REPORT DIGEST

 

ILLINOIS STATE BOARD
OF INVESTMENT

 

COMPLIANCE EXAMINATION

For the Year Ended:

June 30, 2006

 

 

Summary of Findings:

Total findings this report            3

Total findings last report            1

Repeated findings                     1

 

Release Date:

May 24, 2007

 

 

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 Full Report

are also available on

the worldwide web at

http://www.auditor.illinois.gov

 

 

 

 

 

 

 

SYNOPSIS

 

·        The Illinois State Board of Investment (Board) does not have an adequate established accounting and financial reporting process for determining the fair value measurements and disclosures, selecting appropriate valuation methods, and identifying and adequately supporting significant assumptions used for its alternative investments. 

 

·        The Board identified deposits and investments in their June 30, 2006 financial statements that were exposed to custodial credit risk.  In addition, the Board disclosed they did not have a formal policy to address custodial credit risk.

 

 

 

 

 

 

 

 

 

 

 

 

 

{Financial information and activity measures are summarized on the reverse page.}

 


 

 

 

 

ILLINOIS STATE BOARD OF INVESTMENT

INFORMATION FROM COMPLIANCE EXAMINATION

YEAR ENDED JUNE 30, 2006

 

SCHEDULE OF OPERATIONS

FY 2006

FY 2005

REVENUE:  Investment Income - Interest............................

Investment Income - Dividends.........................

Investment Income - Securities Lending...........

Realized Gain on Investments..........................

Unrealized Gain on Investments......................

Total Investment Income.............................

External Support (Investment Expense) ........

Total Revenue (Net Investment Income)....

EXPENSES:Operating Expenses.......................................

Revenue over Expenses............................

$   183,047,403

       123,178,718

           4,321,712

             775,805,644

       116,794,342

  $1,203,147,819

       (28,556,047)

$1,174,591,772

$    (1,586,585)

$1,173,005,187

 $    142,444,438

        119,713,292

     3,674,829

505,168,829

   260,921,934

   $1,031,923,322

  (23,025,047)

$1,008,898,275

$    (1,457,162)

   $1,007,441,113

INVESTMENT PORTFOLIO ANALYSIS – Fair Value

JUNE 30, 2006

JUNE 30, 2005

Total Government Obligations..............................................

Total Corporate Obligations................................................

Foreign Obligations............................................................

Fixed Income Options.......................................................

U.S. Common Stock & Equities........................................

Preferred Stock ...............................................................

Non – U.S. Equity Securities............................................

Real Estate Investments..................................................

Private Equity.................................................................

Hedge Funds..................................................................

Money Market Investments...........................................

Forward Foreign Currency Contracts..............................

     Total Investment Portfolio.........................................

$  1,111,089,551

1,382,574,163

104,455,671

(169,563)

5,369,124,032

1,057,334

1,113,268,102

1,134,025,154

482,264,036

416,462,183

320,641,552

              26,145

  $11,434,818,360

$ 1,130,079,107

1,645,591,189

88,970,486

(251,151)

5,579,812,196

487,946

986,200,950

778,951,123

466,871,030

0

283,461,008

         (497,874)

$10,959,676,010

INVESTMENT RETURNS – ACTUAL (bold) & BENCHMARK (unaudited)

FY 2006

FY 2005

Total Fund...................................................................

Composite benchmark...................................................

U.S. Equities..............................................................

Wilshire 500 Index......................................................

Non- U.S. Equities....................................................

MSCI-EAFE Index......................................................

Fixed Income............................................................

Lehman U.S. Universal Bond Index..........................

Real Estate.........................................................

NCRIEF Real Estate Index.....................................

Private Equity......................................................

11.0%

11.5%

10.7%

10.0%

28.9% 

27.1%

0.8% 

(0.3)%

19.5% 

18.7%  

21.3%

10.1%

10.9%

9.3%

8.4%

14.8% 

14.1% 

6.9%  

7.4% 

14.8%

15.6%     

29.6%

SUPPLEMENTARY INFORMATION

FY 2006

FY 2005

Average Number of System Employees................................

Total Brokerage Commissions Paid (unaudited)....................

Total Investment Manager Fees..........................................

11

$2,777,611

$27,434,504

10

$3,316,588

$22,010,299

EXECUTIVE DIRECTOR

During Audit Period:  William R. Atwood

Currently:  William R. Atwood


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Inadequate process for determining fair value for alternative investments

 

 

 

 

 

 

Board staff performed additional procedures to address AICPA guidance and auditor requests

 

 

 

 

 

 

 

 

 

Reportable condition

 

 

 

 

Lack of an established process led to significant delays in completing the Board’s audit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$80,566,513 of Board deposits were not insured or collateralized for amounts in excess of FDIC coverage

 

$56,122,313 of Board investments were uninsured or held by a trust department or agent not in the Board’s name

 

 

No formal policy to address custodial credit risk

 

 

 

The State Officers and Employees Money Disposition Act notes when deposits are in excess of FDIC coverage other collateral shall be obtained 

 

 

 

 

 

 

 

 

 

Board does not believe State law applies to them

 

 

 

 

 

Auditors’ comment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funding legislation was changed to reduce the required employer (State) contributions to participating retirement systems for fiscal years 2006 and 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

INTRODUCTION

 

      This digest covers our compliance examination of the Illinois State Board of Investment for the year ended June 30, 2006.  A financial audit covering the year ending June 30, 2006 was issued separately. 

