SDCERS BOARD MEETINGS - May 14- May 16, 2008 Submitted by Patricia Karnes

Patti's Notes I attended the Audit Committee, Business & Governance Committee and watched the full Board meeting on  Channel 24 for these notes. (Notes do not necessarily follow the order of the committees or the full Board meeting, they may be by subject. They are my understanding of what happened. CDs of SDCERS' committees and Board meetings are available through the Board Secretary, visual recordings are available through City Channel 24. Live streaming will be available soon. Full Board meetings are on Channel 24 around 5 or 6pm, usually the third Friday of the month, and repeat on Sundays at 1pm.) Retiree Representative: Dave Hall Hall, like former retiree representatives Joe Flynn and Carmen Lutes, is fleshing out his primary fiduciary role as trustee of SDCERS' assets, versus his responsibilities to fellow retirees. "WATERFALL" At the Business & Governance Committee this month: Chris Waddell reported two choices on the Waterfall that will be presented to Council on May 27th: 1) IBA/ OverSight Monitor version. 2) City Attorney version that eliminates contingency payments for 13th Check, Corbett and Cola. Wescoe pointed out that "surplus earnings" are already history, as Cheiron added the 13th Check, Corbett, and Cola to SDCERS' liabilities. PRESIDENTIAL BENEFITS Sullivan reclused for this matter. The IRS' unwinding of Judie Italiano's President's benefit was unsolvable from the SDCERS' end, and she is still in negotiation with the City. Union-paid and employee paid contributions must be returned, with interest. DROP, etc. must be recalculated solely on City services and overpayments collected. Unlike Saathoff, she was not working for the City for 20 of those years she was union president. When her years at the union became unusable for retirement purposes due to the IRS, she became ineligible to retire at 55, and ineligible for the $6,755.58 monthly retirement payments she had been receiving. As she is now 62, she is eligible for a monthly retirement allowance of $622.92 based on her final City average salary of $1,407.30. Unfortunately the $622.92 is not going to cover a repayment plan to SDCERS. Under best case scenario, if the City reinstates the years she worked at the City in 2005-2006 and enable her to purchase all available service credits, Italiano will still owe SDCERS  $240,567. The repayment would still result in a full forfeiture of her retirement benefit. A hearing before the whole Board is planned in June or July. She has not retired for a second time yet. SDCERS' Board voted to approve offering purchase service solutions and/or adjustments to DROP dates, to the retired police union presidents,  as they were not appropriately counseled regarding presidential benefits when they made their decisions. The Board was told it must find these waivers because the union presidents did not knowingly and intelligently make their decisions. Tom Hebrank, as Board President will sign the "findings of fact and decision of the Board". Meyer asked if this was lawful? Roxanne said yes, it will be reported to the IRS for their review. IceMiller added that the IRS accepts previous California court cases telling how to interpret the Board's waiver as part of the SDCERS plan. Past police union presidents are still negotiating with the City on this issue. Saathoff is the least impacted as he worked for the City along with his Firefighter's union presidency. Union contributions are being returned and his DROP amount re-calculated. GROUP TRUST and IRS C-Cycle Filing June 9th is SDCERS' IRS C-Cycle Filing deadline.  SDCERS must re-file every 5 years to keep compliance. This year, the C-Cycle Filing will include making SDCERS a Group Trust with three separate plans. The Port and City have approved the Group Trust. The Airport will vote for it on June 5th. Steve Meyer asked Roxanne Story Parks how SDCERS will maintain compliance? Roxanne answered: monitoring laws, a minimum of annual training, and update plan sponsors on need for plan amendments. She added that the outside independent auditor would look at SDCERS' controls to ensure that this happens in the future. Splitting assets: Mark Hovey reported SDCERS is finalizing the accounting procedures associated with a Statement of Plan Net Assets and a Statement of Changes in Plan Net Assets providing separate values for each plan sponsor.  