North Carolina Department of State Treasurer Statutory ......North Carolina G.S. §147-69.12(b) mandates annual reporting on fees and performance of all externally and internally managed

Investment advice and consulting services provided by Aon Investments USA Inc.

North Carolina Department of State Treasurer

Statutory Review of Governance, Operations & Investment

Practices

January 25, 2021

2Proprietary & Confidential


Table of Contents

I. Introduction

II. Executive Summary

III. Current Authority, Duties, Laws

IV. Policy and Process Review

V. Compliance Process Review

VI. Transparency, Accountability, and Ethics

VII. Ethics Policy and Insider Trading Policy Review

VIII. Summary of Recommendations

Appendix

I. Introduction



Introduction−Background

▪ The North Carolina Department of State Treasurer (“DST”) selected Aon Investments USA Inc.

(“Aon”) to conduct a statutory review (“Review”) of the Investment Management Division’s (“IMD”)

governance, operations and investment policies. North Carolina law requires that the DST engage an

independent expert at lease once every four years to conduct the Review and to make

recommendations for improvements. North Carolina G.S. §147-69.10(b). This is the first statutory

Review for North Carolina DST.

▪ Scope of Work: Aon was engaged to review the following five areas for comparison to industry

common and best practices and to make any recommendations for enhancements:

1. Current Authority, Duties, Laws

2. Policy and Process Review

3. Compliance Process Review

4. Transparency, Accountability, and Ethics

5. Ethics Policy and Insider Trading Policy Review



Background–Methodology

▪ The development of this report progressed through several stages. These stages included document

and information collection, interviews, discussions, research, analyses, and report drafting. Aon

submitted a draft version of the report for IMD staff review and feedback. The final report took staff

comments into consideration. The final report, however, reflects the independent work and

professional judgment of Aon staff. This approach is consistent with the Aon review methodology

used for the many other reviews it has performed.

▪ We appreciate the time and cooperation provided by IMD staff during the preparation of this Review.

II. Executive Summary



Executive Summary

Overall, we found the IMD governance, operations and investment policies to be in line with best

practices. We have offered recommendations for enhancements as outlined in the report and in the

Summary of Recommendations. We summarize our findings for each of the five scope of work areas

below.

1. Current authority, duties and laws:

▪ The statutory language governing investment of North Carolina Retirement Systems’ (“NCRS”)

assets reflects sound trust principles, parallels model laws, and is similar to laws in other states

that establish public pension funds. The statutory framework provides for appropriate

independence, oversight and reporting, transparency, accountability, and high ethical standards.

▪ The statutory creation of the Investment Advisory Committee and its membership is in line with

best practices and consistent with other sole fiduciary states.

▪ The statutes granting the Treasurer independence regarding budgetary authority, personnel, and

procurement comport with best practices and enable the Treasurer to prudently exercise his

duties to act in the best interests of the participants and beneficiaries.

▪ The Treasurer’s investments are subject to a legal list with thresholds. Although IMD staff has

indicated it does not impede its ability to meet investment objectives, we recommend pursuing

statutory changes to remove the legal list and corresponding thresholds limitations as they are

contrary to the Prudent Investor Act standard of care and the modern portfolio theory.



Executive Summary

2. Policy and Process Review:

▪ The Investment Policy Statement (“IPS”) generally follows best practice and contains many of

the components we believe that a well-structured IPS should have. We offer modest

recommendations for enhancements to an already well-structured IPS.

▪ The Investment Manager and Vehicle Monitoring Policy and External Investment Manager and

Vehicle Selection Policy generally align with best practice. We recommend codifying appropriate

segregation of duties related to operational due diligence and having consistency between the

two policies.

3. Compliance Process Review:

▪ The IMD has initiated a thoughtful approach to developing a “Conflict Wall” related to access to

material nonpublic information (“MNPI”). We offer recommendations to supplement the approach

with additional monitoring efforts, codification of a formal policy that is provided to staff and

incorporated into compliance training, and creation and monitoring of a restricted list.

▪ IMD maintains comprehensive process documentation related to its internal equity trading

efforts. IMD’s approach to internal equity trading process aligns with best practice regarding what

processes are implemented. We recommend enhancements to the internal equity program to

ensure appropriate segregation of duties, as well as codification of cross-trade policies and

procedures.



Executive Summary

4. Transparency, Accountability and Ethics:

▪ The depth and breadth of information posted on the DST’s website is in line with best practices, provides relevant investment policies and reports, as well as IAC meeting materials. Taken as a whole, the information demonstrates the commitment to transparency and accountability, compliance with fiduciary principles and a solid ethical framework.

▪ The retained authority and delegations by the Treasurer are generally consistent with other public pension funds as well as those of the sole fiduciaries in New York and Connecticut.

5. Ethics Policy and Insider Trading Policy Review:

▪ The Placement Agent, Political Contribution, and Connection Disclosure Policy is exceptionally comprehensive and consistent with best practices and the associated implementation and monitoring procedures are sound. The policy, procedures and posting of disclosures on the Treasurer’s website evidence excellent transparency and accountability.

▪ The Ethics and Conduct Policies Tier 1 and Tier 2 are comprehensive, provide clear guidance to DST employees, and contain many best practice elements. The Treasurer is to be commended for applying state ethics law requirements of filing statements of economic interest and mandatory training on those employees not governed by the state ethics laws. The adoption of a Secondary Employment Policy is another recognition of potential conflicts and constitutes a best practice.

▪ The IMD Code of Ethics and Conduct Policy serves as an important supplemental policy. It recognizes that IMD employees have heightened responsibilities, addresses MNPI, and contains the expectation of adherence to professional standards.



Executive Summary

5. Ethics Policy and Insider Trading Policy Review (continued):

▪ The IAC Code of Conduct is in line with best practices in addressing ethical issues and conflicts

of interests, clearly states ethical expectations, and promotes transparency and accountability.

To further strengthen the goals of the policy, we recommend having IAC members file annual

internal statements of economic interest for review by Compliance Counsel.

▪ The IMD Insider and Personal Trading policy contains many provisions that are in line with peers

and best practices. The posting of the policy is a best practice and provides excellent

transparency. We recommend revisions to the policy for enhancement and recommend that IMD

review available software utilized by other public funds related to monitoring of trading. Finally,

we recommend a dedicated compliance officer or counsel familiar with federal securities laws

own the responsibility for ensuring safeguards and controls related to the prevention of illegal

insider trading.

III. Current Authority, Duties, Laws



Current Authority, Duties, Laws

▪ Aon reviewed the sufficiency of applicable laws with respect to authority and duties related to the

management of NCRS’ assets compared to common and best industry practices, including whether

any provisions impede the ability of IMD to carry out its functions. We summarize those applicable

laws in this section of the Review. We also reviewed listing of general statutes concerning the

Treasurer provided by staff and found it to be comprehensive and did not note any omissions.

▪ Statutes serve as the governance foundation for investment of the NCRS assets and establish the

Treasurer as the sole trustee with fiduciary responsibility for those assets. As with most large public

pension funds, the retirement assets cannot be used for any purpose other than retirement system

benefits and purposes.

▪ The North Carolina statutes vest exclusive responsibility for the investment of the NCRS assets with

the State Treasurer as the sole fiduciary. North Carolina G.S. §147.69.3. There are only two other

States in the United States with the sole fiduciary model-New York and Connecticut.

▪ Pursuant to North Carolina G.S. §147-69.3(a), the Treasurer is empowered to establish, maintain,

administer, manage and operate one or more investment programs for the deposit and investment of

assets. Funds of the retirement systems and other funds held by the Treasurer may be invested

collectively or separately in the Treasurer’s discretion consistent with fiduciary duties as outlined in

statute.



Current Authority, Duties, Laws−Fiduciary Standards

▪ In the best of circumstances, the laws that create public retirement systems clearly impose the

fiduciary duties of loyalty and prudence on the governing fiduciaries (e.g., sole trustee or board of

trustees). The duty of loyalty requires the governing fiduciary to act solely in the interests of the

retirement system’s participants and beneficiaries, rather than in the interests of themselves,

constituent groups, or appointing authorities. The duty of prudence requires a fiduciary to act with the

care, skill, prudence, and diligence under the circumstances that a prudent person acting in a like

capacity and familiar with such matters would use in the conduct of an enterprise of like character and

with like aims.

