CASH MANAGEMENT AUDIT OCTOBER 2012 - acera.org · Page 5 AUDIT OBJECTIVE The objective of this audit was to provide assurance to Senior Management and the Board of Retirement, that

Alameda County Employees’ Retirement Association Internal Audit Department

CASH MANAGEMENT AUDIT OCTOBER 2012

INTERNAL AUDIT DEPARTMENT

REPORT PREPARED FOR:

THE ACERA BOARD OF RETIREMENT

http://www.acera.org/index.php

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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

1 Cash Management Policies and Procedures are Documented

Medium Partially Effective

2 Ensuring Funds are Fully Invested High Partially Effective

3 ACERA Prepares An Annual Cash Forecast Medium Partially Effective

4 Communication Between Departments is Effective

Medium Partially Effective

5 ACERA Avoids Unplanned Distributions High Effective

6 ACERA Cash Management Internal Controls are Effective and Working as Designed

High Partially Effective

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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

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.

Efficient department

practices and processes in

place

Investment returns are maximized

Accurate benefit

payments are made timely

Documented policies and procedures

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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

•The control will test if ACERA has established documented organizational and departmental cash management policies and procedures.

RISK

•Cash management policies and procedures are not followed consistently, leading to ineffective or inefficient management of cash.

OWNER

•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

Secondary Departments involved in the Cash Management Process

*Fiscal Services Department

Investments Department *Note that the Accounting Department was recently renamed as Fiscal Services

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 Implemented a Cash Mgmt Policy

Colorado Pension Employees Retirement Association No

Contra Costa County Employees Retirement Association No

Iowa Pension Employees Retirement Association Yes

Maine Public Employees Retirement System Yes

Missouri State Employees' Retirement System No

San Diego County Employees Retirement Association No

San Joaquin County Employees Retirement Association Yes

South Carolina Retirement Systems Yes

Tulare County Employees Retirement Association No

Ventura County Employees Retirement Association No

Wyoming Retirement System 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 Business Owner

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. Based on Government Financial Officer Association (GFOA) and IIA guidelines, cash management is deemed a critical function for any organization.

All Departments

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, inter-departmental 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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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:


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. 1Tiger Team is a small interdepartmental tactical team tasked with

accomplishing a specific objective.

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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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:


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.

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.

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.

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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B. CASH IS MANAGED EFFICIENTLY AND FULLY INVESTED

Risk Level - High Audit Results - Partially Effective

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

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

CONTROL

•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 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.

OWNER •Fiscal Services/Investments

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

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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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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:


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.”

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

This was remediated by CEO in August 2012. The issue is resolved.

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

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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manages cash well and ranks high in comparison to their peers among other 1937 Act Retirement Systems. Please see the test results as follows:

Source: 1937 Act County CAFRS (2011)

Recommendations: None

1937 Act

Retirement

System

2011 Plan

Assets

Cash

Allocation

Target

Cash

Allocation

Actual

Difference

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%

Page 17

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.

Page 18

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

Retirement

System

Period used

for

rebalancing

Rebalancing Method Is rebalancing

method purely

mechanical or is

there staff and

consultant input

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.

Primarily

mechanical, but

open to

Investment Staff

and consultant

input regarding

pending cash

flows.

SDCERA Event-Based +/- 3-35% range from target allocation based on

asset class.

Investment staff

and consultant

input.

MOSERS Monthly Determined by beta adjusting the exposure of all

investments that are compared to an investable

policy benchmark. Investments compared to non-

investable benchmarks (T Bills + 4%, S&P 500 + 3%

and NCREIF Timberland) shall not be beta adjusted.

Investment staff

and consultant

input.

SWIB Monthly 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 staff

and consultant

input.

NYSTRS Quarterly Investment policy specifies a target allocation for

each investment category, and +/- 5% for a range

Investment staff

and consultant

input.