Outside independent auditors, MGO, will review the new statement format and provide feedback. AUDITING At the Audit Committee, Michael Collins, acting as chair, Steve Meyer and Tom Hebrank listened to Jim Godsey, from Macias Gini & O'Connell (MGO), report that there were no new issues rising between the independent outside audit reviews of June 2006 and the recently completed June 2007. The full Board later approved the recommendation of the Audit Committee for MGO to start work on the June 2008 independent audit. MGO increased their fee by 7.5% allowing for employee salary increases, in order to compete with the "Big Four" international firms out to recruit their employees. Starting with June 2008's independent outside audit, SDCERS will be evaluated on the new SEC standards and processes of internal control assessment. COSO is the Committee on Sponsoring Organizations and the framework is its Internal Control- Integrated Framework and its related Guidance for Smaller Public Companies: Reporting on Internal Controls over Financial Reporting. This will change the environment for SDCERS and auditors. During a brief training on the SEC's new risk standards, Godsey said that independent outside auditors cannot suggest, they can only say 'yes' or 'no' without impacting their independence. Godsey pointed out that the SEC had reacted to national failures and is now looking at organizations assessing their risks of mistakes. Therefore, MGO will need to verify evidence that internal controls, monitoring the risk of mis-statements, are in place at SDCERS and are understandable. This will include the fair values in financial records, how information is shared, and how the ledger works. SDCERS must satisfy: 1. Monitoring - On-going and separate evaluations, "walk around", follow up and organizational attitude toward correction. 2. Information and Communication - 3. Control Activities - 4. Risk Assessment -What has changed? New staff? Prioritize risk of errors in all significant account balance and/or transaction streams. Existence, completeness, rights and obligations, valuation and allocations, presentation and disclosure. 5. Control Environment - Integrity and ethical values, Governance by the Board, Management philosophy and operating style, Financial reporting competencies, Authority and responsibility, Human resources. Bob Wilson, newly created Internal Auditor, (evaluated by the Audit Committee) is continuing to develop controls. 1) He is preparing SDCERS for the transition to a new General Ledger System, before the City converts to new software. The new financial system will have the capacity to deal with weaknesses in the current system. RFP replies are due May 23rd. Chief Financial Officer, Mark Hovey, in his May 2nd report, said "The go-live date for the ledger project and associated modules is targeted for January 1, 2009." Wescoe expects the ledger transition to occur during a quarter end. 2) Wilson will have SDCERS' required "risk assessment" by June. He will be segmenting duties so SDCERS will become a check and balance of activities. 3) Validations of the accuracy of contribution data, provided by plan sponsors, are also in progress as part of Internal Controls. 4) Information Technology is evolving to support the new controls. BUDGET Board approved $41.8 million for Fiscal Year starting July 2008-9. Budget is down 0.6% even with increase for upgraded positions, a new account clerk position for the Ledger project and City adding post-retiree healthcare to employees benefit costs. Mark Hovey's April 11th report: "Investment Management Services are projected to increase $1.6 million (6.5%) in FY 2009, of which $1.0 million is for a new investment class (Private Markets)." Administrative expenses are down 10.2%. Data processing is down 36% as long term asset purchases will be capitalized. Etc. INTEREST RATE ON OVERPAYMENTS/UNDERPAYMENTS In regard to a Domestic Order correction, Sheffler said the IRS may see 4.5% interest as more appropriate than 8%, in the repayment of an overpayment, if the IRS sees SDCERS as a hybrid plan due to DROP. Waddell felt it was a policy question and makes the Trust whole from what it would have been. DROP INTEREST CREDITING Wescoe said expect a two week delay in posting interest on-line. CREDIT RATE FOR EMPLOYEE/EMPLOYER CONTRIBUTION RATE Updated Market rate under Federal law is still unknown and unavailable. Ten Board Trustees voted to use 8%, with Sheffler voting no. COLA Approved 2% for eligible retirees starting July 1, 2008. Two people left in 1981 plan will receive 1.1%. HEALTH INSURANCE David Arce expects heavy activity for changes during the open enrollment for United Healthcare. INVESTMENTS McCalla's Executive Summary of Staff Reports Fund balance was $4.828 billion on April 2, 2008. Most recent market valuation on May 2 was $4.897 billion unaudited. Monthly benefit payments and