| Public Release Date: May 9, 1994 | No. 94-20 |
On August 29, 1993, the Star Tribune published an article entitled "Overlooking the Books." The Legislative Audit Commission responded to public concerns generated by the article and on November 17, 1993, directed the Legislative Auditor to answer six questions regarding the oversight of the Minneapolis Employees Retirement Fund (MERF). One question addressed the MERF board of directors, the other five questions pertained to the State Auditor's Office (OSA). The questions focused on the tenure of former executive director, Mr. John Chenoweth. Also, the commission directed the Legislative Auditor to contract with an independent consultant, to broadly examine oversight of local pension funds.
The question about the MERF board of directors concerned its reaction to indications of potential illegal acts or misconduct. Our special review revealed four instances when the board obtained information indicating that Mr. Chenoweth may have acted improperly or illegally. We also found that the board learned of some problems with its investments. The board took some action in response to the four incidents of potential improper conduct by Mr. Chenoweth and the problem investments.
We found, however, that the board's oversight capabilities were inhibited by insufficient information. This limitation was primarily attributable to an extensive reliance on Mr. Chenoweth. Board members were reluctant to contain his discretion or to challenge his judgment. In some matters, Mr. Chenoweth also was not completely truthful with the board.
We also found that the MERF board did not fully exercise the oversight responsibilities established in its investment policy. In addition, it did not prevent Mr. Chenoweth from creating personal conflicts of interest with the companies in which MERF invested.
These matters had a cumulative effect as the board grew increasingly distrustful of Mr. Chenoweth. His credibility steadily eroded to the point that the board finally terminated his employment on May 11, 1990.
We reviewed issues related to the State Auditor's independence, audit planning, procedures for auditing MERF investments, audit reporting, and response to indications of potential illegal or improper activities at MERF.
We found that the auditors followed established office policies when investigating allegations and establishing audit scope for MERF. There was no evidence that former State Auditor Carlson had a personal friendship or social relationship with Mr. Chenoweth or that he influenced the scope of MERF audits.
The OSA made numerous changes to its MERF report drafts. We often did not find adequate documentation for the changes in the working papers. The auditors did, however, provide us with explanations for the changes. We found no evidence that the changes were the result of a cover-up. The changes, particularly in the 1989 Management Study, resulted from an attempt to remove judgmental language from the reports. The MERF report style differed from a more adversarial style that OSA had used for other reports it considered to be high-profile and of broad public interest.
The auditors could have done more to test the market value of MERF investments, particularly in the 1989 financial audit. Mr. Chenoweth had added more speculative investments to the MERF portfolio in 1988 and 1989. The investments began to show signs of problems during the 1989 audit. For the 1990 audit, an extensive footnote to the financial statements cautioned about the precarious nature of several investments. Finally, on the 1991 financial statements, MERF wrote its investments down by $58 million.
We reviewed activities that occurred in 1988 and 1989 and did not evaluate current practices of MERF or OSA. We think, however, that there are lessons to be learned from MERF's experiences in the late 1980's.
It would have been beneficial for the MERF board to have had outside directors, an investment advisory committee, tighter investment guidelines, and an audit committee. It also could have benefited from a formal code of conduct, recorded board proceedings, and annual performance evaluations of its executive director.
The State Auditor's Office would have been more effective if its reports had used a consistent tone, spoke to a broader public audience, and been issued on a more timely basis. The auditor's experience also emphasized the need to verify the underlying value of investments, particularly alternative investments such as limited partnership and real estate. Finally, it would have been helpful for the auditors to document reasons for report changes and to resolve any professional differences of opinion.
