
established criteria for efficiency. We researched standards for the industry’s best practices.
We have compiled the following list of best practices for the organization:
1. Utilize analytical software that is integrated into each system used at ACERA to
insure that the information for cash management does not miss some part of the
process
2. Establish a collaborative formal cash flow forecasting practice that includes all
departments involved in the process so that all issues can be addressed as they
arise
3. A standard cash flow reserve should be established ahead of time to allow for any
major unplanned activities that might arise
4. Establish specific rules to use when emergency needs arise and would require alerts
to be sent to key people
5. Guidelines should be established to identify what constitutes a material problem
when emergency situations arise
6. Cash projections that are used in forecasts should be provided to all departments
involved in the different processes so that they could have input to the forecast
7. To ensure accuracy, uniformity and consistency of information, all those involved in
putting together the spreadsheets standards should be set and adhered to
8. There should be a way of putting forecasts together that would allow a person to go
from a summary cash position to a detailed cash position as the need arises
9. Set standards of deviation between actual and projected forecasts at the highest
level so that projection deficiencies can be identified and corrected
10. Forecasting should be monitored on a weekly basis as well as on a monthly or
annual basis to ensure that significant deviations can be identified on a timely basis
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Results:
ACERA has implemented some best practices, and making progress on others.
Recommendation:
Recommendation
1. All departments involved in the cash management process
should understand their role in the forecasting process. These
departments should be involved in developing reasonable
expectations around timing and amounts of planned
expenditures. This ensures all possible outflows are measured
and prioritized.
Business Owner
 All Departments
2. Currently, ACERA’s CEO is the final approver of Fiscal Services
Monthly Cash Forecast Workbook. Normal industry standards
would have this procedure performed by persons in the Fiscal
Services departments of the organization. We recommend that
the Assistant Accounting Manager or Fiscal Services Officer be
the primary approver of the cash forecast workbook.
 Fiscal Services
TEST 4: BEST PRACTICE LANGUAGE INCORPORATED IN ACERA’S INVESTMENT
POLICY
We inquired with SIS to determine if they have suggestions for modification to ACERA‘s
Investment Policy with regard to promoting effective cash management.
Results:
SIS stated they had “no recommendation for change, but ACERA could add one sentence
specifying, “cash is not a strategic asset,” to offer clarification in the Investment Policy
language referring to what is meant by ACERA being “fully invested.”
Recommendation:
Recommendation
1. We recommend that the CIO evaluate whether to insert the
recommended language about cash not being a strategic
asset.
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32
Business Owner
 Investment
TEST 5: IMPLEMENTS BEST PRACTICE PROCESSES AND PRACTICES IN THE
OPERATIONS
From an operational perspective, we summarized the information from an Aberdeen Group
Survey (“Corporations Increase Focus on Cash and Liquidity Management” - May 2010).
The survey of 130 public and private companies indicated that 82% of these companies had
increased their focus on cash management in 2009. 53% of the Best–in-Class companies
polled answered that they were less likely to rely on spreadsheets and manual processes for
managing cash. Furthermore, about a third of respondents indicated a need to improve
liquidity. Aberdeen Group attributes this statistic to the fact that many companies rely on
fragmented processes and systems across treasury, payments and receivables, giving them
only a partial view of cash and making predicting cash requirements difficult.
In addition, Best-in-class performers are 44% more likely to be able to carry out detailed
planning for short-term cash and better able to monitor forecast accuracy than the laggards.
The best in class are also 28% more likely than their peers to align the cash management
process as strategic within the business, and they are more likely to be able to drill down into
successive levels from a summary cash position. Highest performers had the highest use of
systems such as electronic invoice payment and presentment. “All of the best-in-class
companies reported that their vendors are putting them under pressure to pay faster,”
Best-in-class performance should strive for maximum visibility into cash and the financial
supply chain (including customers and suppliers), and establish collaborative formal cash flow
forecasting practices.
Results:
Partially Effective
Although the organization has taking steps to improve efficiency (i.e. electronic payments),
ACERA has not incorporated several best practices necessary to maximize cash management
capabilities including building an annual forecast, reducing reliance on spreadsheets, and
utilizing cash management as a strategic element in the business.
Recommendations:
Recommendation
1. Since cash management is an organization-wide process, the
forecast should be integrated with budget planning and the FiveYear Business Plan.
Business Owner
 All Departments
2. We recommend that ACERA implement an executive dashboard
report that reflects the cash flow for the whole organization. We
recommend that the Fiscal Services Officer or Assistant
Accounting Manager own this process.
 Fiscal Services
3. During the cash management audit, we reviewed cash forecast
worksheets that were not easily understood or readable. We
recommend, ACERA’s financial information of cash
management, be presented in a standardized format. The cash
management worksheets and data should be clear, definite, and
easy to follow.
 Fiscal Services
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33
C. ACERA PREPARES AN ANNUAL CASH FORECAST
Risk Level - Medium
Audit Results - Partially Effective
CONTROL
RISK
•This control will test if ACERA prepares and monitors a cash forecast
detailing projected inflows/outflows on an annual basis.
•ACERA will not have the required funds in a timely fashion to meet
administrative expenses, manage payroll, pay vested benefits, and/or
provide for investment funding.
•Fiscal Services/Investments
OWNER
TEST 1: ACERA PREPARES AN ANNUAL CASH FORECAST
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34
ACERA does not prepare annual cash forecasts for the organization. Based on Government
Financial Officer Association (GFOA) recommended best practices, cash flow forecasting is
defined as an estimate of cash receipts and cash disbursements during a given period. When
used as a cash management guide, it can lead to the optimization of funds as well as ensure
sufficient liquidity. Cash flow forecasting can determine what dollar amount of the portfolio
needs to remain liquid to meet disbursement obligations. In addition, it can identify core funds,
or those funds available for longer-term investing. For instance, cash flow forecasts can help
identify reasonable maximum and weighted average maturities of investments. Therefore, we
tested if departments independently prepared annual forecasts for operations and investments.
FISCAL SERVICES DEPARTMENT- OPERATIONS FORECAST
For operations, we tested if the Fiscal Services Department forecasted the cash needs
effectively. We examined whether benefit and administrative expenses were made timely and if
cash on hand was minimized by transferring excess cash to a higher interest bearing account
or investment accounts in a prudent fashion. We also reviewed the monthly cash forecast to
test the preparation and approval process.
In addition, we conducted walkthroughs of the April and May 2012 cash forecasts. We
determined that the Fiscal Services Department effectively prepares and monitors its
departmental cash forecast on a monthly basis. We observed that the cash forecast is updated
for changes throughout the forecasting process, with proper management review. The Fiscal
Services Department is already evaluating best practices to create the annual cash forecast.
The largest cash outlays typically occur at the end of each month to fund ACERA’s retiree
payroll. There are smaller expenditures paid out on a weekly basis. This uneven flow of cash
requires judicious forecasting to ensure that cash on hand is managed in the most efficient
manner.
ACERA manages cash through two different banks, Wells Fargo Bank for operational purposes
and State Street Bank for investment purposes. The cash needs for operational purposes is
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35
managed through Wells Fargo, and become critical at the end of each month, because
contributions from the employers alone rarely meets the cash needs for monthly retiree payroll.