▪ Because public pension funds are held in trust, basic principles of trust law apply. Trust law is

hundreds of years old and was developed by courts over time. The original common law prudent

standard relative to trusts was that of a “reasonable man”. This was a lower standard which required

that the trustee was “under a duty to the beneficiary in administering the trust to exercise such care

and skill as a man of ordinary prudence would exercise in dealing with his own property…”.

Restatement of Trusts 2d (1959). Therefore, certain investments had to be avoided because of the

risk of loss.




▪ As investments evolved and became more sophisticated over time, the Prudent Investor Rule was developed. The Prudent Investor Rule differed from the ‘reasonable man” standard in four important ways:

− A trust account’s entire investment portfolio is considered when determining the prudence of an individual investment

− Diversification is explicitly required as a duty for prudent investing

− No category of type of investment is deemed inherently imprudent

− A fiduciary is permitted to delegate investment management and other functions to third parties

▪ The National Conference of Commissioners on Uniform Laws approved and recommended the Uniform Prudent Investor Act (“UPIA”) to all states August 4, 1994, and the Uniform Management of Public Employees Retirement Systems Act (“UMPERSA”) on August 1,1997. These two uniform laws effectively incorporate the major principles of the modern portfolio theory and total return approach to the exercise of fiduciary investment discretion. The concepts set forth in the uniform laws are often considered “best practice” and therefore have been used as models by public pension funds and investment boards to modernize fiduciary and investment standards.

▪ The Prudent Investor Standard of Care provides “a trustee shall invest and manage trust assets as a prudent investor would, considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution”. Prudent Investor Act, Section 2




▪ While private sector pension funds are governed by the federal Employee Retirement Income Security

Act of 1974 (“ERISA”), public pension funds are governed by their respective state or local laws, and

in some case their state constitutional provisions. ERISA is very influential for public pension funds as

it sets forth fiduciary duties and standards, is often modeled by state laws, and serves as guidance in

the absence of state precedent with respect to fiduciary matters.

▪ The ERISA exclusive benefit rule provides that a fiduciary shall discharge his duties with respect to a

plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of

providing benefits to participants and their beneficiaries and defraying reasonable expenses of

administering the plan. ERISA § 404(a)(1)

▪ In line with those best practices, the North Carolina legislature adopted the prudent investor standard

of care and the exclusive benefit rule with respect to the discharge of the Treasurer’s fiduciary duties.

Additionally, the North Carolina Constitution, Article 5, Section 6(2) provides that the retirement funds

shall be used solely for the provision of benefits and payment of expenses related thereto.




▪ The Treasurer is required to discharge his or her duties with respect to each fund:

− Solely in the interest of beneficiaries;

− For the exclusive purpose of the fund, including providing benefits and paying reasonable

administrative expenses;

− With care, skill, and caution of a prudent investor under the then prevailing circumstances;

− Impartially;

− Incurring only reasonable costs; and

− In accordance with good-faith interpretation of governing laws.

North Carolina G.S. §146-69.7(a).



Conclusion: Current Authority, Duties, Laws−Fiduciary Standards

Conclusion:

▪ The statutory language governing investment of NCRS’ assets reflect sound trust principles, parallels

model laws, and is similar to laws in other states that establish public pension funds. It establishes a

solid framework for modern portfolio practices. It allows for independence and appropriate reporting

and oversight. It establishes a framework for transparency and accountability, and high ethical

standards.



Current Authority, Duties, Laws−Oversight and Reporting

▪ Although the Treasurer is the sole fiduciary for the retirement systems funds, the Treasurer is subject

to reporting and oversight requirements set forth in statute.

▪ North Carolina G.S. §147-69.12(a) requires reporting on the Treasurer’s investment programs,

including any placement fees, asset fees, performance fees, money management fees, total assets,

rates of return and any comparable benchmarking, percentage of total assets by asset class and any

percentage limitations, and details for each investment program, including the nature and character of

the investments, revenues, administrative costs, location on the Treasurer’s public website for list of

new commitments to external investment managers, use of placement agents, any information

requested by the House of Representatives and Senate Finance Committees, and any other

information helpful in understanding investment policies, practices and results.

▪ North Carolina G.S. §147-69.12(b) mandates annual reporting on fees and performance of all

externally and internally managed investments for the NCRS, including for each the name,

commitment amount, inception year, value, management and incentive fees, rates of return, and any

placement agent fees.

▪ Pursuant to North Carolina G.S. §147-69.12(c), the Treasurer must report the treasury balance and a

summary of receipts and payments during the preceding fiscal year to the Governor on an annual

basis and to the General Assembly on a biennial basis.

▪ All of the reports required under North Carolina G.S. §147-69.12 are required to be delivered to the

Joint Legislative Commission on Government Operations, chairs of the House of Representatives and

Senate Appropriations Committees, chairs of the House of Representative and Senate Finance

Committees, Fiscal Research Division, Governor, Council of State, and State Auditor. The reports are

also to be posted on the Treasurer’s public website.



Current Authority, Duties, Laws−Oversight and Reporting

▪ North Carolina G.S. §147-69.8 requires annual reporting by the Treasurer to the General Assembly

of any investments made under any broadened authority granted by the General Assembly, including

returns, earnings, changes to value, and gains and losses. For each new type of new investment

authority, the report must be made for a minimum of four years.

▪ North Carolina G.S. §147-69.9 requires the Treasurer to issue financial statements for each fiscal

year regarding investments that must be audited by a commercial independent third-party audit firm.

The report must include the investment programs’ risk and returns compared to benchmarks, total

management fees and incentives paid, and peer cost benchmark comparisons. The audit firm’s report

and the financial statement are to be provided to the Joint Legislative Commission on Governmental

Operations, the House of Representative Appropriations Committee, the Senate Appropriations/Base

Budget Committee, and the Fiscal Research Division.

▪ North Carolina G.S. §147-69.10(b) requires this Investment Review at least once every four years.



Conclusion: Current Authority, Duties, Laws−Oversight and Reporting

Conclusion:

▪ The oversight and reporting requirements set forth in the statutes are appropriate and consistent with

best practices, particularly considering the unique sole-fiduciary model.



Current Authority, Duties, Laws−Investment Advisory Committee

▪ Investment advisory councils are formed to assist public fund fiduciaries in the administration of

investments by serving as a source of investment expertise and guidance. Members are usually

required to have financial or investment expertise to serve as a sounding board to the governing

fiduciaries and a check on investment policies and practices.

▪ The laws governing the state public pension funds in New York and Connecticut, the other two states

that utilize the sole fiduciary model, require the appointment of an investment advisory council, where

the role of the particular investment advisory council ranges from consultative to oversight. See §423

of the New York State Retirement and Social Security Law, §3-13b of the Connecticut General

Statues.

▪ There are other non-sole fiduciary public funds that use an investment advisory council in a

consultative role, including the Florida State Board of Administration, the Minnesota State Board of

Investments, the Virginia Retirement Systems, and the Texas Employees Retirement System.

▪ Pursuant to North Carolina G.S. §147-69.2(b1) the Treasurer is responsible for appointing an

Investment Advisory Committee (“IAC”) with advisory powers only. The appointed IAC members must

have experience in areas relevant to the administration of a large, diversified investment program.



Current Authority, Duties, Laws−Investment Advisory Committee

Conclusion:

▪ The statute requiring the creation of the IAC and its membership is in line with best practices and

consistent with the other sole fiduciary states. The IAC serves as an important piece of ensuring

investments are managed in the best interests of the participants and beneficiaries and in a prudent

manner.



Current Authority, Duties, Laws−Independence

▪ It is important for governing fiduciaries in charge of the investments of retirement system assets be

independent-whether a sole fiduciary or board of trustees. UMPERSA specifies that the governing

fiduciary must have a level of independence that is sufficient to allow them to perform their duties

effectively and efficiently. Governing fiduciaries are subject to extensive and stringent fiduciary

standards such as the duty of loyalty. Independence permits the governing fiduciaries to perform their

duties in the face of pressure of others who are not subject to the same obligations.

▪ Independence is often measured by a governing fiduciary’s authority regarding budgets, personnel,

and procurement.

− Budgetary authority-the North Carolina statutes grant the Treasurer independence with respect to

budgetary authority. North Carolina G.S. §147.68 (e) provides that the Treasurer shall be

independent of any fiscal control exercise by the Director of the Budget or the Department of

Administration and shall be responsible to the General Assembly and the people of North

Carolina for the efficient and faithful exercise of the responsibilities of his office.



