J
PLEASE RETURN
Montana 55601
OFFICE OF THE LEGISLATIVE AUDITOR
STATE OF MONTANA
STATE CAPITOL • HELENA
MONTANA STATE LIBRARY
3 0864 1002 4554
STATE OF MONTANA
BOARD OF INVESTMENTS
AUDIT REPORT
Conducted Under Contract By
Arthur Andersen & Co.
June 30, 1978
Digitized by the Internet Archive
in 2010 with funding from
Montana State Library
http://www.archive.org/details/stateofmontana1978mont
STATE OF MONTANA
MORRIS L BRUSETT
LEGISLATIVE AUDITOR
^ttitt xti tJb:e '^t^hiniiixt ^ubiixtx
STATE CAPITOL
HELENA. MONTANA 59601
406/449-3I22
November 1978
DEPUTY LEGISLATIVE AUDITORS:
JOSEPH J. CALNAN
ADMINISTRATION AND
PROSRAM AUDITS
ELLEN FEAVER
FINANCIAL-COMPLIANCE AND
CONTRACTED AUDITS
STAFF LEGAL COUNSEL
JOHN W. NORTHEY
The Legislative Audit Committee
of the Montana State Legislature:
Transmitted herewith is the report on the audit of the Board of
Investments for the year ended June 30, 1978.
The audit was conducted by Arthur Andersen and Co., Certified
Public Accountants under a contract between the firm and our office.
The comments and recommendations contained in this report represent the
views of the firm and not necessarily the Legislative Auditor.
The agency's written response to the report recommendations is
included in the back of the audit report.
Respectfully submitted,
Morris L. Brusett, C.P.A.
Legislative Auditor
TABLE OF CONTENTS
General
PAGE
Overview of Audit 2
Appointive and Administrative Officials 4-
Financial Statements
All Funds, Excluding the Short-Term
Investment Pool
Auditors' Report 5
Statements of Investments Managed o
Statements of Investment Income 6
Statements of Changes in Investments
Managed 7
Notes to Financial Statements 8
Short-Term Investment Pool
Auditors ' Report 10
Statements of Investments Managed H
Statements of Investment Income
and Distributions 12
Statements of Changes in
Investments Managed 13
Notes to Financial Statements 14-
Memorandum of Suggested Improvements in
Accounting Procedures and System of Internal
Control 15
Prior Year Recommendations 20
Portfolio of Investments Appendix A
STATE OF MONTANA BOARD OF INVESTMENTS
OVERVIEW OF AUDIT
JUNE 30, 1978
Our examination of the financial statements of
the State of Montana Board of Investments was conducted
primarily to enable us to render an opinion as to the fairness
of their presentation. Included in this report are our
opinions on the June 30, 1978 financial statements expressed
in our auditors' reports dated September 21, 1978. In
conjunction with our examination, the Montana legislative
auditor specifically requested that our audit procedures
include the following:
1. Review all state laws applicable to the Board and
determine the Board's compliance therewith;
2. Physically examine all securities held by the
Treasurer's office at June 30, 1978 and confirm with the
holding institution those securities held in safekeeping;
3. Confirm with the servicing institution, the outstanding
balances for all mortgages and SBA loans owned at June 30,
1978;
4-. Examine all mortgages and related documents
at specified bank locations ;
5. Test the accuracy of individual securities listed
in the portfolio;
6. Test Short-Term Investment Pool transactions to
determine compliance with established guidelines for
operation of the pool;
7. Examine minutes of the monthly Board of Investments'
meetings .
During our examination, several items came to our
attention which should be considered by the Board and which
have been transmitted to the Board under the title "Memorandum
of Suggested Improvements in Accounting Procedures and System
of Internal Control". These items were considered by us
during our examination; however, they do not modify the
opinions expressed in our auditors' reports. The Board's
actions relating to these suggestions should result in
improved procedures and controls in future periods.
-3-
STATE OF MONTANA BOARD OF INVESTMENTS
APPOINTIVE AND ADMINISTRATIVE OFFICIALS
JUNE 30, 1978
BOARD OF INVESTMENTS
Dean H. Albert, Chairman Term Expires January 5, 1981
John MacMillan Term Expires January 5, 1981
Patricia P. Douglas Term Expires January 5, 1981
John A. Hauf Term Expires January 1, 1979
Jay LaLonde Term Expires January 1, 1979
ADMINISTRATIVE OFFICIALS
Jack C. Crosser Director, DBpartment of Administration
James R. Howeth Investment Officer
David J. Brown Assistant Investment Officer
STATE OF MONTANA BOARD OF INVESTMENTS
ALL FUNDS, EXCLUDING THE SHORT-TERM INVESTMENT POOL
FINANCIAL STATEMENTS
AS OF JUNE 30, 1978 AND 1977
TOGETHER WITH
AUDITORS' REPORT
Arthur Andersen & Co.