operating expenses were $14.75 for March. Private Equity Board passed RFP to start with a discretionary consultant and customize long term vision, match asset size and meet objectives, with launch date of March 2009. Overview of what is private equity: Non-public companies not traded on an exchange. Investments are equity and debt. It can be Private Investments in Public Entities (PIPE) not available to the public, or private transactions not available to the public. Benefits: Higher returns, better asset/liability management and good match for long term returns for SDCERS. Risks: Not liquid, long lean times, short term initial loss followed by gains. Investment returns: years 1-3 to raise funds, years 3-5 to invest and evaluate if going to be profitable, and years 5-8 to mature and harvest the return. There is $2 trillion in private equity, compared with $60 trillion in the global stock market. Meyer said SDCERS is now large enough to invest in private equity, SDCERS continues to add asset classes and private equity offers diversification. Franklin asked if SDCERS is lowering the bar and good dollars are chasing bad dollars. Sheffler pointed out the headline risk, like San Diego Country's retirement system experienced, noting you can't jump out in bad times. McCalla responded this is not a single leveraged transaction. It is highly diversified. Presenter continued saying that successful P.E. managers get a track record of their network and relationships to connect to the best opportunities. Successful managers have operational success in turning around companies, etc. There are five degrees of control for SDCERS to build private equity: 1) direct into a company, 2) into a fund, 3) fund of funds, 4) discretionary consultants, and 5) non-discretionary consultants that just provide advice. Asset Allocation Policy 2008 Asset Allocation Review prepared by Callan Associates, was passed as policy by the Board. Cash Overlay Management Services No action or investment at this time. Information only. Liza Crisafi, Deputy Chief Investment Officer gave a preliminary overview of Callan's cash securitization. This would utilize cash from trades and cash for monthly expenses. Wescoe added it would be about 2% of SDCERS' assets, and also that this program tries to mimic what would have earned if totally invested. Cash securitization converts cash into an asset return/loss via "future contracts" to simulate being invested in things SDCERS is already invested in. There is market risk, margin/liquidity risk, tracking error risk, operating risk, and/or value may decline. This form of "futures" could earn SDCERS $24.9 million over 9 years or $2.7 million a year, although it would have lost money in the current market. Callan's report to SDCERS of March 31, 2008 Executive Summary, page 2 of 5. Asset Allocation "As of quarter end, the assets of the Fund were valued at $4,698 million.  This represents a decrease from the December 31, 2007 value of $5,048 million. Approximately $64 million was paid out during the quarter. In addition, the Fund experienced a net investment loss of about $293 million due to the combination of income and realized and unrealized gains/losses. The Fund ended the quarter closely tracking its long-term strategic target of 38% Domestic Equity, 17% International Equity, 30% Domestic Bonds, 4% International Bonds and 11% Real Estate." Total Fund Performance "SDCERS' first quarter return of -5.8% followed a slightly negative fourth quarter return of -0.6% (excluding private real estate whose valuations are lagged one quarter) and was behind the Total Fund Benchmark's -3.9% return. For the one year ended March, the System was down -0.8%, lagging the total fund benchmark return of +1.0% and ranking in the 75th percentile of the public fund universe.  The fourth quarter of 2007 and first quarter of 2008 was particularly difficult given the financial crisis brought on by problems in subprime mortages and the weak housing market.  Equities in general and small cap in particular, suffered. International equity, which had been a bright spot in the port folio, contributed to the negative absolute and relative return in the first quarter." 