Maintaining Proper Internal Controls for Investments in a Downsized Environment

Maintaining Proper Internal Controls for Investments in a

Downsized EnvironmentPresented by

Donna Collins

Milestone Professional Services

Factors Affecting our Current Environment

• Global financial crisis• Uncertainty in Unexpected Places

(SBA, Municipal Bond Ratings)• Increased Regulation and Oversight

(Tax Reform, CCOC) leading to diminished control over revenues

• Smaller staff due to Budget Cuts

Factors Affecting our Current Environment

• Trends in the Audit Community– SAS 112 (documentation of internal controls)– Risk Assessments– Fraud Risks

• Oversight at the Federal Level– Transparency

Factors Affecting our Current Environment

• Governments are being asked to do more with less.–Money and human resources

Factors Affecting our Current Environment

Downsized Environment – Greater Scrutiny

The Clerk’s Responsibility• 28.12  Clerk of the board of county

commissioners.--The clerk of the circuit court shall be clerk and accountant of the board of county commissioners. He or she shall keep the minutes and accounts and perform such other duties as provided by law. The clerk shall have custody of the seal and affix the same to any paper or instrument as required by law.

The Clerk’s Responsibility• Clerk of Courts is Accountant for Board

under F.S. • Clerk of Courts is charged with

responsibility for investment of excess funds

• How does the Clerk do a conscientious job in this market?

• Focus today - Investments

The Clerk’s Responsibility• 28.33  Investment of county funds by the clerk of the circuit

court.--The clerk of the circuit court in each county shall invest county funds in excess of those required to meet expenses as provided in s. 218.415. No clerk investing such funds shall be liable for the loss of any interest when circumstances require the withdrawal of funds placed in a time deposit and needed for immediate payment of county obligations. Except for interest earned on moneys deposited in the registry of the court, all interest accruing from moneys deposited shall be deemed income of the county and may be expended as receipts of the county as approved by the board of county commissioners pursuant to chapter 129.

The Clerk’s Responsibility

• One way to fulfill this responsibility with regard to investments is to develop a strong system of internal controls – including appropriate policies and procedures.

Internal Control - Definition• Internal Control is a process, effected by

management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:– Effectiveness and efficiency of operations– Reliability of financial reporting– Compliance with laws and regulations

Internal Control - Definition

• Internal control consists of five interrelated components

Internal Control Components

• Control Environment• Risk Assessment• Control Activities• Information and Communication• Monitoring

Control Environment• Sets the tone for the government• Influences control consciousness• Foundation for all other control

components• Includes: integrity, ethical values,

competency, management’s philosophy and the way authority and responsibility is assigned

Practical Application - Control Environment

• Establish current policies with regard to ethical behavior (Code of Conduct)

• Enforce appropriate discipline for failure to comply with these policies

• Ensure personal adherence to strong moral code

• Reward competency

Impact of the Control Environment

• Don’t underestimate the importance of this part of the control system. All the great control activities in the world will not be effective if employees know that management is not concerned with strong internal control.

Risk Assessment• Risks result from both external and

internal sources• These change over time based on

economic, regulatory, and operating conditions

• Risk Assessment must link identified objectives (liquidity, protection of principal, rate of return) to specific risk factors

Risk Assessment• Risk factors include:

– The risk of particular investments– The type of custody arrangement– Active versus passive investment strategy

Risk Assessment• Passive Investment Strategy: investments

are generally held to maturity, securities are purchased throughout the year to achieve average weighted yield, securities are low-risk instruments

• Active Investment Strategy: investments may be sold before maturity to earn a gain, purchase are more sporadic and timed by market fluctuations, securities are may include higher risk instruments

Practical Application - Risk Assessments

• Be realistic about the true risk with regard to a particular investment

• Consider all types of risk: inherent, credit risk, interest rate risk, concentration of credit risk, custodial credit risk and liquidity risk

Practical Application - Risk Assessments

• Inherent Risk –• Credit Risk –• Interest Rate Risk – • Concentration of Credit Risk –• Custodial Credit Risk - • Liquidity Risk -

Practical Application - Risk Assessments

• Remember that use of a third party does not eliminate management’s responsibility for assessing risks.– Structure of agreement is important– Investments must be reconciled to general

ledger and transactions reviewed for propriety• Identify “What could go wrong?”