Boise, Idaho
To the Legislative Audit Committee
of the Montana State Legislature:
We have examined the statements of investments
managed by the State of Montana Board of Investments, All
Funds, Excluding the Short-Term Investment Pool, as of
June 30, 1978 and 1977, and the related statements of investment
income and changes in investments managed for the years then
ended. Our examination was made in accordance with generally
accepted auditing standards, and accordingly included such
tests of the accounting records and such other auditing
procedures as we considered necessary in the circumstances.
In our opinion, the accompanying financial statements
present fairly the investments managed by the State of
Montana Board of Investments, All Funds, Excluding the
Short-Term Investment Pool, as of June 30, 1978 and 1977, and
its investment income and the changes in its investments
managed for the years then ended, in conformity with generally
accepted accounting principles consistently applied during
the periods .
Our examination has been made primarily for the
purpose of forming the opinion stated in the preceding
paragraph. The portfolio information as of June 30, 1978,
contained in Appendix A of this report, although not considered
necessary for a fair presentation of the aforementioned
financial statements, is presented as supplementary information
and has been subjected to the audit procedures applied in
the examination of the basic financial statements. In our
opinion, the portfolio information is fairly stated in all
material respects in relation to the basic financial statements,
taken as a whole.
(::^UU^oiy<^l^<^Uu^^~i^ ,
5oise , Idaho ,
September 21, 197f
3TATF OF MONTANA BOARD OF INVESTMENTS
ALL FUNDS, EXCLUDING THE SHORT-TERM INVESTMENT POOL
STATEMENTS OF INVESTMENTS MANAGED
JUNE 30, 1978 AND 1977
Investments managed at book value (current value of $588,267,503 in 1978
and $540,770,863 in 1977) (Note 2)
Dividends and interest receivable
Net unamortized deferred losses on bond swaps (Note 2)
Interest purchased receivable
1978
$625,595,682
10,124,068
5,397,906
81,966
1977
$542,638,554
8,495,357
6,453,323
154,031
Total investments managed
$641,199,622
$557,741,265
STATEMENTS OF INVESTMENT INCOME
FOR THE YEARS ENDED JUNE 30, 1978 AND 1977
INCOME:
Interest income
Dividend income
Gain on sale of investments
Rental income
1978
$ 41,841,642
1,249,591
585,428
31,671
1977
$ 35,589,090
837, 562
223,816
31,324
EXPENSES:
Administrative expenses
Net amortization of deferred losses on bond swaps (Note 2)
43,708,332
(91,455)
(1,124,595)
36,681,792
(79,254)
(1,152,541)
(1,216,050)
(1,231,795)
Net investment income
$ 42,-492,282
$ 35,449,997
The accompanying notes are an integral part of these financial statements
-6-
STATE OF ftONTANA BOARD OF INVESTMENTS
ALL FUNDS, EXCLUDING THE SHORT-TERM INVESTMENT POOL
STATEMENTS OF CHANGES IN INVESTMENTS MANAGED
FOR THE YEARS ENDED JUNE 30, 1978 AND 1977
1978
1977
TOTAL INVESTMENTS MANAGED, BEGINNING OF YEAR
Net investment income
Income remitted to agencies
Accrued income transferred
^2,492,282
(40,863,571)
$557,741,265
35,449,997
(33,985,157)
9,648
$477,832,425
Increase in dividends and interest receivable
Interest purchased during the year
Interest purchased collected during the year
272,352
(344,417)
1,628,711
292,719
(299,743)
1,474,488
Decrease in interest purchased receivable
Net bond swap losses incurred during the year
Net amortization of deferred bond swap losses
69,178
(1,124,595 )
(72,065)
75,599
(1,152,541)
(7,024)
Decrease in net unamortized deferred
losses on bond swaps
Increase in book value by net amortization of
discounts and premiums
Securities purchased
Securities sold and matured
7,302,654,537
(7,220,425,162)
(1,055,417)
727,753
5,923,750,142
(5,844,984,772)
(1,076,942)
752,948
Increase in carrying value of securities
purchased
82,229,375
78,765,370
TOTAL INVESTMENTS MANAGED, END OF YEAR
$641,199,622
$557,741,265
The accompanying notes are an integral part of these financial statements
- 7-
STATE OF MONTANA BOARD OF INVESTMENTS
ALL FUNDS, EXCLUDING THE SHORT-TERM INVESTMENT POOL
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1978
HISTORY AND ORGANIZATION:
The State of Montana Board of Investments (the Board)
was created by an act of the Legislature to invest and
manage the State of Montana's investment funds on a
centralized basis. The investments and the income
therefrom are owned by various State of Montana agency
funds and managed on their behalf by the Board.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Inve stments
Investments, except mortgages, are presented in the
statements of investments managed at original cost
adjusted for discount and premium amortization where
applicable. Mortgages are presented in the statements
of investments managed at par value. Mortgage discounts
are recorded in the accounting records of the applicable
administrating agencies. Current values for publically
traded securities are determined primarily by reference
to market prices supplied to the Board by various
brokerage houses. Unrealized market loss on investments
managed was $35,460,488 in 1978, and unrealized market
gain was $18,950,552 in 1977. The investments managed
relate principally to investments which will be held
to maturity or otherwise disposed of at no significant
loss to the fund.