Therefore, ACERA transfers a large amount of cash from State Street to Wells Fargo to fund
the month-end payroll. After month-end payroll is funded, the Fiscal Services Department
notifies the Investment Department of excess funds that can be transferred back from Wells
Fargo to State Street. The Fiscal Services Department’s objective is to maintain a cash
balance at Wells Fargo, which is high enough to meet immediate needs, but low enough to
ensure that cash is maximized in higher earning investment funds at State Street Bank.
Based on the response to the internal control survey, from the Fiscal Services Department,
they were not aware of a policy that requires ACERA to be “fully invested”, so there was no
clear expectation of what amount of cash should remain in Wells Fargo accounts to be
compliant with the Investment Policy. The Fiscal Services Department invests short-term funds
into the Wells Fargo Stagecoach Investment Sweep Account, which is an interest bearing
account.
ACERA has the following six Wells Fargo Bank accounts:
Stagecoach Investment Sweep Account
ACERA Concentration Account
ACERA Deposit Account
ACERA Administrative Disbursement Account
ACERA Benefit Payments Account
ACERA Retire Payroll Account
The Concentration Account is the main bank account. The five other bank accounts are sweep
accounts, which are used to facilitate bank account reconciliations on a monthly basis. Sweep
accounts are zero balance accounts (ZBA), meaning any balances in the account is swept
back into the concentration account at the end of the day. The ZBA accounts will typically have
only a nominal amount or no monies in the account at the end of the month.
The Concentration Account typically maintains a daily balance of $100K, and transfers any
excess funds on a daily basis to the Stagecoach Investment Sweep Account, which serves as
a short-term investment account. If additional funds are needed to maintain the Concentration
Account, and are not available from the other four accounts, funds are swept from the
Stagecoach Investment Sweep Account to the Concentration Account.
The Fiscal Services Department has an informal policy in place that requires them to maintain
no more than $350K in the Wells Fargo accounts at month end. The Fiscal Services
Department prepares cash forecasts at the beginning of each month, estimating surplus cash
in the Wells Fargo Bank accounts. When a surplus occurs, the Fiscal Services Department
notifies the Investment Department of the surplus fund amount and the expected date of the
surplus via email. The Investment Department responds to the notification via email requesting
the Fiscal Services Department to prepare a wire transfer for Wells Fargo Bank to transfer
surplus funds back to State Street Bank.
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INVESTMENT DEPARTMENT - CASH OPERATIONS FORECAST
The Investment Department does not prepare an annual forecast. They do prepare daily cash
analysis to forecast future cash needs. The Investment Department also prepares a daily
rebalancing analysis to forecast future cash projections. We conducted a walkthrough of the
Investment Department’s monthly cash forecast. We also reviewed their approval process and
confirmed any changes to the original monthly cash forecast are approved only after proper
management review. In addition, we surveyed other 1937 Act Retirement Systems and
national pension funds, to determine if annual forecasts are being prepared by other agencies
for investment cash flow activity. The results indicate few of the 1937 Act Retirement Systems
do, but many national retirement systems do.
Retirement
System
VCERA
TCERA
CCCERA
SDCERA
SJCERA
Performs Annual
Comments
Cash Forecast
No
No, works with Investment Consultant to manage cashflows. Operational
expenses are running $50M over employer contributions.
No
No Investment Dept. - too small. They do have a cash overlay as a specific
investment, so staff is not involved in maximizing use of cash not needed to pay
benefits immediately. Performs quarterly estimates of cash needed to pay
benefits.
No
No. Accounting identifies CCCERA’s needs on a monthly basis. CCCERA does not
produce a cash flow “forecast”, but does produce a cash flow report to track inflows
and outflows semi-annually (6/30, 12/31).
No
No, attempted to prepare an annual cash forecast in the past, but due to the
inability to accurately forecast collateral calls it was not very successful or benefit
did not appear to outweigh the cost and effort.
Yes
Yes, prepares an informal annual cash forecast
Source: Survey performed by Marguerite Malloy, ACERA Legal Department
Retirement
System
South Carolina
Retirement
Systems
IOWA PERS
MOSERS
TRS of Texas
CALPERS
Performs Annual
Cash Forecast
Comments
Yes
Yes, performs 3 Year Cash Forecast
Yes
Yes, the forecasts done are to “ensure adequate cash is available for the payment
of benefit obligations and the funding of investments
No
No, annual cash forecast not performed. Keep a spreadsheet that shows daily,
monthly, quarterly liquidity so we don’t find ourselves in a bind if the market tanks
and the derivatives demand cash from us.
No, but
No, don’t have a formal process or requirement for preparing cash flow
investigating
projections. The investments division prepares them when necessary. Historically,
creating a formal they have been very liquid, so there has not been a need. Investment staff are
process.
investigating creating a formal process and would like the accounting staff to
prepare a formal cash forecast going forward.
Yes
Source: Survey performed ACERA Internal Audit Department through APPFA. Additional information
provided by Vincent Brown, ACERA CEO on CALPERS
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Results:
Remediation in Progress
We determined that the Fiscal Services Department and Investment Department do not
prepare a joint annual cash operations forecast, although both Departments are now in the
process of developing the same.
When we initially questioned the Investment Department and SIS, if an Annual Cash Forecast
(annual forecast of cash inflows and outflows) could benefit ACERA from an investment
perspective, both initially felt that an annual forecast would offer minimal value, since
investment cash flows are largely unpredictable. Similarly, the Fiscal Services Department had
mixed feelings about whether an annual cash forecast would be beneficial for operations.
Both SIS and the Investments Department did acknowledge that annual cash forecasts could
be developed and that it is not unreasonable to use assumptions and estimates from all
managers including PEARLS managers to provide a rough guideline for ACERA’s internal cash
flow planning purposes.
The Investment Department has created a template to capture cash flows from the PEARLS
and real estate portfolio. In addition, the Investment Department has created a template to
capture historical cash flows from PEARLS and real estate portfolios. A separate real estate
forecast is provided by Townsend, and can be incorporated into the overall ACERA forecast,
as well.
Recommendation:
Although the survey results indicate that several members of our peer group (1937 Act
Retirement Systems) do not prepare cash forecasts, we believe the best practice is to follow
the trend of those systems that forecast annually and implement annual cash forecasts for the
organization.
Based on the input from other organizations, who attempted to incorporate annual planning in
the cash forecast, we found a few struggled with implementation due to lack of ability to predict
events like capital calls, lack of personnel and reliance on outside consultants to assist in
managing cash. We would highly recommend for ACERA to contact these retirement systems
to gain their advice and lessons learned.
GFOA Best Practices dictate that cash flow forecasting is distinct from governmental
accounting and budgeting. It is a forecast to measure the organization’s ability to meet liquidity
needs. The ultimate goal of this forecast is to mitigate the need for short-term borrowing or
liquidation of securities (investments) before maturity.
Forecasting should be done organization-wide. This allows spending patterns to be
coordinated to mitigate potential shortfalls and balance the flow of funds. We agree with the
GFOA guidance, and recommend that ACERA develop an annual forecast for operations that
rolls up with the annual forecast for investments into an organization-wide annual forecast for
the organization.
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38
Recommendation
1. We recommend that ACERA contact other agencies with
strong cash management practices to understand best
practices they have employed.
