REPORT DIGEST

OFFICE OF THE TREASURER

FISCAL OFFICER RESPONSIBILITIES

FINANCIAL AUDIT AND COMPLIANCE EXAMINATION

For the Year Ended:

June 30, 2008

Summary of Findings:

Total this audit                   1

Total last audit                   1

Repeated from last audit    1

Release Date:

April 21, 2009

State of Illinois

Office of the Auditor General

WILLIAM G. HOLLAND

AUDITOR GENERAL

To obtain a copy of the Report contact:

Office of the Auditor General

Iles Park Plaza

740 E. Ash Street

Springfield, IL 62703

(217) 782-6046 or TTY (888) 261-2887

This Report Digest and the Full Report are also available on

the worldwide web at

http://www.auditor.illinois.gov

SYNOPSIS

·        The Office did not maintain adequate controls during the preparation of the Fiscal Officer Responsibilities financial statements and notes to the financial statements.  

        {Expenditures and Activity Measures are summarized on the reverse page.}

Lack of controls over financial statement preparation

Understatement of $57,312,500

Difference of $55,197,474

Trust’s Attorneys continue to pursue the matter

Foreclosure sale October 18, 2007

November 1, 2007 court issued judicial deed

Sale closed August 26, 2008

Trustee currently pursuing collection proceedings

Trust purchased President Lincoln Hotel on March 4, 2008

FINDINGS, CONCLUSIONS, AND RECOMMENDATIONS

NEED TO IMPROVE CONTROLS OVER FINANCIAL REPORTING      

      The Office did not maintain adequate controls during the preparation of the Fiscal Officer Responsibilities financial statements and notes to the financial statements.  We noted the following:

·        An adjusting entry for securities lending collateral was not properly recorded as the balance was understated by $51,312,500.

·        An adjusting entry for clearing cash reconciling items was not properly recorded as money market account balances were overstated by $2,581,631, clearing account deposits and deposits in transit were overstated by $2,171,808 and agencies’ deposits outside the State Treasury were overstated by $4,753,439. 

·        An incorrect amount was reported in the Deposits and Investments Note (Note D) for the market value of securities on loan as of June 30, 2008.  The amount was reported as $1,399,725,017, but should have been $1,454,922,491, a difference of $55,197,474.

      Strong management controls require procedures to include proper checks and balances and adequate supervision in all fiscal related activities to ensure proper financial reporting.  In addition, the Fiscal Control and Internal Auditing Act requires State agencies to establish and maintain a system, or systems, of internal fiscal and administrative controls to provide assurance that financial data is properly recorded and accounted for to permit the preparation of reliable financial reports.  (Finding 1, pages 11-12)

      We recommended the Office establish and maintain effective controls over the financial reporting process to ensure the accurate submission of financial data, including a timely and adequate review of the financial statements and notes to the financial statements. 

      Treasurer officials agreed with our finding and recommendation and stated they will continue to evaluate and strengthen controls over the financial reporting process to ensure the accurate submission of financial data, including timely and adequate review of the financial statements and notes to the financial statements.

OTHER DISCLOSURES

ILLINOIS INSURED MORTGAGE PILOT PROGRAM TRUST                                    

      As of June 30, 2008 there were two properties in the Illinois Insured Mortgage Pilot Program Trust (Trust).  The Trust held the mortgage loans on the properties as underlying collateral for the State’s investment in the program.  The two properties are hotels, the Abraham Lincoln Hotel and Conference Center (formerly the Renaissance) in Springfield and the Holiday Inn in Collinsville.

      The recorded value for these investments was $6,439,000 as of June 30, 2008, and the loan balance was $36,748,000. 

        The mortgage loans on the two properties are considered nonperforming assets.  Accrued interest receivable at June 30, 2008 for the nonperforming assets approximated $1,517,000.  Interest on nonperforming assets is recognized when collected, and therefore has not been recorded on the financial statements.

      In 1995 the Treasurer authorized the Trustee to sell the mortgage notes to the hotel owners for $10 million.  The Illinois Attorney General opined that his consent to the proposed sale in 1995 was required, and he refused to give it.  As a consequence, the Treasurer did not proceed with the transaction.  Affiliates of the owners of the hotels filed a lawsuit against the Trustee and the Treasurer seeking specific performance of the buy-sell agreement on the terms agreed to. 

      On March 13, 2000 the Circuit Court in Madison County entered a judgment order requiring the Trustee and the Treasurer to sell the mortgage loans on the hotel properties to the plaintiffs.  The Court found that the plaintiffs were ready, willing and able to perform the buy-sell agreements at the time originally set for closing in 1995.  The Trustee and the Treasurer appealed the order.  Briefings on the appeal were completed in February 2001, and oral arguments followed.  The Illinois Appellate Court, Fifth District, affirmed the Circuit Court’s decision in all material respects.  An appeal of that ruling was petitioned by the Trustee to the Illinois Supreme Court and granted on October 7, 2003.  As of June 3, 2005, the Illinois Supreme Court reversed the Appellate Court’s decision on the basis of sovereign immunity.  The plaintiffs have requested that the Illinois Supreme Court reconsider its decision.  If the Illinois Supreme Court declines to do so, the case will be remanded to the Madison County Circuit Court and the stays will be vacated. 

      The Trustee of the Illinois Insured Mortgage Pilot Program, at the direction of the Illinois State Treasurer, filed two lawsuits on October 31, 1997, one against the Collinsville Hotel Venture and the other against the President Lincoln Hotel Venture, for breaching their cash flow notes by improperly deducting capital expenditures from cash flow in violation of their respective loan agreements.  The loan agreements provide that capital expenditures may be deducted from cash flow only to the extent that payments pre-approved by the Trustee are made by the Ventures into a capital reserve account.  The Trustee claims that these violations of the loan agreements, and the failure of the Ventures to pay upon demand money they improperly deducted from cash flow, constitute a default of the notes making them immediately due and payable.         

