OLYMPIA - A performance audit of the $37 billion Washington State Board of Investment, Olympia, found its investments generally are sound, but monitoring operational performance need improvement.
The audit, issued by State Auditor Brian Sonntag and completed by Independent Fiduciary Services Inc., Washington, made 43 recommendations, mostly operational ones.
The report found the investment program and practices were fundamentally sound, but monitoring whether procedures were being followed seemed to be lacking.
On the investment side, the audit recommended that the chief investment officer's job description include setting periodic rebalancing procedures.
"Although the WSIB has articulated some general standards for rebalancing, we believe the board should articulate more specific policies," the report said,
It also noted the board's investment guidelines for individual managers needed to be improved, especially concerning derivatives.
"For example, the guidelines for fixed-income managers do not adequately prohibit high risk mortgage-backed derivatives . . . which we understand the board and staff intend to exclude from the portfolio," the report said.
It also said the board needed to improve monitoring real estate investments, and to create concrete frames of reference - benchmarks - for certain real estate operating expenses.
Among the operational recommendations: establish and staff an internal audit function; create an asset-liability report; and seek written clarification from the state attorney general one whether the board may hire independent counsel.
Deputy State Auditor Linda Sheler said both the board and the state auditor were pleased with the report. She added the board already has started working on many of the recommendations. The report, presented to the board April 3, was requested by state Treasurer Daniel K. Grimm.
The absence of an internal audit function concerned IFS officials, the report said. While an outside auditor tests the fairness of financial statements, internal controls and compliance with state laws, the internal auditor could monitor the adequacy of brokerage and other transaction costs, and compliance among managers with investment guidelines and risk controls.
"If you are going to put a policy in place, you pretty clearly want to have follow through," said Samuel "Skip" Halpern, executive vice president and general counsel at IFS.
In response to the report, board members agreed an internal controls would improve the system. They noted, however, the board has received clean financial and compliance audits from the state auditor's office for the past five years.
As for the asset-liability report, the audit recommends the report be jointly written by the state actuary, the executive director of the Washington investment board and heads of other state agencies concerned with liabilities. The report would review the funded status of each plan, actuarial assumptions, anticipated cash flow and investment strategy. In Washington state, the board is only concerned with the investment side; the state actuary handles the liability side. The joint report would combine asset-liability information in one document.
In the legal area, the IFS report recommended the board contract legal assistance. While the attorney general's office is the legal representative for all state agencies, it isn't able to respond quickly enough and with the needed level of special expertise, the report said.
Executive Director James Parker agreed an-house legal counsel was needed, especially someone with fiduciary experience.
IFS' Mr. Halpern added IFS was concerned with the hypothetical situation where the board is accused of an alleged breach and the attorney general decides not to represent the board.
"There needs to be a policy in place because otherwise politics could really get in the way," Mr. Halpern said.
Mr. Parker said he agreed with IFS' recommendation to improve communications with the board's constituencies. IFS recommended the board report investment performance and fees to legislators, participants and other groups involved with the pension fund. IFS said the board should develop a consolidated annual report to for the various groups to better understand the board's functions and investment decisions.