Business Owner
 Fiscal Services
 Administration
 Investment
TEST 2: ACERA INCORPORATES LONG-TERM CHANGES IN THE CASH FORECASTING
PROCESS.
Budgeted cash flow projections provide reliable forecasts to estimate short-term liquidity needs.
For the pension fund overall, on a monthly basis, net outflows are based on fluctuating
estimates. This test was designed to determine if long-term factors were considered in
preparing short-term cash forecasts. We reviewed factors that could cause long-term impacts
to total cash inflow, including the amount of contributions and investment income expected to
be received by the pension plan.
SEGAL’S INPUT ON LONG-TERM CONSIDERATIONS FOR CASH FORECASTING
To frame our analysis, we requested Segal (ACERA’s Actuary) to help us understand how
certain factors could affect cash flow in the long-term. We specifically asked them to help us
evaluate trending for the following ( Please note the estimates provided by Segal were only
high-level estimates to assist us in understanding the potential impact of the following factors to
cash flow, and should not be relied on for decision making).
Employer Contributions
Retiree Payroll/Benefit Expenses
Employee Contributions
We summarized Segal’s responses as follows:
1. Employer Contributions
Segal previously provided illustrative employer contribution rates for ACERA under three
hypothetical market return scenarios for calendar year 2011, assuming alternatively that the
fund would earn a market return of 0%, 7.9% and 15.8% in 2011 (and 7.90% per year
thereafter). Segal believes ACERA may use the illustrative contribution rates provided under
Scenario #1 in Exhibit 1 to estimate the future employer rates. However, the following factors
will need to be taken into account:
a) The projections were based on the results from the 12/31/09 valuation adjusted only to
include the market return of 13.7% for 2010 and they had not been adjusted to include
the other actuarial gains/losses that took place during the 2010 calendar year. For
instance, the projected employer rate as of 12/31/10 provided on Exhibit 1 of 21.2% was
slightly different from the actual employer rate of 20.8% that we determined in our final
12/31/10 valuation.
b) The actual 2011 market returns for the Association were about 5.3% for the first 6
months of 2011 but -6.0% for the last 6 months of 2011. The aggregate market return for
2011 was somewhat less than the 0% assumed in Scenario #1.
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c) Other than the deviation in the 2011 market return, the projected employer rates were
developed assuming no change in the actuarial assumptions and no actuarial
gains/losses following the 12/31/09 valuation. For instance, the new actuarial
assumptions adopted by the Board for the 12/31/11 valuation and the actuarial gains/
losses during 2011 have not been reflected in the projections.
d) In estimating the actual dollar contributions, ACERA may want to use a projected
payroll of $898.3 million Segal estimated in the 12/31/10 valuation for calendar year 2011
and assume that future payroll would increase at an annual rate of 4.0% assumed in the
12/31/10 valuation. However, as budgetary conditions deteriorate, there may be very little
or no growth in the employer’s payroll over the short term. ACERA may need to take that
into account in the projections.
2. Retiree payroll and benefit expenses
a) The projected payments from the SRBR can be found on page 8 of the 12/31/10
SRBR valuation report dated 8/31/2011.
b) The projected payments from the retirement plan for the statutory benefits used in the
12/31/10 retirement valuation.
c) The results provided in 2a) and 2b) were only determined with respect to the members
reported in the 12/31/10 valuation. In particular, Segal did not included any refunds or
benefit payments from active employees entering the Association after 12/31/10.
3.) Employee contributions
a) The aggregate employee rate determined in the 12/31/10 valuation was 8.7% of
payroll. ACERA may want to use this rate in the projections.
b) The aggregate rate has not been adjusted to reflect changes in actuarial assumptions
and actuarial gains/losses similar to what have been discussed in 1c).
c) The actual dollar contributions may be estimated using the payrolls provided in 1d).
ADDITIONAL CONSIDERATIONS FOR LONG-TERM FORECASTING
In addition, the Internal Audit Department used available public information to discuss other
long-term trends that may affect future cash flows. We believe long-term factors should be
considered in forecasting on an annual basis. As demonstrated in Exhibit A, total ACERA
membership has increased by 11% over the last 10 years. Active Membership has decreased
by 6%, yet Retired Membership has increased by 32% and Deferred Membership has
increased by 60% over the same period.
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EXHIBIT A – MEMBERSHIP DEMOGRAPHIC TRENDS
ACERA Membership 2002 to 2011
Retired
18,475
18,731
11,338
11,220
10,514
5,996
6,287
6,334
6,591
1,141
1,224
1,407
1,541
YE 2003
YE 2004
YE 2005
Deferred
Total
20,148
20,121
20,244
20,475
10,980
11,136
10,952
10,849
10,746
7,038
7,193
7,319
7,548
6,892
1,658
1,766
1,819
1,850
1,847
19,226
18,646
18,298
10,557
YE 2002
Active
10,676
YE 2006
19,784
YE 2007
YE 2008
YE 2009
YE 2010
7,903
1,826
YE 2011
Source: 2002-2011 ACERA CAFRS
Active Membership is generally a source of cash, while Retired Membership is generally an
expense to ACERA. Deferred membership is generally cash neutral for current spending, but
reflects a future expense over the coming years. In summary, the trends represented in this
graph indicate future cash flows may possibly be impacted, as one source of income declines,
and expenses continue to climb.
EXHIBIT B – TRENDS FOR BENEFIT PAYMENTS AND ADMINISTRATIVE EXPENSES
Total Pension Expenses
Total SRBR Expenses
Admin Expenses
$330,390
$306,115
$285,750
$268,579
$249,282
$225,605
$33,574
$10,778
2006
$35,290
$12,211
2007
$39,098
$38,539
$41,783
$43,490
$13,315
$12,255
$13,001
$13,306
2008
2009
Source: 2002-2011 ACERA CAFRS
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2010
2011
In Exhibit B, Non-OPEB benefit payments made to members and beneficiaries have increased
by approximately 8% per year over the last 5 years, while OPEB benefits increased to slightly
above 5% per year. The trend in administrative expenses since 2006 shows a 4.5% average
increase over the 5 years.
It is interesting to point out that from a cash flow perspective, expenditures in the last year 2011
for benefit payments (Non-OPEB and OPEB) represented over 96.5% of the total expenditures
made. It indicates that the focus for the cash forecast clearly needs to be on the trends
associated with benefit payments, especially in light of changes resulting from pension reform.
EXHIBIT C – DIFFERENCE BETWEEN EMPLOYER CONTRIBUTIONS AND EXPENDITURES
Incomes & Expense Trend
Contributions
Expenditures
$387,186
$360,899
$320,992
$336,544
$296,783
$269,957
$223,043
2006
$230,559
2007
$237,448
2008
$243,825
2009
$260,404
2010
$277,795
2011
Source: 2002-2011 ACERA CAFRS
Exhibit C describes the difference between employer contributions and expenditures. The
shortfall is funded through investment funds and earnings. The graph indicates the difference
between contributions and expenses has been growing larger emphasizing the need to
maximize investment earnings. Even though ACERA has a “fully invested” investment policy as
a target, we must recognize that investible funds will decrease, as more monies will be
allocated to pay expenses.