Premiums and discounts are amortized using the straight-
line method over the life of the securities. An average
life of eight years is used for amortization of mortgage
di scount s .
Bond Swaps
Bond swaps involve trading one security for another
security having the same par value for the purpose of
enhancing portfolio content and/or yield. The Board
defers gains and losses resulting from bond swaps and
amortizes such gains and losses over the shorter of
either the remaining life of the bonds sold or the
bonds purchased for replacement. As shown in the
accompanying financial statements at June 30, 1978
and 1977, the accumulated net unamortized deferred
losses on bond swaps aggregate $5,397,906 in 1978,
and $6,453,323 in 1977. The net amortization of the
deferred losses totaled $1,124,595 in 1978, and
$1,152,541 in 1977.
3. INVESTMENTS NOT CONTROLLED:
Certain mortgages, buildings and land, the cost of which
are included in investments managed in the accompanying
financial statements, are not under direct control of
the Board. The agencies administering these assets
maintain control and provide the Board with the necessary
financial information. Rental income from these buildings
and interest income from the mortgages are included in the
statements of investment income; however, occupancy and
depreciation charges relating to the buildings are not
included.
The book value of these assets included in investments
managed in the accompanying financial statements at
June 30, 1978 and 1977 are as follows:
1978
1977
Mortgages
Land and Buildings
$56,301,777
308,530
$50,167,756
317,312
• 9-
STATE OF MONTANA BOARD OF INVESTMENTS
SHORT-TERM INVESTMENT POOL
FINANCIAL STATEMENTS
AS OF JUNE 30, 1978 AND 1977
TOGETHER WITH
AUDITORS' REPORT
Arthur Andersen & Co.
Boise, Idaho
To the Legislative Audit Committee
of the Montana State Legislature
We have examined the statements of investments
managed by the State of Montana Board of Investments, Short-
Term Investment Pool as of June 30, 1978 and 1977, and the
related statements of investment income and distributions
and changes in investments managed for the years then ended.
Our examination was made in accordance with generally accepted
auditing standards, and accordingly included such tests of
the accounting records and such other auditing procedures as
we considered necessary in the circumstances.
In our opinion, the accompanying financial statements
present fairly the investments managed by the State of
Montana Board of Investments, Short-Term Investment Pool, as
of June 30, 1978 and 1977, and its investment income and
distributions and the changes in its investments managed for
the years then ended, in conformity with generally accepted
accounting principles consistently applied during the periods.
Our examination has been made primarily for the
purpose of forming the opinion stated in the preceding
paragraph. The portfolio information as of June 30, 1978,
contained in Appendix A of this report, although not considered
necessary for a fair presentation of the aforementioned
financial statements, is presented as supplementary information
and has been subjected to the audit procedures applied in
the examination of the basic financial statements. In our
opinion, the portfolio information is fairly stated in all
material respects in relation to the basic financial statements,
taken as a whole.
^^^Ut^i^y^ ^^^^c/a^{tc.-f!^ ,
ioise , Idaho ,
September 21, 1978
STATE OF MONTANA BOARD OF INVESTMENTS
SHORT-TERM INVESTMENT POOL
STATEMENTS OF INVESTMENTS MANAGED
JUNE 30, 1978 AND 1977
1978
1977
Cash
Interest receivable
Investments managed at current value
(cost of $170,717,487 and
$155,007,735, respectively) (Note 2)
$ \K,K21
2,733,273
$ 11,794
2,161,817
168,415,515 167,481,198
Total assets
Accrued expenses
171,163,215
(20,401)
169,654,809
( 17,807)
Value of units
Income due participants
171,142,814
(1,091,227)
169,637,002
(958,692)
Net asset value
$170,051,587 $168,678,310
Units outstanding
Unit value
170,781 164,699
$ 1,002.12 $ 1,029.98
The accompanying notes are an integral
part of these financial statements.