Current Authority, Duties, Laws−Independence

− Personnel-North Carolina G.S. §147-69.3(i2) authorizes the Treasurer, consistent with

applicable fiduciary duties, to establish market-oriented compensation plans for investment

professional staff in order to promote investment objectives and retain skilled investment staff.

The investment staff are exempt from classification and compensation rules established by the

Office of State Human Resources.

− Procurement-the Treasurer is authorized to retain independent appraisers, auditors, actuaries,

attorneys, investment consulting firms, statisticians, custodians, or other persons of firms with

specialized skills or knowledge necessary for the proper administration of investment programs.

North Carolina G.S.§147-69.3(g).



Conclusion: Current Authority, Duties, Laws−Independence

Conclusion:

▪ The independence granted to the Treasurer in these vital areas is in line with best practices and

enables the Treasurer to prudently exercise his duties to act in the best interests of the participants

and beneficiaries.



Current Authority, Duties, Laws−Legal List

▪ “Legal lists” typically define the types of investments that a fiduciary can make, along with the extent

of the investment that can be made in each type of investment.

▪ Legal lists lack flexibility provided by prudent investor standards to consider asset classes and

products that can provide superior returns or lower portfolio risk through diversification. Most public

pension funds have moved away from legal lists towards autonomy and full discretion over the

management of pension fund assets within fiduciary parameters and have adopted the prudent

investor or prudent expert standard. Both standards are based on modern portfolio theory which

permits investments in any investment which, after following a due diligent process of analysis, they

find prudent, within the context of the overall portfolio. This prudent standard also requires

diversification, unless it would be imprudent to do so under the circumstances.

▪ UPIA and UMPERSA do not support the use of legal lists based on the theory that “no particular kind

of property or investment is inherently imprudent.”



Current Authority, Duties, Laws−Legal List

▪ The Treasurer’s investments are subject to a legal list with thresholds.

− We determined that North Carolina G.S. §147-69.2 conflicts with the Prudent Investor Act

standard of care found in North Carolina G.S. §147-69.7(a);

− We believe it to be contrary to the modern portfolio theory in North Carolina G.S. §147-

69.7(b)(1)(c) and (d); and

− Contrary to the diversification requirement mandated by North Carolina G.S. §147-69.7(b)(2).



Conclusion and Recommendation: Current Authority, Duties, Laws−

Legal List

Conclusion and Recommendation:

▪ Although IMD staff has indicated that the legal list has not impeded their ability to meet their

investment objectives, we recommend pursuing statutory changes to remove the legal list and

corresponding limitations as they are outdated and not consistent with common or best practices of

public retirement systems.



Current Authority, Duties, Laws−Federal Securities Laws

▪ Public pension funds, including the NCRS, are subject to the anti-fraud provisions of federal securities

laws and the U.S. Securities and Exchange Commission (“SEC”) rules thereunder. SEC Report of

Investigation pursuant to 21(a): The Retirement Systems of Alabama.

▪ Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5 prohibit

the purchase or sale of securities on the basis of material non-public information in breach of a duty of

trust or confidence. See 15 U.S.C.§78j(b) and 17 C.F.R.§240.10b-5.

▪ Controlling persons who fail to prevent insider trading may be subject to civil penalties under Section

21A of the Exchange Act.

▪ The North Carolina ethics laws also prohibit a public servant from using or disclosing nonpublic

information in a way that would affect the public servant’s personal financial interest, or a member of

the public servant’s extended family, or a person or governmental unit with whom or business with

which the public servant is associated. The ethics laws also prohibit a public servant from improperly

using or disclosing any confidential information. North Carolina G.S. §138A-34.

IV. Policy and Process Review



Investment Policy Statement for North Carolina Retirement Systems

▪ Aon reviewed the Investment Policy Statement for North Carolina Retirement Systems, in light of

industry common and best practices.

▪ Although ERISA does not require a written Investment Policy Statement (“IPS”) for private pension

plans, the Department of Labor (“DOL”) strongly encourages their creation and adoption by trustees.

Most public pension plans are not required by law to adopt a written IPS. North Carolina’s statutes,

however, do so and are in line with best practices and the DOL’s guidance.

▪ North Carolina G.S. §147-69.10(a) requires the IPS to contain the following elements:

− Descriptions of investment objectives and strategy

− Roles and responsibilities

− Permissible asset classes

− Asset allocation targets and ranges

− Risk Management and compliance guidelines

− Evaluation criteria necessary to measure investment performance

▪ The statute additionally requires the Treasurer to present the IPS to the IAC on at least a biennial

basis for the IAC’s consultation.




▪ There is no uniform industry content and no absolute model to follow when drafting an IPS. The IPS

should ideally be a highly customized document that is uniquely tailored to the preferences, goals,

and situation of the plan.

▪ Over recent years NCRS has reviewed its IPS on a biennial basis. To facilitate the Aon review of the

IPS, we have included the table on the next few slides outlining what we believe to be the key

sections of an IPS and how we think about IPS development. The table includes a broad title of each

section type, the type of information we expect to be included in each section, and a symbol

representing the relative inclusion of this type of information within the Policy. As shown in the table,

the IPS includes most of the components that we believe a well-structured IPS should have, but we

do have some ways in which the IPS could be further enhanced. However, we see these as modest

enhancements to an already well-structured investment policy statement that generally follows best

practice.

▪ The table on the next few slides utilize the following symbols to represent inclusion of the information

in the IPS.

√ - This type of information is currently well represented within the IPS

~ - This idea is included, but could be addressed more directly

O – We do not believe this information is represented within the IPS









Conclusion and Recommendations: Investment Policy Statement for

North Carolina Retirement Systems

Conclusion and Recommendations:

▪ The IPS generally follows best practice. While there is no uniform standard for the content and no

absolute model to follow when drafting an IPS, we have evaluated the aspects of the NCRS IPS

relative to our criteria for what should be included in an IPS to be considered best practice. That

information is outlined in the table on the previous slides. The NCRS IPS includes sufficient detail on

most items we desire in a well-structured IPS, with the exceptions further outlined below.

− Identification of Roles and Responsibility – The IPS includes a “Roles and Responsibilities”

section which outlines the responsibilities of the State Treasurer, Investment Advisory

Committee, and Investment Management Division. However, this section does not include

information on the roles and responsibility of other external providers (actuary, investment

consultants, etc.). We recommend enhancing he document through the broader inclusion of

this information.

− Benchmarks – The IPS outlines in detail, the target asset allocation, asset class benchmarks,

and the two Total Fund benchmarks. However, the document does not state the frequency for

reviewing benchmarks. Additionally, the document does not include overall benchmarking

principles. We recommend adding a short section which outlines the goals and principles

associated with benchmarking, as well as a timeframe for reviewing benchmarks.



Conclusion and Recommendations: Investment Policy Statement for

North Carolina Retirement Systems (cont’d.)

• Currently the IPS references the 2013 Asset Liability Study for the creation of the Long-

Term Policy Benchmark. We recommend additional context regarding the reaffirmation

of this benchmark over time.

− Monitoring and Reporting - We recommend including a descriptive timeline of the cycle for

reporting on key metrics associated with the governance of the Plan.

− Governance – Based on our review it appears that the IPS is reviewed on a biennial basis

which is in compliance with the statutory requirements. We recommend stating this cycle in

the document.



Investment Manager and Vehicle Monitoring Policy

▪ IMD maintains a comprehensive Investment Manager and Vehicle Monitoring Policy, most recently

updated in October 2019.

▪ Aon has reviewed the policy and also discussed its implementation with a range of Staff members.

Staff has also provided Aon with an interim questionnaire it uses to collect information from third

party investment managers in order to supplement its monitoring efforts.



Conclusion and Recommendation: Investment Manager and Vehicle

Monitoring Policy


▪ Aon finds that the Investment Manager and Vehicle Monitoring Policy generally aligns with market

and best practice; however, it does not designate which members of the team (or external

consultants) are responsible for assessments of a third-party investment manager’s investment

capabilities versus operational capabilities. Each type of assessment can require subject matter

expertise that is unique and specialized. Best practice related to operational due diligence is

evolving to a point where segregated investment and operational diligence teams conduct separate

reviews of these areas. IMD has indicated that operations staff or external consultants with subject

matter expertise are responsible for the operational reviews and we recommend codifying this

approach within the Investment Manager and Vehicle Monitoring Policy as way to enforce the

segregation it has already functionally implemented.



External Investment Manager and Vehicle Selection Policy

▪ IMD maintains a comprehensive External Investment Manager and Vehicle Selection Policy, most

recently updated in October 2020.

