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					    49th Annual ACUA Conference
             September 2005

     Investment Auditing
        Special Topics
External Investment Managers


   Bob Mullins, Director, Internal Audit HHMI
Greg Loftin, Assoc. Director, Internal Audit HHMI
  Alicia Rose, Partner, Deloitte & Touche, LLP
Agenda

 HHMI’s Experiences
 Selection Policy & Process
 Selection Process Considerations
 Key Differences between Selection & Monitoring Processes
  & Considerations
 Developing & Improving the Processes
 Q&A …please ask throughout session too.




                               2
Overview

 Colleges & Universities are increasingly using External
  Investment Managers to manage endowment money
 Fiduciary responsibility and need to manage risks remains
  with College/University
 ―Scandals‖ in the investment management arena, greater
  public awareness and transparency of College/University
  investments, wider variety and use of ―riskier‖ investments
  (i.e. hedge funds and private equity products), questions
  from boards and governance committees ….all lead to
  increased need for managing and monitoring of external
  managers
 What should you know and where should you start?




                              3
HHMI’s Experiences

 Endowment established 1985 $4.2 bn vs $14bn+

 Largely internally managed until 1990’s

 Now roughly 85% externally managed

 More complex investments

 More managers means a more complex control
  environment




                              4
HHMI’s Experiences

 Two reviews: 1991 Introduction. 1996 Comprehensive.

 1996 covered all important functional areas.

 Objective was to develop comprehensive understanding of
  the full range of investment activities.


 Allowed us to develop a risk analysis to guide future
  reviews consisting of 16 auditable domains.




                              5
The Auditable Domains -- Systems

   Absolute Return Risk Management System
   BARRA Risk Management System
   Bloomberg Portfolio Trading System
   PACE Investment Data Warehouse
   PORTIA Portfolio Accounting System
   Private Investments Application
   FXall Foreign Exchange Trading System
   End-user developed systems




                              6
The Auditable Domains -- Operations

   Trade Initiation & Processing
   Currency
   Fixed Income
   Private Investments
   U.S. Equity




                              7
The Auditable Domains

   Risk Management & Reporting
   Collateral Management
   Conflict of Interest
   Counterparty Selection & Monitoring
   Custodial Services & Fees
   Human Resources Management
   Income Requirements & MRO
   Investment Accounting
   Investment Management Reporting
   Performance Measurement & Reporting
   Policies & Desk Reference
   Records Retention
   Regulatory Reporting
   Securities Lending
   Use of Leverage
   External Investment Managers

                              8
Overview of External Manager Relationship

 Identification

 Selection of Strategies/Managers

 Investment Manager Agreement

 Portfolio Reporting

 Periodic Monitoring

 Disengagement




                             9
Policy & Process for Selection

 Who is involved with setting the Policy?
   – Board of the College/University

   – Investment Committee

   – College/University Investment Office

 What should be considered in the Process?
   – Asset Allocation & Investment Strategy

   – Operations & Compliance Control Activities

   – Risks to College/University Finances & Reputation




                               10
Policy & Process for Selection (cont’d)

 How can the Process be                    DOCUMENTS YOU MAY HAVE OR
                                               MAY WISH TO CONSIDER
  accomplished?                                REVIEWING

                                               Form ADV Part I and Part II
   – Investment Research
                                               Corporate & Structural
   – Background Checks                          Organizational Chart

                                               Compliance Manual & Code of
   – Other ―Clients‖ and Service                Ethics
     Providers                                 Operational Practices Manual:
                                                including Trading,
   – Document Reviews                           Reconciliations, Valuation
                                                Procedures

   – Fact Gathering – through                  Business Continuity Plan
     Questionnaire                             SAS 70 – if available

                                            
   – On-Site Visit of interviews & walk-        Private Placement
                                                Memorandum – if applicable
     throughs

   – Sample Testing of certain activities


                                11
Considerations for the Selection Process

 Appropriate Asset Class & Investment Strategy

 Controls over Regulatory & Operational Activities
   – Portfolio Management

   – Trading & Brokerage

   – Portfolio Accounting & Back Office Operations

   – Regulatory, Legal & Compliance Environment

   – Client & Mandate Management

   – Technology Administration & Business Continuity

 Ability to meet College/University Reporting Needs




                              12
External Manager Activities—Areas of Interest

 Business Model
 Duty to Disclose
 Code of Conduct/Ethics
 Trading and Trade Allocations
 Brokerage
 Accounting, Recordkeeping, and Pricing
 Advertising and Performance Reporting
 Custody
 System Administration
 Miscellaneous Matters