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42
EXHIBIT D – SPIKES IN MONTHLY EMPLOYER CONTRIBUTIONS
2011 Summary
35,000,000.00
30,000,000.00
25,000,000.00
20,000,000.00
15,000,000.00
10,000,000.00
5,000,000.00
0.00
Jan
Feb
Mar
Apr
May
Total Expenses
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Total Contributions
Source: ACERA Monthly Payroll (2011)
Exhibit D shows differences in cash flow from employer contributions and expenses on a
monthly basis over 2011. Expenses show a slight increase over the year, rising at a fairly
consistent rate. Employer contributions are increasing at a slightly lower rate, with large spikes
in April and September, since payroll was paid three times in those months, instead of the
normal two times on a bi-weekly basis. Exceptions in financial activity need to be considered in
the annual forecasting process.
Results:
We found no evidence that long-term impacts to the cash forecast are taken into account.
Recommendation:
Recommendation
1. We recommend that the ACERA investigate software to assist
the organization in preparing a formal annual forecast, which
has the capability to do what-if analysis and input variables
that could affect future cash flows (i.e. Hamilton Lane Horizon
Model)
Business Owner
 Fiscal Services
 Investment
2. We recommend that ACERA create an executive dashboard,
charts and planning tools that can help Senior Management
monitor cash flow at a high level.




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43
Administration
Fiscal Services
Investment
Benefits
D. COMMUNICATION BETWEEN ACERA DEPARTMENTS INVOLVED IN
THE CASH MANAGEMENT PROCESS IS EFFECTIVE
Risk Level - Medium
Audit Results - Partially Effective
CONTROL
RISK
•Departments involved in the cash management process openly
communicate in an effective and timely manner.
•The cash management process is ineffective due to inadequate
communication or miscommunication between departments.
•All Departments
OWNER
TEST 1: INTERDEPARTMENTAL COMMUNICATION IS EFFECTIVE
We surveyed the key departments involved in the cash management activities (Fiscal Services,
Administration, Benefits and Investment Departments) to have them comment on the
effectiveness of interdepartmental communications. We focused our questions on the key
activities including the cash request to payment cycle, the forecast, and the escalation process
for unforeseen problems (i.e. unplanned distributions).
Results:
We surveyed the departments involved in the Cash Management Process, and found that the
inter-departmental communication is only partially effective. Based on the responses received,
we found in general that departments continue to operate in silos. There were also instances
of good communication, especially between the Fiscal Services Department and Investment
Department, where the evidence indicates both departments communicate regularly throughout
the month, to ensure that the funds are transferred on a timely basis, although the method of
communication (email lists), may not be most efficient and/or confirms an action will be taken.
Inter-departmental communication issues uncovered in the audit included:
1. We were advised by the CEO of an example where a vendor payment was in jeopardy
of being paid on time, and the CEO was requested to authorize an emergency
withdrawal. We did not have the correct escalation plan in place to handle such
emergencies.
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2. We also uncovered that lump-sum payment to members were not always properly
communicated to the Fiscal Services Department for payroll processing. Lump sum
payments are one-time only refund payments paid to beneficiaries and former ACERA
members. The largest lump-sum payments are typically death refunds and termination
refunds. The communication was only partially effective since not all individuals
involved in the cash management process were properly notified of the lump-sum
payments. Note, that this process was subsequently remediated.
3. The CEO encountered an incident when State Street Bank needed to have an approval
for a wire transfer. ACERA did not have enough approvers and had to scramble to find
a back-up signor. Ensuring back up signors were available for wire payments was not
well coordinated. The Administration Department increased the number of approved
signors for State Street Bank to remediate this problem.
4. We discovered instances of weak internal communication within different departments.
5. Improvement opportunities existed for better communication between departments for
long-range planning.
Part of our audit involved facilitating discussions between departments, to determine ways to
improve communication. Two key departments, which took a strong initiative to improve interdepartmental communications, were the Fiscal Services Department and Benefits Department.
In our first meeting, both departments openly discussed pending issues and prior
miscommunications in the cash management process. The meeting was productive and
informative, and as a result, the Benefits Manager continues to meet with the Fiscal Services
Department once a month to discuss issues related to the processing of payroll. We view this
effort as an excellent example of cross-departmental communication and clearly demonstrates
each department’s commitment to communicate across department lines.
Recommendation:
Recommendation
1. We agree with the Human Resources Officer
recommendation that ACERA investigate how ACERA’s
intranet site can be utilized to enhance inter-departmental
communication.
Business Owner
 Human Resources
 PRISM
 Administration
2. We recommend that each department assign a
Communications Representative, who will be the liaison
serving as the department contact. The Communications
Representatives from all departments will meet at least
quarterly to discuss and inventory cross-departmental issues
and report to Senior Management.
 All Departments
3. We recommend a higher weighting on the communication
aspect of each Manager/Senior Manager’s performance
appraisal, where inter-departmental communication is
specifically evaluated.
 Human Resources
 Administration
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45
4. We recommend that the HR Department be strategically
used to monitor and advise Senior Management on problem
areas of interdepartmental communication and best practice
solutions for the organization to improve. Solutions could
include training for the organization/individuals, third party
assessments, or an advisory team to help remedy
communication issues between departments.
 Human Resources
TEST 2: COMMUNICATION WITH THIRD PARTY BANKS IS EFFECTIVE
This test was conducted to determine if the departments involved in the cash management
process have effective communications with third parties (i.e. Wells Fargo Bank, State Street
Bank). We sent internal control surveys to the Fiscal Services, Administration, Benefits and
Investment Departments to gather an understanding of the quality of communication between
ACERA and the respective banks. We also sent confirmation letters to State Street and Wells
Fargo inquiring about the quality of communication with ACERA.
Results:
Based on interviews with the departments, communications with State Street have been
effective, but we have encountered issues in communications with Wells Fargo, where Wells
Fargo has failed to monitor and notify the Fiscal Services Department of potential overdrafts on
the account, as per the agreement. The Vendor Compliance Remediation Audit (Issued July
2012) and Wire Payment Audit (October 2012) will provide more details about the lack of
effective communication from Wells Fargo.
We sent confirmation letters to each bank to determine if either bank has experienced poor
communication from ACERA and if they recommend ways to improve communications. We
received confirmation letters from State Street and Wells Fargo. Neither bank has encountered
situations involving poor communication with ACERA.
Recommendation:
Recommendation
1. We recommend that ACERA review the relationship with
Wells Fargo Bank. The communication issues should be
addressed, and a performance improvement plan for Wells
Fargo considered.
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46
Business Owner
 Fiscal Services
E. ACERA AVOIDS UNPLANNED DISTRIBUTIONS DUE TO
INACCURATE OR INCOMPLETE MONTHLY FORECASTS
Risk Level - High
Audit Results – Effective
•The purpose of this control is to test if ACERA has a cash management
process to avoid unplanned distributions of cash. This control will also test
the accuracy of Investment and Fiscal Services calculations of estimated
CONTROL cash inflows and outflows.
RISK
•ACERA has unplanned cash distributions causing a significant cash flow
issue as a result of inadequate information or incorrect calculations of
estimated cash flows.