Maine Public

Employees

Retirement

System

Monthly Uses +/- 5% range from the target allocation. Since

Infrastructure, Real Estate, Private Equity, and

Opportunistic Strategies are illiquid, rebalancing is

not practical or possible.

Purely mechanical

State of

Wyoming

Annually Utilize an overlay program that rebalances at a 3%

threshold.

Investment staff

and consultant

input.

Page 19

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 out-perform 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.”

Page 20

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 Rebalanced within 5 Business

Days Rule

1 September 12, 2012

Pass





6 March 26, 2012

Pass

7 March 27, 2012

8 March 28, 2012

9 March 29, 2012

10 March 30, 2012

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.

Investment

Page 21

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 sub-asset 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

Page 22

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 Standard Deviation Factor

2000 2.10

2004 1.70

2005 1.85

2006 1.80

2007 1.80

2008 1.80

Recommendation: None

Page 23

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

Page 24

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 25

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:

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 on-site 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

Real Estate Portfolio Vintage

Year

Funded Amount Current Market

Value

Expected

Annual Return

of Income

(Distributions)

Expected

Annual Return

of Capital

Expected

Liquidation Date

Full (F) or Partial (P)

Liquidation**

Core Portfolio

ACERA Oakland Building Porfolio 2003 48,098,813 42,826,138 $1,654,386.16 $0.00 N/A N/A

Blackrock Granite Property Fund 2007 50,000,000 25,060,087 $255,207.52 $20,583,783.79 2013 F

JP Morgan Strategic Property Fund 2008 51,668,864 44,793,821 $0.00 $399,905.03 OECF OECF

PRISA 2007 51,556,340 35,812,141 $1,376,923.98 $0.00 OECF OECF

RREEF America REIT II 2006 30,000,000 20,592,290 $0.00 $20,592,290.00 2012 F

RREEF America Separate Account 2003 217,124,361 56,075,359 $458,257.55 $28,037,679.50 2006 F

Total Core Portfolio 448,448,378 225,159,836

Value Added Portfolio

AEW Value Investors Fund II 2007 21,812,461 16,349,456 $3,456,221.00 $0.00 2016 F

CIM Urban REIT 2007 25,148,421 26,728,744 $960,024.00 $0.00 2017 F

CIM Urban REIT II 2012 0 0 $259,000.00 0 2023 F

Heitman Value Partners II 2008 22,751,989 19,630,953 $241,427.97 $0.00 2017 F

JP Morgan Alternative Property Fund 2006 20,000,000 9,672,794 $1,211,803.68 $4,836,397.00 2014 F

PRISA II 2004 43,935,452 34,204,768 $1,151,192.36 $0.00 OECF OECF

Total Value Added Portfolio 133,648,323 106,586,715

Total Portfolio 582,096,701 331,746,551

Page 26

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 Q4-

2013 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.


Page 27

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-to-Value 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.

Page 28

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.

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 re-invest 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.

Page 29

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:


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.

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

Page 30

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

Page 31

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:


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.

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:


1. We recommend that the CIO evaluate whether to insert the recommended language about cash not being a strategic asset.

Investment

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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:


1. Since cash management is an organization-wide process, the forecast should be integrated with budget planning and the Five-Year Business Plan.

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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C. ACERA PREPARES AN ANNUAL CASH FORECAST


TEST 1: ACERA PREPARES AN ANNUAL CASH FORECAST

CONTROL

•This control will test if ACERA prepares and monitors a cash forecast detailing projected inflows/outflows on an annual basis.

RISK

•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.

OWNER •Fiscal Services/Investments

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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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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.

Source: Survey performed by Marguerite Malloy, ACERA Legal Department

Source: Survey performed ACERA Internal Audit Department through APPFA. Additional information

provided by Vincent Brown, ACERA CEO on CALPERS

Retirement

System

Performs Annual

Cash Forecast Comments

VCERA No No, works with Investment Consultant to manage cashflows. Operational

expenses are running $50M over employer contributions.

TCERA 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.

CCCERA 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).

SDCERA 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.