2nd ANNIVERSARY -PROGRESS REPORT by DAVID WESCO Progress by Board, staff, constituent groups and plans sponsors. Achievements, with thanks to Cheiron and professional advisors: · 20 Year Amortization period for City's unfunded actuarial liability (UAL), with no negative amortization. · Return to Entry Age Normal (EAN) as a funding method for SDCERS. · Recognized all "contingent" liabilities, no surplus earnings, everything is paid by plan sponsors. · Asset apportionment is better. · Audit integrity has improved with the establishment of an independent Audit Committee ( three appointed outside members and two Board members). Created an Internal Auditor position that reports directly to the Audit Committee. Board has retained a new independent audit firm, Macias, Gini & O'Connell LLP. · Benefit administration has re-focused. Staff is re-organized into subject matter focused teams. Comprehensive reviews of benefit processes were conducted. Created electronic files and work flow to move to an almost paperless process. · Board Governance is on the leading edge nationally with corporate governance policies and procedures, as well as, where the Board wants to go. Established the Business and Governance Committee, Audit Committee, and created Chief Compliance Officer position reporting to the Board without undue management interference. Instituted fiduciary training program. Adopted whistleblower, ethics and conflict of interest policies. Wescoe expressed appreciation for SDCERS legal staff. · Produced four CAFRs- from 2004 to 2007, each without unqualified audit opinion from SDCERS independent auditor MGO. · Communications are more effective. Improved web site. Improved , but not perfect communications with plan sponsors. Supportive of active and retired employee groups. · Disability has added medical review services and reinstituted affidavit and re-exam program, etc. Also improved processing and reduced backlog of three years. · Group Trust established, clarifying relationships with plan sponsors and allowing SDCERS to take on additional plan sponsors. · Information Technology division created. Developed a five year IT strategic plan. Prepared a business continuity plan in case of a major disaster. Implemented Electronic Document Management System (EDMS). Migrated to an independent "sdcers.org" network domain. Reduced reliance on third-party IT vendors. · Increased Investment officers from 2 to 4. Revised investment policy statement. Added non-US property to real estate strategic plan. Conducted general investment consultant search for the first time in 20 years. · IRS issues resolved pro-actively and voluntarily. IRS Compliance Statement approved. Received favorable IRS Determination letter. Unfortunately it was long, painful and hurtful to some of the members. · Litigation has been successful. Won summary judgement affirming SDCERS' right to retain own legal counsel and to pay benefits, according to the Municipal Code. · Created Member Service division with a dedicated call center for the new web site. Re-invigorated the retirement seminar program. · Moved to new office space on time, on budget, more functional and costs less. · Staff is flatter, leaner, more talented, and better organized and focused. New senior management team. Improved staff training and education programs. Consulting services have been significantly reduced.  · The distance left is shorter than SDCERS has gone. Thank you to the Board who served without compensation under adverse circumstances. · SDCERS is more efficient, stable and successful in the face of political climate. The funded ratio has risen from 65% to 78.9%. President Hebrank thanked Wescoe for his help. PROCESS FOR PERFORMANCE REVIEWS While Hebrank noted that life is timing, the Board approved the process of performance reviews for the Chief Administration Officer, Chief Compliance Officer and Internal Auditor. DISABILITY SDCERS' counsel Elaine Reagan said occasional Beach Patrol didn't count as usual and customary duties for a disabled police desk sergeant. The Board approved sending another case to an adjudicator, but this time it is to assess what are usual and customary  job duties, and not to assess injuries which were verified. Elaine Reagan again pointed out that disability applicants, and City Departments, can not be relied on for accurate information, unless they are under oath. Mark Sullivan, police detective and Chair of B & G, seemed to appreciate this technicality better than others of us.  What is a permanent position, and what is light duty, appears to be a Union and MOU issue to resolve. It could be corrected by the City Council in an Ordinance to make it part of the Municipal Code and therefore a SDCERS plan document. Later in the meeting, Dave Hall expressed concern that injured employees not stumble ignorantly into an adversarial position with SDCERS. COMMENTS Tom Hebrank had heard members were noting there was little discussion on issues. He re-assured members that discussions are done in committee meetings that run three to four hours, so issues are reviewed beyond what happens at Board meetings.