•Fiscal Services/Investments/Benefits
OWNER
TEST 1: THE MONTHLY FORECASTING PROCESS IS ACCURATE
The Fiscal Services Department procedures describe the purpose of the cash forecast is to
strike a balance between ensuring that ACERA can meet its cash obligations and at the same
time minimize holding idle cash. The Fiscal Services Department develops a monthly estimate
of its liquidity requirements to meet its obligation for payment of retiree benefits, health
insurance, ACERA payroll, and other operating expenses. To ensure the accuracy of the
forecasts, the Fiscal Services staff updates the forecast for unexpected events and analyzes
the variances that result from comparing the prior month’s forecast to actual deposits and
disbursements. Any changes in trends or calculations are then corrected in the current
month’s forecast.
The forecasting of cash is limited to developing an estimate of cash needs, which is required to
meet ACERA’s weekly and monthly cash obligations. It takes into account different sources
and uses of funds, adjusts for known events and uses historical trends when appropriate. The
Fiscal Services Department is responsible for developing the cash forecast. Part of the
forecast includes coordinating with the Benefits Department to establish a payroll calendar
specifying the payroll dates. The Investment Department performs the actual liquidation of
securities needed to cover the difference between ACERA’s other cash receipts such as
contributions and ACERA’s operating expenses and staff and retiree payroll. The Benefits
Department uses Pension Gold to transfer the payroll information to the Fiscal Services
Department. In addition, the Benefits Department also notifies Fiscal Services of any single
transaction of $100,000 or more. Internal controls in place include the following:
a. The Fiscal Services Department check calendar for events that impact forecast
including if the pay date (county employees) falls on either of the last two working
days of the month and determining if it is a three pay period month.
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47
b. The Fiscal Services Department determines if the payroll estimates need to be
increased in April, as historically there are more retirements and if the contribution
rates have increased in September, since this is the month contribution rates
change.
c. Every two weeks, ACERA wires money to County to cover the ACERA payroll. A
worksheet comparing the wires sent and the actual ACERA payroll numbers is
maintained. This worksheet is used to determine the ACERA payroll estimate for
the next period.
d.
The Fiscal Services Department confirms with Human Resources Department
regarding resignations, terminations, etc. to estimate vacancies during the
forecasted month.
e. The Fiscal Services Department reviews accounts payable for items.
f.
The Fiscal Services Department reviews the budget for estimated expenditures,
which have not been invoiced by the vendor.
Also, note that the Fiscal Services Department uses an informal $350K cushion in the cash
forecast as a safety net to account for unexpected expenditures. The $350K has recently been
modified from a higher amount used in previous years, and may be reduced further. Fiscal
Services monthly reconciliation of the bank account, analyzes cash inflows and cash outflows.
In addition, the actual monthly cash inflows and cash outflows are compared to the projected
monthly cash inflows and cash outflows for variances.
The discrepancies are taken into account where appropriate for ongoing changes. If the
discrepancy is material, other departments impacted by the discrepancy are notified of the
change. The cash forecast worksheet is updated to include the discrepancy for future
projections. We did not find any inaccuracies with the monthly cash forecast workbook. The
cash forecast workbook did not have large variations between the projected and actual cash
inflows and cash outflows. The variations were minor and expected in their monthly cash
expenditures.
Results:
Monthly Cash Forecast is Accurate
Sample #
Sample Date
Pass/Fail
Comments
1
February 2012
Pass
N/A
2
March 2012
Pass
N/A
3
April 2012
Pass
N/A
4
May 2012
Pass
N/A
The monthly process is well documented, and considered several routine and non-routine
inputs as part of the process. We found no exceptions.
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48
Recommendations:
Recommendation
1. We would recommend the Fiscal Services Department
continue to review the $350K buffer to determine if the
amount needs to be adjusted in the future. We would
recommend the buffer be formalized as part of the forecast
procedure.
Business Owner
 Fiscal Services
2. In the future, we would recommend that the Fiscal Services
Department consider incorporating long-term inputs as part of
the monthly forecast. For example, there may be
opportunities to provide advanced notice to the Investment
Department on future spikes in revenues or large expected
expenses.
 Fiscal Services
 Investment
 Benefits
3. We agree with the Asst. Accounting Manager
recommendation that ACERA should review key assumptions
made by the Actuary to ensure we understand them.
 Fiscal Services
 Investment
 Benefits
TEST 2: GENERAL LEDGER CASH ACCOUNT RECONCILES TO THE BANK STATEMENTS
The Fiscal Services Department monitors the daily cash activity in a Microsoft Excel
spreadsheet referred to as the Daily Cash Log. This spreadsheet includes all daily cash
deposits and disbursements during the calendar year, and the serves as the basis for the
monthly forecast. The Retirement Accountant II reconciles the General Ledger Bank Accounts
(Great Plains) to the Daily Cash Balance Worksheet, and to the Wells Fargo Bank Statements
on a monthly basis. The Assistant Accounting Manager reviews and approves the General
Ledger Bank Account Reconciliation and Daily Cash Balance worksheet. In this internal
control, the Fiscal Services Department also compares the prior month forecast with actual
cash.
Results:
Reconcile General Ledger to Bank Statements
Sample #
Sampling Dates
1
2
3
4
February 2012
March 2012
April 2012
May 2012
Cash Log
Reconciliation
Pass
Pass
Pass
Pass
General Ledger
Reconciliation
Pass
Pass
Pass
Pass
Bank Statements
Reconciliation
Pass
Pass
Pass
Pass
We reviewed the Fiscal Services Department methodology for managing the monthly
reconciliation of ACERA’s Great Plains cash balance to Wells Fargo Bank Statements. No
exceptions reported.
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49
Recommendations:
None
TEST 3: CASH RECEIPTS RECONCILES WITH THE CASH RECEIPTS LOG
The third internal control is the comparison and validation of cash receipts using the cash
receipts log (MS Access report). In this procedure, the Fiscal Services Department verifies the
accuracy and completeness of the cash receipts report using:
Wells Fargo Bank (WFB) Deposit Activity
Scanned Deposit Records in EDMS Onbase
Check Copies
Results:
Reconcile Cash Receipts with the Cash Receipts Log
Sample Date
Pass/Fail
Comments
February 2012
Pass
N/A
March 2012
Pass
N/A
April 2012
Pass
N/A
May 2012
Pass
N/A
No exceptions found in the reconciliation process.
Recommendations:
None
TEST 4: CASH FORECAST WORKBOOKS ARE APPROVED
We sent internal control surveys to Fiscal Services to gather an understanding of the cash
forecasting process. We determined if Fiscal Services cash forecasting process takes into
account unexpected expenses and unplanned distributions. We tested the accuracy of Fiscal
Services’ monthly cash forecast workbook process. We reviewed the cash inflows and cash
outflows used for the cash projections. We compared actual cash inflows and outflows with the
cash forecast. We determined if Fiscal Services’ cash forecasting process takes into account
unexpected expenses and unplanned distributions
The Fiscal Services Department develops a monthly estimate of the liquidity requirements to
meet obligations for payments related to retiree benefits, health insurance, ACERA payroll, and
other operating expenses. The Retirement Accountant II prepares a monthly cash forecast
workbook, which requires the review and approvals of the Assistant Accounting Manager and
Chief Financial Officer (CFO). The forecast is revised based on changes recommended by the
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50
management review. The cash forecast is provided to the Chief Executive Officer (CEO) for
final approval.