▪ Aon has reviewed the policy and also discussed its implementation with a range of Staff members.



Conclusion and Recommendations: External Investment Manager and

Vehicle Selection Policy


▪ Aon finds that the External Investment Manager and Vehicle Selection Policy generally aligns with

market and best practice; however, it does not designate which members of the team (or external

consultants) are responsible for assessments of a third-party investment manager’s investment

capabilities versus operational capabilities. Each type of assessment can require subject matter

expertise that is unique and specialized. Best practice related to operational due diligence is

evolving to a point where segregated investment and operational diligence teams conduct separate

reviews of these areas. IMD has indicated that operations staff or external consultants with subject

matter expertise are responsible for the operational reviews and we recommend codifying this

approach within the External Investment Manager and Vehicle Selection Policy as way to enforce

the segregation it has already functionally implemented.



Conclusion and Recommendations: External Investment Manager and

Vehicle Selection Policy (cont’d.)

▪ We recommend the following enhancement to its External Investment Manager and Vehicle

Selection Policy:

– The External Investment Manager and Vehicle Selection Policy’s discussion of due diligence

components related to operational aspects is general and not specific (e.g., it requires a

“Review of risk and operational considerations (identified by staff or consultant”)).

– However, IMD’s Investment Manager and Vehicle Monitoring Policy is more explicit and

includes detailed information on which operational aspects are included in the review (including

items such as trading, allocation policy, cash controls, custody, financing, and counterparty

management).

– Aon recommends that IMD include similar detailed language in its External Investment

Manager and Vehicle Selection Policy in order to help ensure that pre-investment due diligence

is implemented consistently and with a level of detail similar to that of its monitoring efforts.

V. Compliance Process Review



Compliance Process Review

▪ Aon conducted a gap analysis of the current policies and procedures related to internal trading

and private market investment activity; including whether there is a need for information

barriers, a pre-trade clearance process, a trading blackout period, and other trade controls.

− Specifically, Aon reviewed and compared to best practices the trading process related to

the internal equity portfolio, including reviewing the processes related to middle/back

office and valuation, including the processes used for trade confirmation, reconciliation,

cash controls, collateral administration, valuation, and book of record and shadow

accounting. Aon also reviewed practices for handling material non-public information and

the process used to monitor insider trading.



Compliance Process Review: Internal Trading and Private Markets

▪ IMD private markets investment activity has evolved to consider transactions in more individual

companies. This approach has introduced concerns regarding staff access to material non-public

information (“MNPI”). IMD has begun to develop polices and procedures related to access to MNPI

and potential impact to internal trading and personal account trading.

▪ In general, IMD has taken an approach which focuses on creating an “information barrier” that limits

who among staff is or can be made aware that MNPI related to certain companies may exist within

IMD. IMD refers to this approach as establishing a “Conflict Wall.”

▪ The Conflict Wall process is currently in development and has not entirely been formalized into a

defined Policy.



Conclusion and Recommendations: Compliance Process Review:

Internal Trading and Private Markets

Conclusion and recommendations:

▪ IMD has initiated a thoughtful approach to developing a Conflict Wall related to access to MNPI and staff

demonstrates awareness of the reputational and other risks associated with an MNPI event; however, the

approach currently focuses on front-end prevention efforts. Aon recommends that IMD supplement its

current approach with additional monitoring efforts that can help identify issues that could arise if the

Conflict Wall is breached.

▪ We recommend the following enhancement to the IMD’s current Conflict Wall approach to MNPI as it

relates to internal/IMD trade activity:

1) IMD should further codify its Conflict Wall process into a formal policy. This policy should be provided

to staff and incorporated into ongoing compliance training efforts.

2) As part of the Conflict Wall Policy, IMD should include steps that when MNPI risk is identified,

securities associated with relevant companies should be coded into IMD’s trade order management

system. The system should then generate reporting when trades are entered in these securities. This

reporting could be pre- or post-trade or both. The key aspect of this recommendation is that

appropriate members of the IMD team are aware when trading occurs in securities related to

companies where MNPI may be a consideration. These reports (and related trades) should be

reviewed by compliance personnel in order to assess any concerns related to MNPI or Conflict Wall

violations.



Internal Equity Trading Review

▪ IMD maintains comprehensive process documents related to its internal equity trading efforts, most

recently updated in October 2020.

▪ Aon has reviewed the Internal Equity Operational Process and Control Guide and also discussed its

implementation with a range of staff members, including investment/trading and operations staff.

▪ In general, IMD’s approach to its internal equity trading process aligns with market and best practice

in regard to what processes are implemented. However, IMD’s portfolio managers/traders effect

many of the processes which are considered operations functions, including submitting trades to

custodians or counterparties, reconciling trade activity, and oversight of remediating unsettled trades.

This approach erodes segregation of duties controls that are typically in place when dividing trading

responsibilities from trade settlement responsibilities. It is unusual for Aon to see this approach in an

institutional trading environment.



Internal Equity Trading Review

▪ In our review of IMD’s policies and procedures, along with our interviews with IMD staff, it is

apparent that IMD and certain staff members recognize that the limits in segregation discussed here

do create additional risk exposure. IMD has, therefore, integrated a range of ancillary controls within

its process that help to mitigate these risks. Additional considerations/controls include the use of

SS&C as an additional independent third party (beyond the custodian) to review trade activity, as

well as certain reviews/four-eye checks on the activities of IMD’s portfolio managers/front office

personnel.

▪ While these supplemental/additional controls do have the ability to mitigate additional risk exposures

related to the group’s approach to segregation of duties, we generally consider that operating

controls are most effective when they are the most direct and simple (i.e., just segregating the

duties) rather than relying on a range of downstream controls that have the goal of synthetically

replacing the primary control.



Conclusion and Recommendations: Internal Equity Trading Review


We recommend the following enhancements to the IMD Internal Equity Trading program:

1) Portfolio Managers/Traders should not actively be involved in trade settlement activities after execution. Operations staff is typically considered a first check and balance to front office staff and should oversee trade transmission, reconciliation, and remediation of trade breaks. Portfolio Managers/Traders can be involved in these activities (and may need to be in order to provide context in certain circumstances); however, they should not oversee them.

Aon recognizes that the risk environment related to IMD’s current equity trading platform

(generally, index program trading) does not create the risk-taking inducements seen in more

active or opportunistic trading environments. However, segregation of duties concerns within

IMD’s current approach to trade settlement are not exclusive to purposeful or bad-actor activities;

segregation controls are also important considerations for promptly identifying errors or omissions

that may occur in the ordinary course of activities.

At present, multiple members of IMD staff indicated that the group does not currently have

the appropriate capacity and/or expertise in the right functions to initiate an immediate shift in

trade settlement activities to the IMD operations staff. Aon recommends that IMD develop a

viable timeline to train or hire operations staff with the capacity and expertise to take over

trade settlement activities during 2021.



Conclusions and Recommendations: Internal Equity Trading Review

(cont’d.)

2) Portfolio Managers/Traders periodically allocate positions from one portfolio to another (effectively a

cross-trade) in order to limit execution costs. This situation generally occurs when individual index

constituents are moved from one index to another. This process is currently guided by the team’s

subject matter expertise rather than a defined policy or procedure. We recommend that IMD codify

its cross-trade policies and procedures into the Internal Equity Operational Process and Control

Guide. Cross-trade activity can create unique exposures related to downstream settlement and

accounting and this approach will help to ensure cross-trade activity is implemented consistently

and effectively.



Private Market MNPI and Insider Trading

▪ As previously discussed, IMD private markets investment activity has evolved to consider

transactions in more individual companies. This approach has introduced concerns regarding staff

access to material non-public information (“MNPI”). IMD has begun to develop polices and

procedures related to access to MNPI and potential impact to internal trading and personal account

trading.

▪ In general, IMD has taken an approach which focuses on creating an “information barrier” that limits

who among staff is or can be made aware that MNPI related to certain companies may exist within

IMD. IMD refers to this approach as establishing a “Conflict Wall.”

▪ The Conflict Wall process is currently in development and has not entirely been formalized into a

defined Policy.

Aon | Retirement and Investment

Proprietary & Confidential

Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc., an Aon Company. 51

Conclusions and Recommendations: Private Market MNPI and Insider

Trading

▪ IMD has initiated a thoughtful approach to developing a Conflict Wall related to access to MNPI and

staff demonstrates awareness of the reputational and other risks associated with an MNPI event;

however, the approach currently focuses on front-end prevention efforts. Aon recommends that

IMD supplement its current approach with additional monitoring efforts that can help identify issues

that could arise if the Conflict Wall is breached.

