Different audit types: operational, forensic
Your June 27 editorial, "Audit consultants," states that "trustees by and large have not scrutinized the activities of either consultants or those of their own fund." In response, we have two points. The first is that in fact, while this statement is probably correct "by and large," many pension fund boards of trustees have "scrutinized" their consultants and their own funds. Secondly, when considering whether and how to scrutinize investment consultants and funds, boards as well as regulators should distinguish between various types of "audits" that may, or may not, make sense under various circumstances.
Since the early 1990s, our firm has assisted numerous public and ERISA-covered pension funds in evaluating a wide range of their investment-related functions and processes, compared to industry best practices. These evaluations often cover several aspects of the role of the regular investment consultant, including, but not limited to:
• the adequacy of the consultant's scope of services, in light of the fund's particular needs;
• how the consultant's actual performance compares to its contractual duties;
• the methodologies the consultant employs to produce its analysis and advice;
• whether and in what respects the consultant suffers conflicts of interest;
• the controls the fund has established (if any) to detect and manage such conflicts; and
• the reasonableness of the structure and amount of fees (hard dollars and soft) the consultant receives in connection with its role.
These many "operational review" projects — or as the industry often calls them, "investment fiduciary audits" or "performance management audits" — typically are geared to produce forward-looking, concrete recommendations designed to enhance the pension fund's policies, procedures and practices. Our work along these lines evaluates (as your editorial puts it) "what policies and procedures the pension funds had to guard against unbiased advice, and what kind should they adopt now." So, for example, we often have identified conflicts of interest that may compromise the objectivity of the advice the consultant provides the client and have recommended enhanced controls, disclosures and contractual terms the board should adopt to address the situation going forward.
By contrast, the type of "forensic audit" your editorial mentions is a different type of exercise, more oriented toward civil or even criminal legal proceedings. The purpose of this type of audit is to determine the who, what, when and how of negligent or fraudulent behavior. This typically entails investigating a complex web of evidence; seeking to resolve fuzzy or disputed versions of the facts in order to determine what "really" happened; and, finally, seeking to assign liability (as in a court proceeding) for unlawful or inappropriate past conduct that caused losses. This requires sophisticated determinations of cause and effect, e.g., whether certain conduct by certain parties actually and demonstratively caused the pension fund to suffer quantifiable losses.
The forward-looking operational review — as a constructive planning tool, designed to upgrade policies and procedures — should help avoid future fiduciary breaches and losses, reduce undue costs, control risk and enhance public confidence in the fund's ongoing investment program and practices. On the other hand, once a board of trustees or regulators conclude that breaches and resulting losses may have already occurred, a forensic audit — seeking to assign liability — may well be warranted.
executive vice president
Independent Fiduciary Services Inc.