Results:
Approval of the Monthly Cash Forecast
Sample Date
Asst Acct Mgr Approval
CFO Approval
CEO Approval
February 2012
Pass
Pass
Pass
March 2012
Pass
Pass
Pass
April 2012
Pass
Pass
Pass
May 2012
Pass
Failed, but Compensating
Control in Place
Pass
* Failure occurred because CFO terminated employment with ACERA in April
We tested the Cash Forecast Workbook for proper review and approvals from February 1,
2012 through May 31, 2012. The Assistant Accounting Manager properly approved the Cash
Forecast Workbook for all periods tested. The CFO approved the Cash Forecast Workbook for
all periods, except May 31, 2012. The CEO (assumed the duties as the interim CFO, until an
adequate replacement is found or change in process takes place), approved the May 31, 2012
Cash Forecast Workbook in place of the CFO, which was an adequate compensating control.
In addition, the actual monthly cash inflows and cash outflows were compared to the projected
monthly cash inflows and cash outflows for variances. The discrepancies were within an
acceptable range. We did not find any inaccuracies with the monthly cash forecast workbook.
. Recommendations:
Recommendation
1. Documentation should be updated to define an approval path
in the event the Assistant Accounting Manager or CEO is
unavailable. Update documentation to include Fiscal
Services Officer and eliminate CFO.
Business Owner
 Fiscal Services
TEST 5: INVESTMENT CASH ANALYSIS WORKSHEETS ARE ACCURATE
We tested the accuracy of Investment Department’s Cash Analysis Worksheets. We reviewed
the cash inflows and cash outflows for discrepancies in the cash projections. We compared
actual cash inflows and outflows with the cash analysis.
Results:
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51
We observed the Investment Department perform their cash management duties from January
2012 to March 2012 to gather an understanding of the cash analysis process. We understood
that they monitor cash by analyzing rebalancing daily and performing the cash analysis. These
tools allow the Investment Department to plan for emergency funding. In addition, the
Investment Department monitors cash on a daily basis. The major source of funding is from the
Mellon and Baird accounts, since they are liquid accounts with minimal transaction costs
associated with liquidation. The account balances in these two accounts are estimated at more
than $1.3 billion. We found the cash analysis worksheets were accurate. We also confirmed
the cash projections were consistent with the actual cash inflow and cash outflows.
Recommendation:
None
F. CASH MANAGEMENT INTERNAL CONTROLS ARE EFFECTIVE AND
WORKING AS DESIGNED
Risk Level - High
Audit Results - Partially Effective
CONTROL
RISK
•Management has established effective cash management internal
controls.
•ACERA’s cash is not managed efficiently and effectively causing
insufficient funds to meet cash obligations due to inadequate internal
controls.
•All Departments
OWNER
TEST 1: BENEFITS ENHANCED REPORTING TOOL PROVIDES ACCURATE AND TIMELY
INFORMATION
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52
In order to make timely cash management decisions during any month, the Benefit Accounting
Unit is heavily dependent on a specially designed Microsoft Access Database system called
the Benefits Enhanced Reporting Tool (BERT), to access the necessary information from
Pension Gold (PG) to make accurate healthcare provider payment for members. BERT pulls a
partial snapshot from the Oracle database housing data from Pension Gold, the organization's
pension administration software.
The process of creating such a snapshot is called a ‘refresh’, and is scheduled to occur every
morning automatically (typically the following morning) for the Fiscal Services Department to
access the data. Changes that were made in Pension Gold the previous day will be captured
in the BERT reports. Sometimes the automatic refresh fails to kick off in the morning, at which
point the Project Information Systems Management (PRISM) Department performs a manual
refresh.
When we inquired with the Benefits Accounting Unit about cash management issues that might
prevent them from making accurate and timely payments on behalf of the members, it was
mentioned that the automatic BERT refresh failed on several days during the vendor payroll
process, and poses a risk to complete vendor payroll timely and accurately. Based on this
information, we contacted the PRISM Department to find out if there was a plan of action in
place to address this issue.
We worked with the PRISM Department to determine the seriousness of the issue. The
PRISM Department provided guidance that the root cause of the failures is unclear. The
refresh is a complicated multi-step process that occasionally results in complications. It fails at
different points in the process, and can be due to BERT software or hardware, the network,
logged in users, the file server, the PG server, or a combination of these. As a short-term
solution, PRISM resources check the status of BERT each morning and manually refresh the
database, if needed.
At this point, the plan is to investigate the root cause of the issue, to define the alternatives and
work towards a permanent solution. The PRISM Department understands that changing to a
new solution can be a massive effort requiring thorough planning, testing, and a budget for new
technology. The PRISM Department has already started discussing a possible project to review
the current reporting tool during the development of the 2013 IT Budget.
Results:
We deem this issue to be a risk to the organization, which can affect the payment of health
benefit premiums on behalf of the membership. According to the Benefits Accounting team, if
BERT does not refresh, it can have an impact on ACERA’s ability to meet its vendor payroll
deadlines, and therefore an adverse affect on the cash management process. The refreshed
data must be available by 9 AM on the processing date for calculating payroll, in order to
complete the payroll process timely and accurately.
The PRISM Department estimates that the automatic refresh fails to kick off approximately 1.5
times per week; 45 times, so far this year, but points out that the manual refresh has not failed
yet. Overall, we are concerned that MS Access may have other inherent limitations on
reporting considering the volume of Pension Gold data, and the entire BERT tool could
eventually fail altogether.
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Recommendation:
Recommendation
1. We raised our concerns to the PRISM Department, Fiscal
Services Department and the CEO, and all have agreed that
it is in the best interest for ACERA to hire a third party expert
consultant to investigate the root cause for the failure. Based
on the results of the investigation, ACERA can determine the
appropriate course of action.
Business Owner
 PRISM
TEST 2: INTERNAL CONTROLS FOR THE MONTHLY PAYROLL PROCESS ARE
EFFECTIVE
We developed process AS-IS Process Flow Charts with the assistance of the Benefits and
Fiscal Services Departments to gather an understanding of the issues surrounding the monthly
payroll processing. We then focused on internal controls that had the greatest impact and
prevented the most significant risks in the monthly payroll process (known as the Key Controls)
in our testing.
On a weekly and monthly basis, the Benefits Accounting Unit provides the Administration Staff
the Check Pull Report. Administrative Staff reconciles the checks received from Wells Fargo
Bank with the Check Pull Report to ensure that we received the expected number of pulled
checks. In addition, documentation is available to ensure checks were distributed to the
appropriate person.
We inquired if there is a process to reconcile the checks that are printed, with outstanding
checks, and the checks that have been returned to ACERA, and placed in the safe. This
control would give Fiscal Services a more accurate picture of what checks are outstanding. In
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54
addition, it would provide staff with a tool to follow up on why member’s checks were returned
back to ACERA undeliverable.
Results – Benefit Department Monthly Payroll Controls
Remediated
The Benefits Department identified two key controls.