▪ We recommend IMD consider the following enhancement to its current Conflict Wall approach to

MNPI as it relates to personal account trading:

1) IMD should further codify its Conflict Wall process into a formal policy. This policy should be

provided to staff and incorporated into ongoing compliance training efforts.

2) As part of the Conflict Wall Policy, IMD should include steps that when MNPI risk is identified,

securities associated with relevant companies should be added to a restricted list. The

restricted list should be circulated among IMD staff and should be incorporated into IMD’s

personal account trading policies. The rationale for inclusion on the restricted list does not

need to be disclosed, which concurrently allows for facilitating both a restricted list and a

Conflict Wall. These policies should be developed to include prohibitions on trading securities

that are maintained on IMD’s restricted list.

VI. Transparency,

Accountability, And Ethics



Transparency

▪ Aon reviewed, in light of other funds, the current information provided to stakeholders and whether it

is adequate to foster transparency and accountability and provides a view into the ethical behavior of

the IMD.

▪ Transparency and accountability are fundamental tenets of good governance and foster public

confidence. Both assist fiduciaries in demonstrating they are acting consistently with the duties of

loyalty and prudence. Posting updated, relevant information on a website that is easily accessible by

the public is an excellent means of disseminating information to stakeholders and interested parties

and heightening public awareness. Most public pension funds post information on the fund’s

operations, policies, investment transactions and performance. When such type of information is not

shared with the public, it can create mistrust about how a fund is being managed.



Transparency

▪ The DST website embraces the governance component of transparency, and in fact, has a

Commitment to Transparency section on its site. The site also posts the following policies, among

others:

– Investment Policy Statement for North Carolina Retirement Systems

– IMD External Manager and Vehicle Selection Policy

– Placement Agent, Political Contribution and Connection Disclosure Policy

– Insider and Personal Trading Policy

– IMD Code of Ethics and Conduct Policy

– Investment Manager and Vehicle Monitoring Policy

– Divestment and Contract Prohibition Policy

– Proxy Voting Guidelines

– Quarterly Investment Performance Reports

– Annual Performance and Fee Reports

– Annual Financial Statements

– Public Records Policy

– Contractual Provisions for Indemnification and Liability Policy



Transparency

▪ Additionally, the public website contains IAC Committee Members Profile, IAC Committee Code of

Ethics, IAC Charter, IAC meeting calendar, agendas, minutes and materials going back to calendar

year 2011, listing of investment managers, listing of IMD salaries, link to NC Open Book, listing of

vendor payments and contracts, and listing of IMD Management Staff Contacts.



Conclusion: Transparency

Conclusion:

▪ The depth and breadth of the information posted on the DST’s public website is in line with best

practices. The website contains relevant investment policies, ethics policies, information on the IAC

and its meetings and materials, and reports. Taken as a whole, the information is a demonstration of

the commitment to transparency and accountability, compliance with fiduciary principles and statutory

requirements, and a solid ethical framework.

56



Delegation

▪ Aon reviewed the current level of delegation, including an evaluation of what authority has been

delegated versus what has been retained, as well as the Signatory Authority Policy.

▪ Under the old common law of trusts, governing trustees were under a duty not to delegate to

others those activities which the trustees could reasonably be required to perform. Restatement

of Trusts 2d §171. UPIA and UMPSERA advocate the modernization of the ‘most-criticized rule

that forbade trustees to delegate investment and management functions.” See UPIA comment to

Section 9. Both of these model acts authorize governing trustees to “delegate functions that a

prudent trustee or administrator acting in a like capacity and familiar with those matters would

properly delegate under the circumstances”. UMPSERA Sec.6. This is particularly important

given the complexity of today’s environment in which institutional investors operate. Few

governing fiduciaries have the expertise or experience to perform all of the functions necessitated

by managing assets.

▪ Governing trustees can delegate but they cannot abdicate their responsibilities. They can

delegate duties to qualified agents; however, if they elect to delegate, they must exercise

reasonable care, skill and caution in selecting and monitoring the agents and establishing the

scope and limits of the agents’ authority. This rule also parallels ERISA provisions authorizing

division of fiduciary responsibility and delegating to investment managers.



Delegation

▪ The decision to delegate is a fiduciary and overall governance decision and is ultimately within

the discretion of the governing fiduciary to decide whether, and in what manner, to delegate

investment functions to staff or third parties.

▪ Best practices call for clear delegations in writing evidencing what authority has been specifically

retained, what authority has been delegated, and the parameters of the delegation.

▪ Any delegation must be accompanied by diligent oversight. Trustees must periodically review the

agent’s performance and compliance with the terms of the delegation. The duty to monitor

requires proactive monitoring, trustees must actively seek out knowledge and information about

the actions of those to whom they have delegated responsibilities. The U.S. Supreme Court has

held that fiduciaries have a continuing duty-separate and apart from the duty to exercise

prudence in selecting investments at the outset-to monitor and remove imprudent investment

options. Tibble v. Edison Int’l, 135 S.Ct. 1823 (2015). Trustees are obligated to act with

appropriate prudence and reasonableness to determine whether those who have delegated

duties are performing their fiduciary obligations.



Delegation

▪ The Treasurer’s has authority to select the CIO and to delegate authority. This authority is not limited

by statute or subject to approval by another entity.

▪ The North Carolina legislature recognized the need for the Treasurer to delegate duties. North

Carolina G.S. §145-75 empowers the Treasurer to “authorize a deputy to perform any duties

pertaining to office.” The statute also makes it clear that the Treasurer is still ultimately responsible for

the conduct of his or her deputies.

▪ Pursuant to the IPS, the Treasurer has retained authority to approve:

– Investment policies and modifications

– Recommended asset allocation targets and benchmarks

– Selection and termination of investment managers as recommended

– Selection and retention of a custodial bank

– Selection and retention of recommended consultants and third-party service providers

– Recommendations regarding cost-effectiveness of the Fund



Delegation-Signatory Authority Policy

▪ IMD Signatory Authority Policy sets forth what authority the Treasurer has retained and what authority

the Treasurer has delegated to the Chief Investment Officer (“CIO”) and other IMD staff.

▪ The Signatory Authority Policy provides for protocols in the case of any recusals by the Treasurer,

and procedures in the event of a need for a temporary delegation otherwise reserved by the

Treasurer.

▪ The Signatory Authority Policy permits the CIO or Chief Financial Officer (“CFO”) to make temporary

delegations of signatory authority to a Director.

▪ Any signatory and investment authority not specifically addressed in the Policy is reserved to the

Treasurer, and any delegated authority can be exercised by the Treasurer.

▪ The Policy contains tables setting forth the assigned signatory for the following:

− Internally managed fixed income and long only public equity

− Externally managed fixed income and long only public equity

− Alternative investments

− Other administration, management and operations decisions



Delegation-Signatory Authority Policy

▪ The Treasurer has specifically retained signatory authority under the Policy for:

− Investment management agreements, substantive amendments, termination, full or partial

redemptions, funding letters, rebalancing of funding between managers, master transition

master agreements, and any matters that would violate or waive a provision of the Placement

Agent Policy or any other established policy.

− Most agreements and documents related to alternative investments

− Tax consultant, custody, pooled trust, and securities lending agreements

− Any vendor contract or amendment of $100,000 or greater

▪ The Treasurer specifically delegated signatory authority to the CIO and other IMD for documents

related to internally managed fixed income and other administration, management and operation

decisions.

▪ The Treasurer has shared responsibility with the CIO or other IMD staff on several items. Most of

these items contain footnotes to explain the parameters and expectations of the shared

responsibility. Through our interviews with IMD staff it is clear that these items are understood and

do not cause any confusion as to who is ultimately taking action with respect to the particular item.



Delegation

▪ The DST CIO position description also evidences the delegation and provides that the CIO is

responsible for directing all aspects of the IMD on behalf of The Treasurer, including:

− Developing policies and procedures

− Formulating recommendations for the Treasurer and implementing approved investments

through complex negotiations

− Hiring, training and supervising professional staff

− Providing strategic oversight and direction

− Providing oversight of operations and administration

− Serving as the principal point of contact as directed by the Treasurer to the General Assembly,

other agencies and stakeholders

− Ensuring compliance

▪ The CIO position description explicitly recognizes that the CIO must be able to delegate duties “in

such as way as to minimize risk and optimize return on invested assets.”