What could go wrong?• Unauthorized investments could be

purchased.• Investments could be purchased without

proper ownership identification.• Investments could be recorded at incorrect

value or fail to be recorded.• Income from investments could be

allocated incorrectly.

What could go wrong?• Excessive transaction fees could be

charged to the government.• Investments held by the government could

be stolen (Certificates of Deposit).• Investments outside the government’s risk

tolerance could be purchased and result in loss of principal.

Control Activities• The policies and procedures that ensure

management’s directives are followed• The occur at all levels throughout the

organization• Include : approvals, authorizations.

Verifications, reconciliations, security of assets, segregation of duties and review of operating performance

Practical Application - Control Activities

• Address control objectives: existence or occurrence, completeness, valuation or allocation, rights and obligations, accuracy or classification, cutoff and presentation and disclosure

• Tie control activities to risks previously identified and address “What could go wrong” scenarios

• Balance cost and benefit

Practical Application - Control Activities

• Existence or occurrence : – investment revenues, realized and unrealized

gains and losses – Recorded short and long-term investments

represent investment that exist at the balance sheet date

Practical Application - Control Activities

• Completeness:– Income statement effects of all investment

transactions– All short and long-term investments are

included in the balance sheet investment accounts.

Practical Application - Control Activities

• Valuation or allocation:– Investment revenues, realized and unrealized

gains and losses are reported amounts– Investments are reported on the balance

sheet at fair value, cost, amortized cost, or the amount determined by the equity method, as appropriate for particular investments.

Practical Application - Control Activities

• Rights and Obligations:All recorded investments are owned by the reporting entity.

• Accuracy and Classification:All recorded investments occurring during the period mathematically correct and entered in the proper accounts.

Practical Application - Control Activities

• CutoffInvestment transactions are recorded in the proper accounting period.

• Presentation and Disclosure:Investment balances are properly identified and classified in the financial statements. Appropriate disclosures made for investment portfolio.

Key Control Activities• Develop Investment Policy specific to the

government (risk tolerances, rate of return goals, level of expertise)

• Keep Investment Policy current with government’s objectives

• Separate authorization from recording of investment transactions

• Reconcile investments per general ledger to statements from trustee/custodian

Key Control Activities• Provide for oversight through Investment

Committee (include trustee activities)• Address unusual transactions or variance

from expected benchmarks in timely fashion

• Utilize disclosure checklist to ensure presentation and disclosure requirements are met

Information and Communication• Includes both internal and external

interaction• Requires pertinent information to be

identified, captured and communicated in a form and timeframe for employees to carry out their responsibilities

• Reports must contain relevant operational, financial and compliance information

Practical Application - Information and Communication

• System generated reports must include relevant information

• Statements from broker/dealers must be channeled to correct personnel and provided timely

• Communication with Investment Committee or other oversight body should include:

Impact of Information and Communication

• Communication with Investment Committee or other oversight body should include: – Types of investments held– Average rate of return for period and YTD

compared with benchmarks– Average maturity of portfolio– Compliance with investment policy provisions

Impact of Information and Communication

• Communication with Investment Committee or other oversight body should include: – Changes in investment strategy (if any)– Interest rate environment changes– Discussion of any unusual transaction or

particularly risky investment

Monitoring• Assessing the quality of the internal

control system and making modifications as needed

• This process is ongoing through the normal course of operation and at separate specific evaluations of a particular process

Practical Application - Monitoring

• Controls over investments will change as the makeup of the portfolio changes

• Controls should be evaluated when new investments are added to the portfolio

• Be responsive to information requests of Investment Committee personnel

• Review Investment Policy annually

Practical Application - Monitoring

• Example:• Government changes risk tolerance to

allow for higher return on investments– Change to investment policy– Change in investment process– Increase oversight of these transactions to

ensure no loss of principal and that return is actually warranting the additional risk assumed

Summary• The control environment establishes the

importance of internal control.• Risk Assessments must be realistic and

performed when changes to investment objectives or portfolio composite occur.

• Control Activities should be focused on areas of highest risk. Monitoring controls are effective stopgap for smaller entities.

Summary• Information and Communication must

provide relevant information for managing investments.

• Monitoring of the internal control system is an ongoing process.

Questions?