                            13
Business Model

 Range/Variety of strategies

 Other clients/separate accounts

 Outside affiliations

 Research methods

 Back-testing

 Internal back-office




                                14
Regulatory & Operational Activities

 Duty to Disclose
   – Compliance Oriented
   – Disclosures include:
      • types of advisory services
      • types of clients to whom services are provided
      • methods of securities analysis
      • employee educational standards/business background
      • fees—how calculated, whether negotiable or not
      • affiliations




                               15
Regulatory & Operational Activities

• Code of Conduct/Ethics
   • Existence and acknowledgement
   • Trading on insider information—frontrunning
   • Watch List
   • Firewalls for affiliated entities
   • Restrictions on personal trading, pre-clearance, monitoring,
     blackout periods, reporting
   • Restrictions/required approval for outside activities
   • De-minimis gifts




                                   16
Regulatory & Operational Activities

• Brokerage
   • Broker selection factors
   • Directed brokerage arrangements
   • Conflicts of interest—affiliated broker or referral
   • Soft dollar arrangements
   • Compliance officer reviews




                                 17
Regulatory & Operational Activities

• Accounting, Recordkeeping, and Pricing
   • Periodic reconciliation of client accounts to custodian
   • Three-way reconciliations
   • Trading file review against accounting statements
   • Protfolio valuation
   • Resolution of pricing errors
   • Overrides of pricing provided by third parties
   • Corporate actions
   • Performance measurement
   • Correspondence




                                 18
Regulatory & Operational Activities

• Trading and Trade Allocations
   • Documented trading policies
   • Trade authorizations
   • Review of trades by compliance officer
   • Approved broker list
   • Trade ticket review, retention, and match to broker confirm
   • Trade order changes
   • Timely settlement
   • Allocation of investment opportunity (Side by Side trading)
   • Pre and post-trade allocations
   • Derivatives trading policy




                                  19
Regulatory & Operational Activities
 Custody
   • Custodian for endowment
   • Custodian for commingled pools
   • General power of attorney
   • Signatory authority
   • Omnibus account—trade settlements
   • Direct billing of advisory fees
   • Trustee of client trusts




                                 20
Regulatory & Operational Activities

 Systems Administration
   – Use of firewalls & virus protection

   – Back-up servers & procedures

   – Offsite storage

   – Outsourced IT services

   – Business continuity planning & testing results




                                21
Regulatory & Operational Activities

 Performance & Advertising Materials
   – Reliance placed on performance calculations



 Other Matters
   – SEC examinations

   – Order of investigation, administrative proceeding, injunctions

   – Current or pending litigation

   – Key-person life insurance

   – SAS-70 of third-party service providers




                                 22
Key Differences between Selection & Monitoring

 Both Selection & Monitoring should have Policies
  …outlining content, frequency and format of activities

 Monitoring may involve both portfolio and operations
  professionals from the College/University Investment Office

 Money is Invested so monitoring should/can include ….
   – Compliance with the Investment Management Agreement or
     Private Placement Memorandum

   – Actual Activities for the College/University Account

 Regular monitoring information may come in the form of
  certifications & account-specific data




                                23
Developing and Improving the Selection &
Monitoring Process
                                                THINGS YOU SHOULD KNOW …or
                                                    MAY WANT TO FIND OUT
   Compare existing Process’ format, content      What are the current Selection
    and frequency with:                             & Monitoring Processes –
                                                    consider format & content?
     – College/University Policy & Risk
       Requirements                                What information does the
                                                    College/University currently
                                                    obtain from the External
     – Industry Practices                           Managers – regulatory filings,
                                                    documents, client reporting?
   Content should continually evolve:
                                                   Obtain External Manager
     – ―Hot topics‖                                 Metrics – how many, what
                                                    asset classes, when were they
     – Issues observed with other external          hired?
       managers                                    What is the
                                                    College/University’s Policy for
   Consider content modifications and              Terminating an external
    specialized monitoring based upon results       manager?
    of monitoring:                                 How many external managers
                                                    have been terminated and for
     – Side Letter Agreements                       what reasons?

     – ―Sweep Visits‖


                                     24
Questions & Answers



   Open Discussion…..




                      25

				
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