Delegation

▪ Because the decision to delegate is a fiduciary decision of governing fiduciaries, we have seen a wide

spectrum of investment delegation by public pension funds. Many public pension funds governing

fiduciaries retain authority for the IPS, asset allocation, permissible asset classes, performance

benchmarks, and selection of investment consultants. Based upon our research and empirical

knowledge, several public funds have delegated selection and termination of investment managers,

due diligence, and ongoing manager monitoring to the CIO and investment staff.



Conclusion and Recommendation: Delegation


▪ The retained authority and delegations by the Treasurer are generally consistent with other public

pension funds but more closely mirror, as would be expected, those of the sole-fiduciaries in New

York and Connecticut. For example, the New York State Comptroller has retained authority for the

selection of investment managers based upon recommendations from staff. The sole fiduciaries in

New York and Connecticut also employ investment staff and a CIO who is responsible for oversight

of the investment division, implementing investment strategies and policies, making

recommendations to the sole fiduciary, managing staff, and overseeing day-to-day investment

division operations.

▪ As the Treasurer remains ultimately responsible for the oversight of the Co-CIOs and the investment

program, it is important the Treasurer monitor any delegations. The Treasurer should periodically

review the delegation and determine if it continues to be prudent. The Co-CIOs, in turn, must also

monitor any delegations and the actions and performance of IMD staff. If the Treasurer or Co-CIOs

determine there are any issues, prompt and appropriate action should be taken to address the

matter.

▪ We recommend amending the Signatory Authority Policy and CIO position description to reflect the

existence of two Co-CIOs.

VII. Ethics Policy and Insider

Trading Policy Review



Ethics Policies

▪ Aon reviewed the relevant ethics policies and personal trading policy in light of best practices.

▪ Adherence to legal and ethical standards is a key tenant of good governance and is in line with the

duty of loyalty to act in the best interests of the participants and beneficiaries. The best practices

establish an ethical framework that sets forth written policies, procedures and transparency to inspire

public trust.

▪ In recognition of this importance, North Carolina G.S. §147-69.11 authorizes and requires the State

Treasurer, after consultation with the Investment Advisory Committee, to adopt policies and

procedures to ensure the investment program operates under a strong governance framework with

rigorous internal controls, a high degree of operational transparency, and pursuant to the highest

ethical and professional standards.

▪ The Treasurer is required by the statute to adopt the policies and procedures for the following:

− IMD Code of Ethics

− Training for all employees with responsibilities for investment matters relative to the discharge of

their duties and responsibilities to the funds

− Governing gifts for all employees with responsibilities for investment matters

− Limitations on the use of placement agents

− Ensuring independent assessments of potential undue influence due to personal interest in

investment due diligence, negotiations and contracting




Placement Agent, Political Contribution, and Connection Disclosure

Policy

▪ The information required to be disclosed pursuant to placement agent policies identify investments where a placement agent is going to be used or if a political contribution was made. The policies serve as effective transparency tools that allows interested parties open access to information, such as the names of investment entities that use placement agents, names of placement agents, and whether either made political contributions to decision-makers.

▪ The Placement Agent, Political Contribution and Connections Disclosure Policy adopted by the Treasurer requires detailed disclosure letters from Investment Managers which are reviewed and evaluated by Compliance Counsel.

▪ The disclosure letters require, among other matters, whether the Investment Manager has elected to use or compensate a placement agent in obtaining investments from, or business with, any of the Treasurer’s investment funds.

▪ If a placement agent is identified, the disclosure letter requires disclosures and representations, including background information on placement agent, details of any compensation arrangements, any current or former relationships or connections with the Treasurer or his/her staff, IAC, or any immediate family members of same, whether the Investment Manager currently manages any investment funds or has within the last two years, whether the placement agent has been the subject of any federal, state, or local government or regulatory inquiry, action or investigation in the past 10 years, and confirmation the placement agent is registered with the SEC or FINRA. Additionally, if a placement agent is utilized, the placement agent must also complete a separate disclosure letter.



Placement Agent, Political Contribution, and Connection Disclosure

Policy

▪ The Investment Manager Disclosure requires the Investment Manager to disclose connections or

relationships, family relationships, any former Treasurer or IAC personnel, prior working relationships,

social connections, lobbying information, and political contributions to the Treasurer or any incumbent,

nominee, candidate or successful candidate or affiliated political campaign for same.

▪ The Policy mandates any written updates to material information from the Investment Manager within

14 days.

▪ The Policy also provides:

− Remedies for failure to comply with the provisions of the Policy

− Notification and review process

− Evaluation of disclosure letters by Compliance Counsel

− Corrective procedures

− Prohibitions

− Posting of disclosure letters on the Treasurer’s public website

− Incorporation into the Treasurer’s IMD Contract Execution process, which clearly identifies

process, roles and responsibilities



Conclusion: Placement Agent, Political Contribution, and Connection

Disclosure Policy

Conclusion:

▪ The Placement Agent, Political Contribution and Connection Disclosure Policy is exceptionally

comprehensive and is consistent with best practices.

▪ The implementation and monitoring procedures are sound.

▪ The Policy and related procedures evidence excellent transparency and accountability and assist the

Treasurer in the stated goals of maintaining the highest ethical standards.

▪ The practice of posting the Policy and associated disclosures on the DST public website is a best

practice that allows stakeholders and other interested parties to be aware of particulars concerning

disclosure and eligibility requirements imposed on current investment managers and those seeking to

do business with the DST that have elected to use a placement agent.



Ethics and Conduct Policy (Tier 1) and Supplemental Ethics Policy (Tier 2)

▪ The Ethics and Conduct Policies Tier 1 and 2 sets forth a code of conduct and ethical practices for

DST employees that assist in recognizing, avoiding and mitigating conflicts of interest.

▪ Both policies contain essential elements that assist those governed by the policies in understanding

their ethical obligation and promotes adherence to that obligation, including: purpose and coverage,

definitions, roles and responsibilities, expectations, a ban of gifts, disclosure and mitigation of conflicts,

sanctions for violations, related statutes, rules and policies, and frequently asked questions.

▪ The Tier 1 and Tier 2 policies communicate the existence and use of an Ethics and Conduct hotline for

reporting of suspected misconduct, including violations of the ethics policies. The hotline is managed

by the DST Compliance Officer with assistance from the Director of Internal Audit and Compliance.

This is in line with best practices and affords anonymity to those employees who do not wish to

disclose their name.

▪ Upon hire, employees are required to sign an initial acknowledgement of receipt and affirmation to

comply with the provisions and must file on an annual basis thereafter. This is also considered to be a

best practice.

▪ The Tier 2 policy serves as a supplement to the Tier 1 policy for certain DST personnel. Certain

provisions also apply to vendors and investment managers.

▪ The State Ethics Act applies to employees who defined as “covered” under the Tier 2 Policy and who

are required to file an annual Statement of Economic Interest (“SEI”) with the State Ethics Commission.

Covered employees must also complete an Ethics Commission ethics and lobbying education course.



Ethics and Conduct Policy (Tier 1) and Supplemental Ethics Policy (Tier 2)

▪ Although those defined as “non-covered” employees under the Tier 2 policy are not subject to the

State Ethics Act, the Tier 2 Policy mandates that they also file internal SEIs and complete the ethics

and lobbying education every two years.

▪ The DST Compliance Officer communicates with all staff governed by the Tier 2 policy on

completing the required SEIs, tracks submissions to the Ethics Commission, and evaluates the

content of the forms. There is a process if the Compliance Officer identifies an actual, potential, or

apparent conflict of interest.

▪ The Tier 2 policy restricts improper benefits, gifts, charitable donations, future employment,

placement agent activities, and requires reporting relative to conflicts of interest.

▪ DST has also adopted a Secondary Employment Policy to govern secondary employment that might

have an adverse effect on the primary employment and/or creates a conflict of interest. The Policy

provides a process for employees to request approval of the secondary employment.

▪ The Tier 1 and Tier 2 policies are comprehensive and provide clear guidance to DST employees

regarding their status under the policies and expected conduct. The policies contain best practice

elements including definitions, frequently asked questions, and simplification of the concept of

“conflicts of interest.” The Treasurer is to be commended for applying the state ethics law

requirements of filing SEIs and mandatory training on those employees not governed by the state

ethics laws. The adoption of a process in the case of secondary employment is another recognition

of potential conflicts for DST staff and constitutes a best practice.