 

FINDINGS, CONCLUSIONS, AND RECOMMENDATIONS

 

INADEQUATE PROCESS FOR VALUATION OF ALTERNATIVE INVESTMENTS

 

The Illinois State Board of Investment (Board) does not have an adequate established accounting and financial reporting process for determining the fair value measurements and disclosures, selecting appropriate valuation methods, and identifying and adequately supporting significant assumptions used for its alternative investments.  Alternative investments comprise over 20% of the Board’s total investments and include real estate, private equity, and hedge funds. 

 

In connection with the issuance of recent guidance by the American Institute of Certified Public Accountants (AICPA) relating to auditing alternative investments and requests made from the auditors, management did perform extensive additional procedures and evaluation of alternative investment valuations.  However, theses procedures were performed primarily to address the current year financial statement audit requirements and were not part of an ongoing comprehensive internal control process related to the valuation of alternative investments. Additionally, there were certain areas within the alternative investments, including hedge funds, of which management had limited available information of the underlying investments.

 

This finding is considered to be a reportable condition.  In our judgment, the reportable condition can adversely affect the Board’s ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements.

 

Failure to establish an adequate accounting and financial reporting process for alternative investments could result in the improper reporting of the fair value of investments and result in a qualification of the audit opinion on the Board’s financial statements. In addition, lack of an established process at the Board resulted in a significant delay in completing the financial statement audit.  (Finding 1, pages 9-10)

 

We recommended the Board review its current process for determining the fair value measures and disclosures for alternative investments and develop written procedures related to the determination of fair value measurements, selecting appropriate valuation methods, identifying and adequately supporting assumptions used, and assignment of responsibilities.  Further, the Board should evaluate their current staffing to determine whether appropriate resources exist and work with external investment managers to obtain the necessary financial information on a timely basis.

 

Board officials agreed with our recommendation noting they developed a comprehensive plan that contained additional procedures and evaluations of alternative investment valuations for the fiscal year 2006 financial audit process.  The Board went on to note the scope and depth of the fiscal 2006 plan has been expanded with the implementation of protocols and procedures contained in that plan as well as with additional staff resources.

 

DEPOSIT AND INVESTMENT CUSTODIAL CREDIT RISK

 

     At June 30, 2006, the Board had $80,566,513 of deposits held in their investment related bank account exposed to custodial credit risk.  The deposits were neither insured nor collateralized for amounts in excess of the federal deposit insurance coverage of $100,000.  In addition, the Board also identified $56,122,313 of investments that were uninsured and unregistered, with the securities held by the counterparty or by its trust department or agent but not in the Board’s name.

 

     Custodial credit risk is the risk that in the event of a financial institution failure, the Board would not be able to recover the value of the deposits or investments in the possession of an outside party.  The Board noted they did not have a formal policy to address custodial credit risk.

 

     The State Officers and Employees Money Disposition Act (Act)  (30 ILCS 230/2c) provides that whenever funds deposited with a bank or savings and loan association exceed the amount of federal deposit insurance coverage, a bond, pledged securities, or other eligible collateral shall be obtained.  Board management indicated this issue is pending from first being identified in the prior year report and they are awaiting an opinion from the Illinois Attorney General.

 

     We recommended the Board develop a formal policy to address custodial credit risk as it relates to deposits and investments.  (Finding 3 page 13-15)

 

     Board officials responded to the recommendation noting their counsel is of the opinion that the Board is not subject to the Act.  The Board has requested an opinion from the Illinois Attorney General regarding applicability of the Act to them.  The Board went on to respond that once they receive a response from the Illinois Attorney General they will consider adopting a policy regarding custodial credit risk and applicability of the Act.

 

     The auditors included a comment to the Board’s response noting they believe the Board is part of the Executive branch of the State government and is subject to the provisions of the Act.

 

OTHER FINDING

 

The remaining finding is reportedly being given attention by the Board. We will review the Board’s progress towards implementation of our recommendation during our next engagement.

 

 
PENSION FUNDING LEGISLATION

 

      In June 2005, Public Act 94-0004 became law.  This legislation modified the funding plan of the State Employees’ Retirement System, Judges’ Retirement System and General Assembly Retirement System. The legislation included funding reductions of approximately $496.4 million and $429.4 million in fiscal year 2006 and 2007 respectively, for employer contributions to the State Employees’ Retirement System, Judges’ Retirement System and General Assembly Retirement System.  This reduction in funding resulted in an increase in member systems’ withdrawals from the Board in fiscal year 2006 of $211.3 million to meet their respective funding requirements for benefit obligations.

         

AUDITORS’ OPINION

 

      We conducted a compliance attestation examination of the Board for the year ended June 30, 2006 as required by the Illinois State Auditing Act. 

 

 

 

 

____________________________________

WILLIAM G. HOLLAND, Auditor General

 

WGH:RPU:pp

 

SPECIAL ASSISTANT AUDITORS

 

      KPMG, LLP were our special assistant auditors for this engagement.