Friday, April 18, 2014

Missing the Mark: Another Shot at the NC Pension Plan

Missing the Mark: Another Shot at the NC Pension Plan

Once again I was digging through CalPERS Annual Report when I was distracted by an email entitled, “Nation's Seventh Largest State Pension Can't Afford Financial Audit.”  The email was from Edward Siedle, President of Benchmark Financial Services, who is more than a little upset that the North Carolina’s Comprehensive Annual Financial Report (CAFR), and the State’s underlying pension plans aren’t audited by an outside firm.[1]  In North Carolina, State Auditor Beth Wood provides the accounting review.  The eye-catching email headline was derived from a comment Mr. Siedle received from the State Treasurer’s Office, which said in part: “the high costs of a stand-alone audit would be unlikely to produce any significant additional information.”
Donor Advised Funds (2001)
Mr. Siedle concludes his lengthy critique on North Carolina’s failure to engage an independent auditor with two unwarranted warnings:

Clearly, a stand-alone audit of the $87 billion fund could provide meaningful additional information, would be well worth the limited cost and is decades overdue.

In my forensic experience whenever someone says an investment fund can’t afford an audit—be very, very concerned.

As I read Mr. Siedle’s analysis, I thought about Stockton, San Bernardino, Jefferson County, Harrisburg, Detroit, and Detroit’s retirement plans.  Do you know what all these bankrupt entities have in common?  Independent Auditors.  How about two of the most underfunded pension plans in the country in Illinois and Chicago?  Independent Auditors.

Perhaps the independent auditors of public pensions aren’t sophisticated enough to do the job.  I decided to make a quick survey of major accounting firms and their track record in valuing complicated investments like alternatives and derivatives.  Before the credit crisis, four major accounting firms -- KPMG, Deloitte, Ernst & Young, and PricewaterhouseCoopers -- were paid hundreds of millions of dollars to audit America’s major financial institutions.  Did they provide “meaningful additional information” to investors and the other stakeholders in Fannie Mae, Freddie Mac, Lehman, Citigroup, Bank of America, Countrywide Financial, Bear Stearns, Washington Mutual, and Merrill Lynch?  No.

Mr. Siedle isn’t completely off base when he raises concerns about the ability of North Carolina’s State Auditor to effectively audit the state’s pension plan.  However, he totally misses the source of the problem.  Rather than question Auditor Wood’s competence, Mr. Siedle should consult the State’s budget.[2]  Auditor Woods has been operating with the same budget appropriation for at least the last four years, and her budget for next year shows no increase.  Like all too many agencies in North Carolina, the Office of the State Auditor has been starved for resources.  I urge Mr. Siedle to advocate for additional positions and salary in Auditor Woods’ agency.  While I’m sure he doesn’t intend it, Mr. Siedle’s urgent call for an independent auditor would cause his client, SEANC, to lose a few members as the audit function was outsourced.
In building his case for an external auditor, Mr. Siedle cites an accounting irregularity in 2010 involving North Carolina’s securities lending program.   The irregularity was rectified by the State Treasurer and audited by the State Auditor.[3]  Everyone involved agreed that it was a serious matter, and the Auditor called upon the Treasurer to tighten internal controls.  Mr. Siedle also notes that the State Treasurer is in litigation with the pension plan’s master custodian over certain lost income in the securities lending program.  Mr. Siedle wonders aloud, how North Carolina can continue to retain Bank of New York Mellon given the ongoing dispute.  The answer is straightforward.  The State Treasurer doesn’t have much choice.

Just as the accounting world has shrunk down to the big four, the world a global mater custodians is pretty much limited to JPMorgan Chase, State Street Bank and Trust Company, Citigroup, and The Bank of New York Mellon.  As far as I can tell every one of these custodians had similar types of issues in the wake of the credit crisis, and there’s all sorts of litigation between pension plans and their custodians.  If the State Treasurer had fired the incumbent and hired one of the other three major firms, Mr. Siedle would probably be alarmed that Treasurer Cowell had hired the new firm given its historical problems.

In trying to understand what is really at stake, I highly recommend that Mr. Siedle and SEANC consult the state budget.  The Financial Operations Division of the Department of State Treasurer is responsible in the first instance for accounting for the income and losses of the securities lending program.  The state budget shows that the General Assembly has not provided the funding required for that division to keep up with the growth and complexity of securities lending or investments in general.  Salaries and positions have been largely frozen for years. 

Mr. Siedle is correct when he asserts that the investments of the state pension have become more complex over the last decade.  The members of SEANC and North Carolina’s taxpayers would be better protected if we devoted greater resources to better oversight and analysis.   So far, Mr. Siedle’s inquiries have largely benefitted the Wall Street lawyers who are culling through his public records request.  In his latest pronouncement he is asking us to outsource the audit function.  While I think Mr. Siedle is right that the pension plan could afford an outside auditor, his cost estimate of $150,000 is low.   At the same time, Treasurer Cowell is probably right.  An outside audit wouldn’t tell us much more than we already know.  I strongly believe we should be investing more in the people who already invest, account for, and audit our pension plan.

There are two ironies in Mr. Siedle’s pronouncements thus far.  For someone who has a genuine concern about the rising costs of managing pension investments, he seems intent on pushing those expenses still higher.  Second, as a consultant for the state employee association, I would have expected him to be an advocate for the professionalism, compensation, and security of public servants.

[1] His complete comments are at:

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