Conclusion: Ethics and Conduct Policy (Tier 1) and Supplemental Ethics Policy

(Tier 2)

Conclusion:

▪ The Tier 1 and Tier 2 policies are comprehensive and provide clear guidance to DST employees

regarding their status under the policies and expected conduct. The policies contain best practice

elements including definitions, frequently asked questions, and simplification of the concept of

“conflicts of interest.” The Treasurer is to be commended for applying the state ethics law

requirements of filing SEIs and mandatory training on those employees not governed by the state

ethics laws. The adoption of a process in the case of secondary employment is another recognition

of potential conflicts for DST staff and constitutes a best practice.



Investment Management Division Code of Ethics and Conduct

▪ The IMD Code of Ethics and Conduct Policy specifically applies to IMD employees and serves as an

additional layer to the other relevant ethical policies that are incorporated by reference.

▪ The Policy has a proactive disclosure requirement by IMD employees of any personal, social,

employment, or business activities or relationships that could create a potential conflict of interest or

impair the employee’s impartial decision-making abilities.

▪ The Policy contains an affirmative duty on the part of IMD employees to report any actual or

suspected misconduct or violation of laws or policy.

▪ Employees are advised to use care in discretion with respect to confidential information, and a

prohibition against disclosing or using confidential information for personal gain or private

advantage.

▪ Employees are to abide by recommended standards set by professional organizations such as the

Chartered Financial Analyst (“CFA”) Institute.



Conclusion: Investment Management Division Code of Ethics and Conduct

Conclusion:

▪ The IMD Code of Ethics and Conduct Policy is an important supplement to the other ethics policies

adopted by the DST. It recognizes that IMD employees have heightened responsibilities as they are

managing assets and can come into possession of material nonpublic information. The expectation

of adherence to applicable professional standards such as the CFA Institute is vital, as there are

currently eight IMD staff who are CFA Charterholders. The CFA standards contains important

provisions regarding insider trading and requires its Charterholders to act in an ethical manner when

dealing with the public, clients, prospects, employers, employees and fellow members.

▪ Some public funds have a personal trading policy and a separate related MNPI information policy.

The IMD Code of Ethics and Conduct Policy can be enhanced by adding additional information

regarding material nonpublic information. If DST chooses to add the additional provisions described

in our review of personal trading, they can either add to the instant policy or reference those

provisions in the personal trading policy.



Investment Advisory Committee Code of Ethics

▪ Service as an IAC member is not considered to be pursuant to a public office and therefore its

members are not subject to oversight by the State Ethics Commission and are not required to file

annual SEIs. In Connecticut, members of their investment advisory committee are public officials,

subject to the state’s ethics and campaign finance laws and file annual Statement of Financial

Interests. In New York, the Comptroller has adopted a Code of Ethics for investment advisory

committee members that requires annual filing of statements of financial disclosure.

▪ The IAC Code of Ethics was adopted to address ethical standards of conduct for the IAC members.

The Code was adopted in recognition of the fact that IAC members are not subject to the State’s

Ethics Commission, that the financial or investment expertise on the part of members can give rise to

potential conflicts of interest, and the importance that the IAC plays in its advisory role. The IAC

Charter also addresses the expectation of the highest ethical conduct of its members. In furtherance

of transparency and accountability, both the IAC Charter and Code of Ethics are posted on the

Treasurer’s public website.

▪ The IAC Charter provides that although the IAC members are not fiduciaries, they are expected to act

in good faith and to discharge duties solely in the interests of the members and the beneficiaries, to

follow conflict of interest, disclosure and confidentiality rules and policies, and to adhere to high ethical

standards and avoid even the appearance of impropriety.

▪ Additionally, the Treasurer consults with the IAC on Ethics policies and procedures.




▪ The IAC Code of Ethics requires its members to act with integrity, competence, diligence, and in an

ethical manner, and are to apply their knowledge and expertise solely for the benefit of retirement

system participants

▪ The IAC members are to avoid acting in their personal interests and engaging in even the appearance

of a conflict of interest

▪ The Code of Conduct sets forth restrictions on transactions with “interested parties”, which is

specifically defined in the policy

▪ The Code has prohibitions for IAC members acting as a broker or agent in any transaction with the

Retirement Systems; prohibits the receipt of gifts (excluding honorariums or nominal items) from

parties seeking or doing business with the IMD or interested in IMD matters; and requires that any

gifts are to reported by the IAC member to Compliance Counsel; establishes disclosure and recusal

processes for conflicts on interest; a post-service restriction; and a prohibition against using or

disclosing confidential information to advance the member’s personal or financial interests

▪ The Code has a mandatory conflict of disclosure regarding potential conflicts of interests and an

affirmative duty on the part of IAC members to report any knowledge of any actual or suspected act

by another IAC member or DST staff involving fraud, misconduct or otherwise to the Compliance

Counsel




▪ The Code requires IAC members complete an initial and annual recertification of an

acknowledgement and affirmation to comply with the standards set forth in the Code of Ethics.

▪ The Code provides that any violation or failure to annual attest to compliance may be grounds for

removal with cause by the Treasurer.



Conclusion and Recommendations: Investment Advisory Committee

Code of Ethics


▪ The IAC Code of Conduct is in line with best practices in addressing ethical issues and conflicts of

interests. It clearly states ethical expectations in writing, contains disclosure and recusal protocols,

provides for disclosure requirements and reasonable restrictions regarding the receipt of gifts,

requires annual affirmations from IAC members declaring they have reviewed, understand, and agree

to comply with the Code, and contains sanction for violations. The Code not only clearly states ethical

expectations for IAC members, but promotes transparency and accountability. To further strengthen

the goals of the IAC Code of Conduct, we recommend having IAC members file annual internal SEI

forms for review by Compliance Counsel.

▪ We note that the April 29, 2020 revisions of the IAC Code of Conduct removed the requirement of an

annual ethics session since it appeared it had not been occurring. We believe that best practice is to

provide ongoing orientation and then at least biennial training to IAC members regarding ethics and

conflicts of interest. We recommend that the policy be amended to include the training provisions.



Insider & Personal Trading Policy

▪ Although state funds are exempt from the requirements of the Investment Company Act of 1940 and

the Investment Advisors Act, public pension funds and their employees are subject to anti-fraud

provisions of the federal securities laws and Commission rules thereunder. U.S. Securities and

Exchange Commission (“SEC”) Report of Investigation pursuant to 21(a): The Retirement Systems of

Alabama.

▪ The SEC’s action regarding the Retirement Systems of Alabama is an important reminder the SEC

can bring enforcement actions against public pension funds. The SEC noted that the public fund did

not have a compliance officer, investment staff did not understand federal securities laws including

insider trading prohibitions, and that appropriate policies, procedures, and training could have

prevented the conduct that gave rise to the conduct.

▪ Private and public funds with internal management have an obligation to comply with federal

securities laws. Failure to operate without an adequate compliance program subjects these funds to

undue risk.

▪ As stated in the SEC Division of Enforcement 2020 Annual Report: A critical element in preventing

illegal insider trading is robust corporate controls and compliance policies around the use and

safeguarding of material nonpublic information.

▪ The federal laws create insider trading risks of trading in personal securities by the system on the

basis of material nonpublic information, and failing to prevent foreseeable insider trading by

individuals employed by the plan. This is important because even if an internally managed investment

program is based upon passive indexing, the individual personal trading aspect on behalf of the

covered employees must be also be addressed.



Insider & Personal Trading Policy

▪ We reviewed personal trading and MNPI policies, procedures and information from the SEC and regarding several

large public pension plans, including, among others, Texas Teachers’ Retirement System, Ohio Public Employees

Retirement System, California Public Employees’ Retirement System, New York State Common Retirement Fund,

New York State Teachers’ Retirement System, Texas Employees Retirement System, and the State of Wisconsin

Investment Board.