SJCERA Yes Yes, prepares an informal annual cash forecast

Retirement

System

Performs Annual

Cash Forecast Comments

South Carolina

Retirement

Systems

Yes Yes, performs 3 Year Cash Forecast

IOWA PERS Yes Yes, the forecasts done are to “ensure adequate cash is available for the payment

of benefit obligations and the funding of investments

MOSERS 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.

TRS of Texas No, but

investigating

creating a formal

process.

No, don’t have a formal process or requirement for preparing cash flow

projections. The investments division prepares them when necessary. Historically,

they have been very liquid, so there has not been a need. Investment staff are

investigating creating a formal process and would like the accounting staff to

prepare a formal cash forecast going forward.

CALPERS Yes

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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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1. We recommend that ACERA contact other agencies with strong cash management practices to understand best practices they have employed.

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

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

Source: 2002-2011 ACERA CAFRS

5,996 6,287 6,334 6,591 6,892 7,038 7,193 7,319 7,548 7,903

11,338 11,220 10,557 10,514 10,676

10,980 11,136 10,952 10,849 10,746

1,141 1,224 1,407 1,541 1,658 1,766 1,819 1,850 1,847 1,826

18,475 18,731 18,298

18,646 19,226

19,784 20,148 20,121 20,244 20,475

YE 2002 YE 2003 YE 2004 YE 2005 YE 2006 YE 2007 YE 2008 YE 2009 YE 2010 YE 2011

ACERA Membership 2002 to 2011

Retired Active Deferred Total

$225,605

$249,282 $268,579

$285,750 $306,115

$330,390

$33,574 $35,290 $39,098 $38,539 $41,783 $43,490

$10,778 $12,211 $13,315 $12,255 $13,001 $13,306

2006 2007 2008 2009 2010 2011

Total Pension Expenses Total SRBR Expenses Admin Expenses

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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

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.

$223,043 $230,559 $237,448 $243,825 $260,404

$277,795 $269,957

$296,783

$320,992 $336,544

$360,899

$387,186

2006 2007 2008 2009 2010 2011

Incomes & Expense Trend

Contributions Expenditures

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EXHIBIT D – SPIKES IN MONTHLY EMPLOYER 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:

0.00

5,000,000.00

10,000,000.00

15,000,000.00

20,000,000.00

25,000,000.00

30,000,000.00

35,000,000.00

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2011 Summary

Total Expenses Total Contributions


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)

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.

Administration Fiscal Services Investment Benefits

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D. COMMUNICATION BETWEEN ACERA DEPARTMENTS INVOLVED IN THE CASH MANAGEMENT PROCESS IS EFFECTIVE


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.

CONTROL

•Departments involved in the cash management process openly communicate in an effective and timely manner.

RISK

•The cash management process is ineffective due to inadequate communication or miscommunication between departments.

OWNER •All Departments

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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 inter-departmental 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:


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.

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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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:


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.

Fiscal Services

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E. ACERA AVOIDS UNPLANNED DISTRIBUTIONS DUE TO INACCURATE OR INCOMPLETE MONTHLY FORECASTS

Risk Level - High Audit Results – Effective

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.

CONTROL

•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 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.

OWNER •Fiscal Services/Investments/Benefits

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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:

The monthly process is well documented, and considered several routine and non-routine inputs as part of the process. We found no exceptions.

Sample # Sample Date Pass/Fail Comments

Pass

Pass

Pass

Pass

3 April 2012 N/A

4 May 2012 N/A

Monthly Cash Forecast is Accurate

1 February 2012 N/A

2 March 2012 N/A

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Recommendations:


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.

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:

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.

Sample # Sampling DatesCash Log

Reconciliation

General Ledger

Reconciliation

Bank Statements

Reconciliation

1 February 2012 Pass Pass Pass

2 March 2012 Pass Pass Pass

3 April 2012 Pass Pass Pass

4 May 2012 Pass Pass Pass

Reconcile General Ledger to Bank Statements

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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:

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

Sample Date Pass/Fail Comments

Reconcile Cash Receipts with the Cash Receipts Log

February 2012 Pass N/A

March 2012 Pass N/A

April 2012 Pass N/A

May 2012 Pass N/A

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management review. The cash forecast is provided to the Chief Executive Officer (CEO) for final approval. Results:

* 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:


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.