1. #2. Control Description
5. 1.6. Submit signed-off checklist and other related reports to
Financial Services Specialist II (FSSII) for final normal
payroll trial run
9. 2.10. Benefits staff should check with Benefits Manager if
exception to payroll processing is warranted
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3. Key
Control
7. Key
4. Pass/Fail
11. Key
12. Pass
8. Remediated
Results – Fiscal Services Department Monthly Payroll Controls
The Fiscal Services Department identified five internal controls, of which two were considered
key controls:
Samples #
1
2
3
4
Sampling
Dates
Oct-11
Jan-12
Feb-12
Mar-12
Audit Control
Form
Pass
Pass
Pass
Pass
Payroll Reports vs.
Check Request
Pass
Pass
Pass
Pass
We validated that all checks in the sample originating from ACERA have been approved and
documented, before checks are printed, the Check Print Authorization & Audit Control Form
must be reviewed and signed by the Assistant Accounting Manager or Retirement Accountant
III (RA-III). The Audit Control Form includes relevant information including: process dates,
batch numbers, total number of checks to be printed, the total amount of all checks and the
appropriate account number that the checks should be written from. We also verified that the
checks printed for payroll is equal to what has been reported on the payroll reports, the Fiscal
Services Department matches payroll reports to the check requests. Reviewing both of these
documents together confirms that the number of checks printed and total amount of all of the
checks in a batch are the same.
Results – Inter-Departmental Monthly Payroll Controls
The Fiscal Services Department informed us of other internal control issues with the
incompletion of the signed-off checklist provided by the Benefits Department. The Benefits
Department submits the signed-off checklist for members to the Financial Services Specialist II
(FSSII) for the second and final normal payroll trial runs. The FSSII reviews the checklist for
accuracy and proper approvals from the Assistant Benefits Managers, prior to the second and
final normal payroll trial runs by the RAIII. On February 14, 2012, the FSSII circulated the
second normal payroll checklist and received the checklist with fifty records unchecked. On
February 22, 2012, the FSSI circulated the final payroll checklist and received the checklist with
59 records unchecked. This internal control was partially effective because the Assistant
Benefits Management did not sign-off on the checklists on February 14 and February 22, 2012.
This resulted in a delay in processing the normal payroll.
Benefits has taken ownership of this procedure. The Benefits Manager has initiated a process
that requires the checklist to be signed-off by a Primary Assistant Benefits Manager prior to
submitting the checklist to the FSSII. In addition, two backups to the Primary Assistant
Benefits Manager have been identified, who perform the tasks on a rotation basis, to ensure
adequate knowledge transfer and retention occurs. As result, the normal payroll processing is
more effective and time efficient. We reviewed the months of May and June, both months were
properly signed off by the Benefits Management, and the control appears remediated.
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56
Recommendations:
Recommendation
1. Administration Staff sign off, scan and save reconciled
check pull reports. Keeping these reports will make it
possible to go back and confirm the receipt and action
taken for these checks.
Business Owner
 Administration
2. Reconcile returned checks with outstanding checks and
checks that have been returned in the mail. Fiscal
Services and Benefits staff should be notified when a
check is returned. We recommend that copies of returned
checks are scanned and sent to both the Fiscal Services
and Benefits queue in EDMS. Fiscal Services can keep
track by noting returned checks on the Outstanding
Check Report. Each month the Benefits Department can
give a status on any returned checks in the safe.
 Administration
 Fiscal Services
 Benefits
3. While Administration Staff may be reconciling the Check
Pull Reports with the checks sent by Wells Fargo Bank,
the process is not documented.
 Administration
 Fiscal Services
TEST 3: INTERNAL CONTROLS FOR THE WEEKLY PAYROLL PROCESS ARE EFFECTIVE
We did not test the internal controls for the weekly payroll process, since several key controls
were already reviewed in the monthly payroll process. The unique aspects of the weekly
process, including how checks are voided and reissued, may be scheduled to be investigated
separately. Regardless, we documented the internal controls of the weekly payroll to confirm
our understanding of the process.
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Results:
Not Tested
13. #14. Control Description
17. 1.
18. A benefit staff researches and notifies FSSII to run
another trial.
19.
21. 2.
22. Void and reissue process
23.
3.
25. Benefits staff researches and corrects and notifies
FSSII to run another trial
4.
26. Match payroll reports to check request
27.
5.
28. Submit check print and audit control form to Assistant
Accounting Manager or Retirement Accountant (RAIII)
for approval
29.
6.
30. Administrative staff receives checks and reconcile to
check pull report
31.
Recommendation:
None
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15. Key
16. Pass/Fail
Control
20. Key
Not Tested
24. Key
Not Tested
Non-Key
Not Tested
Key
Not Tested
Key
Not Tested
Non-Key
Not Tested
TEST 4: INTERNAL CONTROLS FOR THE INVESTMENT CASH FLOW PROCESS ARE
EFFECTIVE
We sent internal control surveys to the Investment Department to gather an understanding of
the cash analysis process. We tested if management had planned for emergencies regarding
cash needs and the accuracy of the cash analysis worksheets. We also reviewed the cash
inflows and cash outflows for discrepancies in the cash projections. Finally, we compare actual
cash inflows and outflows with the cash analysis.
The Investment Department has established internal controls for monitoring cash, approving
cash requests and communicating cash needs. We tested the internal controls of cash
analysis, daily rebalancing, and liquidations.
To prevent the misuse of investment funds or fraud, liquidation requests cannot be initiated
without email requests from Fiscal Services. The Retirement Accountant II from Fiscal
Services sends an email to Investments by end of the 1st week or the beginning of the 2nd
week of each month requesting funds to meet ACERA’s monthly cash obligations. The retiree
payroll is the largest monthly cash obligation and the funds are due at least 3 days prior to the
retiree payroll. We tested the timing of the emails from Fiscal Services and the timing of the
funding to cover retiree payroll.
Investments’ liquidation requests cannot be initiated without capital call letters from investment
managers. Liquidation requests are initiated from an outside party or another department
within the organization. This control prevents Investments from initiating liquidation; therefore,
reducing the risk of misusing investment funds by segregation of duties. To further test the
initiation of liquidation, we confirmed that capital calls were processed by Investments for the
stated periods. Our tests confirmed that an email was sent from Fiscal Services to Investments
requesting funds for monthly payroll. This request initiated the liquidation process.
We also tested the liquidation letters to Mellon Capital. The call letters or forms instructing
managers to liquidate funds are prepared by analysts, but will not become valid unless signed
off by authorized signers. This control reflects segregation of duties from authorization,
recordkeeping, and custody; thereby, preventing unauthorized transactions by investment
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analysts. The Mellon Capital liquidation letters and the liquidation were tested for proper
approvals.
In addition, we tested the approval process of direction letters to State Street Bank to transfer
funds between custodial accounts that are prepared by analysts, but will not become valid
unless signed off by authorized signers. This control separates the authorization,
recordkeeping and custody of assets. By requiring an authorized signer, this control prevents
unauthorized liquidations and safeguards the organization’s assets from misappropriation of
funds. We sampled directional letters to State Street Bank.
Results:
Remediated
#
Control Description
1.32. Liquidation requests cannot be initiated without capital call
letters from investment managers or email requests from
Fiscal Services.
33.
2.34. Cash flow analysis spreadsheet and rebalancing analysis
spreadsheet relevant to liquidation requests are prepared by
one analyst, but approved by Investment Officer and Chief
Investment Officer.
35.