▪ We believe personal trading policies should have the following best practice provisions, including:

− Prohibition against insider trading and front running

− A requirement that those covered must be specifically identified and notified of their reporting obligations

− Designation of a compliance officer who is responsible for reviewing and reporting on personal trading activity

− A pre-clearance process, requiring that covered persons cannot engage in certain personal securities transactions

without seeking pre-approval and complying with established disclosure requirements

− Identifications of transactions that are covered and those that are exempt from the pre-clearance process

− Reporting and disclosure process, ideally on a quarterly basis, with an annual holdings report at year-end

− An acknowledgment requirement that all personal securities and related holdings have been reported

− Definition of key terms, including the definition of material non-public information

− Mandatory training by covered employees

− Clearly defined roles and responsibilities

− Sanctions for noncompliance

− Procedures and precautions regarding MNPI, including post-employment obligations



Conclusion and Recommendations: Insider & Personal Trading Policy


▪ The IMD Insider and Personal Trading policy contains the following provisions which are in line with

peers and best practices:

− Definition of “material”

− Prohibition of insider trading, tipping, front running

− Annual certification form

− Annual transactions report

− Who the policy applies to

− New hire training

− Post-employment restrictions on MNPI

− Sanctions for noncompliance

▪ The Insider Trading and Personal Policy is posted on the DST public website. This is a best practice

and excellent transparency as many public funds do not post their personal trading policies.



Conclusion and Recommendations: Insider & Personal Trading Policy

(cont’d.)

▪ We recommend the following revisions to the IMD Insider and Personal Trading Policy for

enhancement:

− Define ‘nonpublic” information

− Add assets to which policy applies and accounts and interests to which policy applies

− Add clearly defined roles and responsibilities

− Add mandatory annual training requirements

− Add procedures for maintenance of restricted list

− Add precautions regarding MNPI (e.g., avoiding discussions in public places, limit access, secure

storage)

▪ Additionally, some public funds use a third-party electronic monitoring platform through which trades

are pre-cleared and reported, and in which trading records, holdings, and attestations are maintained.

The benefits of this compliance software include efficiency, reduced paperwork, reduced manual

reviews, aid the compliance officer in monitoring, and serve as an audit trail of legal and policy

compliance. We recommend IMD review the available software utilized by other public pension

funds.



Conclusion and Recommendation: Insider & Personal Trading Policy

(cont’d.)

▪ We recommend the responsibility for ensuring implementation of the personal trading and MNPI

processes be owned by a dedicated compliance officer or counsel familiar with federal securities

laws.

VIII. Summary of Recommendations



Number Section Recommendations Page

1. Current Authority,

Duties, Laws-Legal

List

We recommend pursuing statutory changes to remove the legal list and

corresponding limitations as they are outdated and not consistent with

common or best practices of public retirement systems.

28

2. IPS-Identification of

Roles and

Responsibilities

We recommend enhancing the IPS by including information on the roles

and responsibility of other external providers (actuary, investment

consultants, etc.).

35

3. IPS-Benchmarks We recommend adding a short section to the IPS that outlines the goals

and principles associated with benchmarking, as well as a timeframe for

reviewing benchmarks. We also recommend additional context regarding

the reaffirmation of Long-Term Policy Benchmark over time.

35

4. IPS-Monitoring &

Reporting

We recommend including a description timeline of the cycle for reporting on

key metrics associated with governance of the Plan in the IPS.

36

5. IPS-Governance We recommend stating the biennial review cycle in the IPS. 36

6. Investment

Manager & Vehicle

Monitoring Policy

We recommend amending the Investment Manager & Vehicle Monitoring

Policy to codify the approach of utilizing operations staff or external

consultants with subject matter expertise as being responsible for the

operational reviews of investment managers.

38

Summary of Recommendations





7. External Investment

Manager & Vehicle

Selection Policy

We recommend amending the External Investment Manager & Vehicle

Selection Policy to codify the approach of utilizing operations staff or

external consultants with subject matter expertise as being responsible for

the operational reviews of investment managers.

40

8. External Investment

Manager & Vehicle

Selection Policy

We recommend amending the External Investment Manager & Vehicle

Selection Policy to include language similar to that contained in the

Investment Manager & Vehicle Monitoring Policy detailing information on

which due diligence operational aspects are included in the review

(including items such as trading, allocation policy, cash controls, custody,

financing, and counterparty management).

41

9. Internal Trading &

Private Markets

We recommend supplementing the current Conflict Wall process related to

access to material nonpublic information (“MNPI”) with additional

monitoring efforts that can help identify issues that could arise if the Conflict

Wall is breached.

45


Private Markets

We recommend further codifying the Conflict Wall process into a formal

policy that is provided to staff and incorporated into ongoing compliance

training efforts.

45






Private Markets

As part of the Conflict Wall Policy, IMD should include steps that when MNPI

risk is identified, securities associated with relevant companies should be

coded into IMD’s trade order management system. The system should then

generate reporting when trades are entered in these securities. This reporting

could be pre- or post-trade or both. They key aspect of this recommendation

is that appropriate members of the IMD team are aware when trading occurs

in securities related to companies where MNPI may be a consideration. These

reports (and related trades) should be reviewed by compliance personnel in

order to assess any concerns related to MNPI or Conflict Wall violations.

48

12. Internal Equity

Trading Review

We recommend that IMD develop a viable timeline to train or hire operations

staff with the capacity and expertise to take over trade settlement activities

during 2021 to ensure appropriate segregation of duties.

48

13. Internal Equity

Trading Review

We recommend that IMD codify its cross-trade policies and procedures into

the Internal Equity Operational Process and Control Guide.

49





14. Private Market

MNPI and Insider

Trading

As part of the Conflict Wall Policy, IMD should include steps that when

MNPI risk is identified, securities associated with relevant companies

should be added to a restricted list. The restricted list should be circulated

among IMD staff and should be incorporated into IMD’s personal account

trading policies. The rationale for inclusion on the restricted list does not

need to be disclosed, which concurrently allows for facilitating both a

restricted list and a Conflict Wall. These policies should be developed to

include prohibitions on trading securities that are maintained on IMD’s

restricted list.

51

15. Delegation We recommend amending the Signatory Authority Policy and CIO position

description to reflect the existence of two Co-CIOs.

64

16. Investment Advisory

Committee Code of

Ethics

We recommend having Investment Advisory Committee members file

annual internal Statement of Economic Interest forms for review by IMD

Compliance Counsel.

78





17. Investment Advisory

Committee Code of

Ethics

We recommend that the IAC members receive at least biennial training

regarding ethics and conflicts of interest, and that the IAC Code of Ethics

be amended to include the training provisions.

78

18. Insider & Personal

Trading Policy

We recommend that the Insider and Personal Trading Policy be revised

as follows: define “nonpublic” information; add assets to which the policy

applies and accounts and interests to which the policy applies; add clearly

defined roles and responsibilities; add mandatory annual training

requirements; add procedures for maintenance of a restricted list: add

precautions regarding material non-public information (e.g., avoiding

discussions in public places, limit access, secure storage).

82


Trading Policy

We recommend IMD review the use of available software utilized by other

public pension funds to assist with pre-clearance approvals, reporting, and

maintaining trading records, holdings and attestations.

82


Trading Policy

We recommend the responsibility for ensuring implementation of the

personal trading and material nonpublic information process be owned by

a dedicated compliance officer or counsel familiar with federal securities

laws.

83


Appendix

90



Documents Reviewed

▪ Relevant laws and legal opinions

▪ NCRS Investment Policy Statement

▪ IMD Investment Manager and Vehicle Monitoring Policy

▪ IMD External Investment Manager and Vehicle Selection Policy

▪ Placement Agent and Political Connection Disclosure Policy

▪ Ethics and Conduct Policy Tier 1 and Tier 2

▪ Code of Ethics for IMD

▪ Investment Advisory Committee Code of Ethics

▪ Insider and Personal Trading Policy

▪ Secondary Employment Policy

▪ Investment Committee Charter

▪ IMD Contract Execution Process

▪ Investment Advisory Council Charter

▪ Valuation Committee Charter

▪ Proxy Voting Policy

▪ Quarterly Investment Reports

▪ Fee & Performance Reports

▪ Audited Financials

▪ Signatory Authority Policy

▪ Temporary Delegation of Signatory Authority exemplars

▪ IMD staff position descriptions

▪ Completed Aon Due Diligence Questionnaire

Note: Any omission of documents from the list above that we used for the findings in this report is unintentional.



Interviews Conducted

For this Review, Aon interviewed the following DST Staff members:

▪ Christopher Morris, Co-Chief Investment Officer

▪ Benjamin Garner, Interim General Counsel

▪ Casey High, Portfolio Manager/Public Equity

▪ Matthew Krimm, Investment Director/Operations & Risk

▪ Deanna Moore-Solomon, Investment Analyst/Risk Management & Asset Allocation

▪ Meryl Murtagh, Assistant General Counsel

▪ Rhonda Smith, Investment Director/Public Equity

▪ Greg Taylor, Portfolio Manager/Public Equity