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:

Sample Date Asst Acct Mgr Approval CFO Approval CEO Approval

April 2012 Pass Pass

May 2012 Pass Pass

Pass

Failed, but Compensating

Control in Place

Approval of the Monthly Cash Forecast

February 2012 Pass Pass

March 2012 Pass Pass

Pass

Pass

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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

TEST 1: BENEFITS ENHANCED REPORTING TOOL PROVIDES ACCURATE AND TIMELY INFORMATION

CONTROL

•Management has established effective cash management internal controls.

RISK

•ACERA’s cash is not managed efficiently and effectively causing insufficient funds to meet cash obligations due to inadequate internal controls.

OWNER •All Departments

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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:


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.

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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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 3. Key Control

4. Pass/Fail

5. 1. 6. Submit signed-off checklist and other related reports to Financial Services Specialist II (FSSII) for final normal payroll trial run

7. Key 8. Remediated

9. 2. 10. Benefits staff should check with Benefits Manager if exception to payroll processing is warranted

11. Key 12. Pass

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Results – Fiscal Services Department Monthly Payroll Controls

The Fiscal Services Department identified five internal controls, of which two were considered key controls:

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.

Samples #Sampling

Dates

Audit Control

Form

Payroll Reports vs.

Check Request

1 Oct-11 Pass Pass

2 Jan-12 Pass Pass

3 Feb-12 Pass Pass

4 Mar-12 Pass Pass

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Recommendations:


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.

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 15. Key Control

16. Pass/Fail

17. 1. 18. A benefit staff researches and notifies FSSII to run another trial.

19.

20. Key Not Tested

21. 2. 22. Void and reissue process 23.

24. Key Not Tested

3. 25. Benefits staff researches and corrects and notifies FSSII to run another trial

Non-Key Not Tested

4. 26. Match payroll reports to check request 27.

Key Not Tested

5. 28. Submit check print and audit control form to Assistant Accounting Manager or Retirement Accountant (RAIII) for approval

29.

Key Not Tested

6. 30. Administrative staff receives checks and reconcile to check pull report

31.

Non-Key Not Tested


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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 Key Control

Pass/Fail

1. 32. Liquidation requests cannot be initiated without capital call letters from investment managers or email requests from Fiscal Services.

33.

Key Pass

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.

Key Remediated

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.

Key Pass

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.

Key Pass

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.

Key Pass

6. 42. Wire instruction letters are prepared by analysts, but will not become valid unless signed off by authorized signers.

43.

Key Pass

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.

Non-Key Not Tested

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# 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:


We recommend that cash management internal controls be tested regularly by Management to confirm the controls are working effectively.

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. Cash Management Policies and Procedures are Documented 2. ACERA Manages Cash Efficiently by Ensuring Funds are Fully Invested 3. ACERA Prepares An Annual Cash Forecast 4. Communication Between ACERA Departments is Effective 5. ACERA Avoids Unplanned Distributions 6. 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. We recommend implementing an organization-level Cash Management Policy and clearly defined communication protocols between departments.

2. We recommend preparing annual forecasts, which incorporate long-term planning assumptions for cash utilization.

3. We recommend investigating the root cause of the BERT refresh failures to ensure a permanent solution is place.

4. We recommend reviewing the process and procedures around leverage and reinvestment of dividends to ensure we are employing best practices.

5. We recommend that employees managing critical functions in the cash management process have adequately trained backup.

Documents

CASH MANAGEMENT AUDIT OCTOBER 2012 - acera.org · Page 5 AUDIT OBJECTIVE The objective of this audit was to provide assurance to Senior Management and the Board of Retirement, that