3.36. Daily rebalancing spreadsheets that monitors account
balance is updated daily by an analyst who does not update
the other spreadsheets involved with liquidation requests.
Duty for updating daily rebalancing spreadsheet will also
rotate amongst the analysts.
37.
4.38. Letters or forms instructing managers to liquidate funds are
prepared by analysts, but will not become valid unless signed
off by authorized signers.
39.
5.40. Direction letters to State Street Bank to transfer funds
between custodial accounts are prepared by analysts, but will
not become valid unless signed off by authorized signers.
41.
6.42. Wire instruction letters are prepared by analysts, but will not
become valid unless signed off by authorized signers.
43.
7. In April 2012, Staff is expected to switch to Private Edge
system to approve/release wires, which is even more secure.
We did not test internal control 7 in this audit since the
Private Edge system was tested in the wire transfer audit.
44.
45.
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Key
Control
Key
Pass/Fail
Key
Remediated
Key
Pass
Key
Pass
Key
Pass
Key
Pass
Non-Key
Pass
Not Tested
# of Samples
Sampling Dates
Cash Analysis Approval
1
September 19, 2011
Fail
2
November 9, 2011
Pass
2
January 17, 2012
Pass
4
February 22, 2012
Pass
5
March 20, 2012
Fail
The Investment Department monitors their cash needs on a daily basis to ensure that ACERA
has enough cash to meet investment demands. An investment analyst prepares a cash flow
analysis worksheet for monitoring cash on a daily basis. The investment analyst reviews and
signs the cash analysis worksheet before forwarding it to a senior investment analyst or the
Investment Officer for approval. The senior investment analyst or Investment Officer reviews
and approvals the cash analysis worksheet and forwards it to the Chief Investment Officer for
the final approval.
We tested the cash analysis worksheets for proper approvals. We found this control partially
effective. Our test results found that the necessary approvals were not received in all cases.
Subsequently, the Investment Department has informed the Internal Audit Department that
they have remediated their approval process to ensure appropriate approvals are received.
Recommendations:
Recommendation
We recommend that cash management internal controls be
tested regularly by Management to confirm the controls are
working effectively.
Business Owner
 All Departments
CONTROLS NOT EXAMINED DUE TO IMMATERIALITY OR CONSIDERATION IN A
SEPARATE AUDIT
STALE DATED AND NINETY DAY CHECK PROCESS
ACERA processes weekly and monthly warrants (checks) for its members and eligible payees.
From the date of issuance, checks are only payable for 180 days. After 180 days, checks
become stale dated, preventing the members and payees from cashing their checks. Reasons
why checks remain uncashed include:
Members may never receive a check and are unaware of that fact until notified by the
Benefits Department.
Some members may lose their checks.
A member may be deceased, and ACERA has not been notified of their death.
The Fiscal Services Department maintains a list of outstanding benefit checks and places the
list on ACERA’s shared drive. After the Fiscal Services Department provides a current list, the
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Benefits Department reviews the list and sends the appropriate letters to members or payees
on the list on a monthly basis.
PETTY CASH FUND PROCESS
ACERA’s petty cash fund is established to allow for the reimbursement of incidental business
expenses in an efficient and cost effective manner. Petty cash funds are used to reimburse
ACERA’s staff for minor business expenses not to exceed $50 per transaction.
Authorized Uses Include:
Petty cash reimbursement is authorized for monies spent on necessary and reasonable
small business expense.
Special situations, such as advances to staff for small business related purchases in
urgent matters are permitted.
The Administration Department is the custodian of petty cash. They are responsible for
providing adequate safekeeping of the petty cash funds including performing regular monthly
reconciliations of the petty cash fund, providing monthly petty cash usage reports to the Fiscal
Services Department and requesting appropriate replenishment of the fund
The Fiscal Services Department provides recordkeeping, reviews monthly petty cash usage
reports to ensure compliance with the petty cash policy, codes expenses to the appropriate
general ledger account, performing reconciliations every six months, conducting audits
semiannually and processes check requests for replenishment.
VOID PROCESS
ACERA issues weekly and monthly payroll checks to its members, beneficiaries and vendors.
Occasionally a check has to be nullified through the void process. Listed below are the three
types of voids that may take place:
Void - check that should not have been issued
Void and reissue - date of check changes
Void and replace - when there are changes to the amount or payee (new taxability
adjustments)
Voids are processed in the Great Plains and Pension Gold systems to reflect accurate
information in the general ledger, bank account and members’ file. The Retirement Accountant
II is responsible for voiding checks using the Wells Fargo CEO portal. The Retirement
Specialist and Financial Services Specialist II are responsible for voiding transactions in
Pension Gold. When the Retirement Specialist discovers that a void transaction needs to be
corrected, Benefits Accounting Unit should be notified. This is a crucial step in the void
process. In addition, when direct deposits for members and beneficiaries require voiding, the
Retirement Specialist notifies Wells Fargo Bank to void the direct deposit.
INVESTMENT MANAGEMENT FEES
The investment Department advised us that ACERA outsources several functions and activities
in managing and overseeing plan assets. The amount of fees paid to investment managers
and investment consultants is a significant cash outflow, and is reviewed to ensure ACERA is
billed correctly in accordance with the contract. The internal controls that would be tested
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would be related to contract compliance, and therefore require a separate compliance audit.
Therefore, this activity was not in scope for the Cash Management Audit. We will consider a
review in this area, as we prepare the audit plan in future years.
G. CONCLUSION
We performed the cash management audit to determine whether the organization’s operational
and investment cash management internal controls are effective. We further investigated the
current cash management processes, policies, procedures and best practices and tested
whether cash forecasting properly projects for future cash needs and operational requirements
on a timely basis. We also tested whether ACERA remains in compliance with the Investment
Policy requirements as related to cash.
Cash management is critical for ACERA to meet its ongoing and future financial obligations.
Cash management internal controls represent an application of prudent conduct to ensure
proper safeguarding of fund assets. Proper internal control mechanisms provide management
with a reasonable assurance that intended safeguards are being practiced consistently. The
integrity of cash management activity depends on the application of best practice internal
control principles and standards. Implementing internal controls is important in the area of
cash management because of the diverse nature of the processes involved, i.e., billings,
collections, deposits, and disbursement processes, as well as oversight responsibilities
generally associated with these processes.
We tested the following six controls:
1.
2.
3.
4.
5.
6.
Cash Management Policies and Procedures are Documented
ACERA Manages Cash Efficiently by Ensuring Funds are Fully Invested
ACERA Prepares An Annual Cash Forecast
Communication Between ACERA Departments is Effective
ACERA Avoids Unplanned Distributions
ACERA Cash Management Internal Controls are Effective and Working as Designed
We found the overall cash management process to be Partially Effective.
Based on our findings, we made the following top five key recommendations for improvement:
1.
2.
3.
4.
5.
We recommend implementing an organization-level Cash Management Policy and
clearly defined communication protocols between departments.
We recommend preparing annual forecasts, which incorporate long-term planning
assumptions for cash utilization.
We recommend investigating the root cause of the BERT refresh failures to ensure a
permanent solution is place.
We recommend reviewing the process and procedures around leverage and
reinvestment of dividends to ensure we are employing best practices.
We recommend that employees managing critical functions in the cash management
process have adequately trained backup.
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