      The two lawsuits were filed in Cook County.  The borrowers both asked the Court to stay the lawsuits while the Madison County action was pending, and their motions were granted.

      After the final judgment was entered in the Madison County case, the Judge in Cook County who was presiding over the Collinsville case lifted his stay.  Plaintiffs in the Madison County case then asked the Court to hold the Trustee and its counsel in contempt for pursuing the Cook County case.  Eventually, the Trustee petitioned the Illinois Supreme Court for a supervisory order to allow it to proceed prosecuting the Cook County case without being held in contempt by the Madison County Court.  The Supreme Court issued such a supervisory order in the fall of 2001, and the Cook County case is now proceeding.  However, the Cook County case against the Springfield Hotel remained stayed. 

      As a result of discovery in the Collinsville case, the Trustee has determined that there have been additional events of default, and as a result it has now filed an amended complaint.  In 2006, the Circuit Court of Cook County entered judgment in favor of the Trustee and against the borrowers declaring that the loan was in default and authorizing the Trustee to pursue collection proceedings against the personal guarantee.  The borrowers petitioned the Court to reconsider its order.  The petition was rejected by the Court and collection proceedings have been commenced against the guarantors.  Citations to discover assets of the guarantors have been served and continue to be pursued.  

      In 1997, the Trustee endeavored to draw on the letters of credit then in its possession.  That attempt was enjoined by orders entered in the lawsuit filed in 1995 seeking to compel the Trustee to sell the borrower’s loan documents.  As of April 24, 2006, such orders ceased to bind the trustee.  In July of 2006, the Trustee again presented drafts on all letters of credit and has collected $439,625 from the Bank of Edwardsville, $300,000 from U.S. Bank National Association and $260,000 from Bank of America.  The payments were recorded as a reduction of principal in fiscal year 2007.  Regions Bank is refusing to pay the letters of credit it holds, which total $1,637,375.  A suit against Regions Bank has been filed.  As of June 30, 2008, the Trust’s attorneys continue to pursue this matter.      

      On January 2, 2007, Park National Bank, Trustee of the Illinois Insured Mortgage Pilot Program Trust, filed foreclosure complaints against both the Collinsville Hotel Venture and the President Lincoln Hotel Venture.  The Collinsville hotel foreclosure complaint was filed in the Madison County Circuit Court.  The foreclosure complaint requested the court appoint a receiver to operate the Hotel during foreclosure proceedings, and on January 12, 2007, an order appointing a receiver was entered.  The receiver assumed management of the property that day.  Pursuant to the Judgment of Foreclosure and Sale, which was entered on May 17, 2007, the Madison County Court conducted a foreclosure sale on October 18, 2007.  At that sale, the Hotel and all associated property were sold to the Trust, as high bidder on the property, for $25,375,654.  The sale price was paid in full through the Trust’s credit of the sale prices against the unpaid principal and interest secured by the mortgage on the property.  On November 1, 2007, the court issued a judicial deed, and the Trust therefore took title to the property.  Through a real estate auction house, the Trust began marketing the property to potential private buyers.  After a sealed bid auction, the Trust sold the property to a hotel developer for $5.25 million.  The sale closed on August 26, 2008.  The parties remain in post closing phase, sorting through final distribution of outstanding assets that were sold with the hotel and issues such as payment of outstanding property taxes. 

      The Trustee is, concurrently, pursuing collection proceedings with respect to the judgment it obtained against the guarantors, and it has filed a lawsuit in the United States District Court for the Northern District of Illinois against Regions Bank to seek payment on four letters of credit, totaling $1.65 million, that were additional collateral for the loan.  Before settling this litigation, the parties needed to resolve an outstanding lien held by the IRS on one of the properties.  On September 29, 2008, the Circuit Court of Cook County confirmed the sale of property and a portion of the funds will be applied to the cost of the sale, the remainder of the funds were applied to satisfy the IRS lien.  The IRS then released its tax lien against the debtor.  The parties are in the midst of settling this litigation.

      The President Lincoln hotel foreclosure complaint was filed in the Sangamon County Circuit Court following a ruling in December 2006 by a Cook County circuit judge declaring the Hotel to be in default of its loan.  The complaint also requested the court appoint a receiver to operate the Hotel during foreclosure proceedings.  On March 1, 2007, a court-appointed receiver formally took over operations of the President Lincoln Hotel.  On January 18, 2008, the Circuit Court of Sangamon County entered a Judgment of Foreclosure and Sale against all defendants.  On March 4, 2008, the Trust purchased the President Lincoln hotel for $100,000; the sale price was paid in full through the Trust’s credit of the sale price against unpaid principle and interest of the mortgage note.  The court confirmed the sale on March 14, 2008.    

AUDITORS’ OPINION

      The auditors stated the financial statements of the Office of the Treasurer, Fiscal Officer Responsibilities, as of and for the year ended June 30, 2008 present fairly, in all material respects the Assets, Liabilities and Accountabilities and the results of investment activity of the Treasurer, Fiscal Officer Responsibilities.  The auditors noted the financial statements have been prepared on a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America.

                  ___________________________________

                  WILLIAM G. HOLLAND, Auditor General

WGH:JSC:pp

SPECIAL ASSISTANT AUDITORS

      Crowe Horwath LLP was our special assistant auditors on this engagement.