11-
STATE OF MONTANA BOARD OF INVESTMENTS
SHORT-TERM INVESTMENT POOL
STATEMENTS OF INVESTMENT INCOME AND DISTRIBUTIONS
FOR THE YEARS ENDED JUNE 30, 1978 AND 1977
Interest income
Realized gain on sale of investments
1978
$12,384,874
31,744
1977
$11,502,634
178,618
Income before administrative expenses 12,416,618
Administrative expenses (Note 2) (216,548)
11,681,252
(214,899)
Net income 12,200,070
Income purchased by participants 951,632
Income due participants, beginning of year 958,692
11,466,353
1,174,207
1,061,319
Income available for distribution
Income distributed on units sold (Note 2)
November distribution (Note 2)
May distribution (Note 2)
14^110_,394
1,013,153
5,841,627
6,164,387
13,701,879
1,196,889
5,916,930
5,629,368
Total distributions
13,019,167
12,743,187
Income due participants, end of year $ 1,091,227 $ 958,692
The accompanying notes are an integral
part of these financial statements.
• 12-
STATE OF MONTANA BOARD OF INVESTMENTS
SHORT-TERM INVESTMENT POOL
STATEMENTS OF CHANGES IN INVESTMENTS MANAGED
FOR THE YEARS ENDED JUNE 30, 1978 AND 1977
Net asset value, beginning of year
Units purchased by participants
Change in current value of
investments managed
Units sold by participants
Net asset value, end of year
1978
$168,678,310
61,494,093
(4,775,434)
(55,345,382)
$170,051,587
1977
$166,086,163
71,392,958
1,202,234
(70,003,045)
$168,678,310
The accompanying notes are an integral
part of these financial statements.
-13-
STATE OF MONTANA BOARD OF INVESTMENTS
SHORT-TERM INVESTMENT POOL
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1978
HISTORY AND ORGANIZATION:
The State of Montana Board of Investments (the Board)
was created by an act of the Legislature to invest
and manage the State of Montana's investment funds on a
centralized basis. The Short-Term Investment Pool
(STIP) provides a short-term investment vehicle to
participants (state and local governmental units)
with a relatively small amount to invest. Investment
in STIP affords the participant liquidity and a return
on their investment. The investments and the income
of STIP are owned by the participants as they purchase
units and are managed on their behalf by the Board.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Administrative Expenses
Administrative expenses incurred by the Board are
charged to STIP daily based on the Board's expenses
applicable to STIP.
Income Distribution
The value of units purchased or sold includes a daily
computation of net asset value and income;
therefore, income to point of sale is included in
proceeds to the seller. Cash distributions of income
are made to continuing participants on the last
working day in the months of May and November. The
amounts shown for units purchased and sold by partici-
pants are net. of income purchased and income sold,
respectively .
Investments
Investments are presented in the statements of investments
managed at current value. Current values for publically
traded securities are determined primarily by reference
to market prices supplied to the Board by various brokerage
houses. Gains and losses on bond swaps are accounted
for on the completed transaction method and are therefore
currently included in income.
-lA-
STATE OF MONTANA BOARD OF INVESTMENTS
MEMORANDUM OF SUGGESTED IMPROVEMENTS
IN ACCOUNTING PROCEDURES AND SYSTEM OF INTERNAL CONTROL
SEPTEMBER 1978
Arthur Andersen & Co.
Legislative Audit Committee
Montana State Legislature
999 Main Street
Boise, Idaho 83702
(208) 345-0937
Gentlemen :
The accompanying memorandum includes suggestions
for improvement of accounting procedures and internal accounting
control measures that came to our attention as a result of
our examination of the financial statements of the investments
managed by the State of Montana Board of Investments (the
Board) for the year ended June 30, 1978. The matters discussed
herein were considered by us during our examination and they
do not modify the opinions expressed in our auditors' reports
dated September 21, 1978, on such financial statements.
In accordance with generally accepted auditing
standards, we performed a review and evaluation of existing
internal accounting controls for the purpose of providing a
basis for reliance thereon in determining the nature,
timing and extent of the audit tests applied in connection
with our examination of the Board's 1978 financial statements.
While certain matters which came to our attention during the
review are presented in the accompanying memorandum for the
consideration of management, such a review was not designed
for the purpose of making detailed recommendations and would
not necessarily disclose all weaknesses in the existing
system .
The accompanying memorandum also includes comments
and suggestions with respect to other financial and administrative
matters which came to our attention during the course of our
examination of the financial statements. These matters are
offered as constructive suggestions for the consideration of
management as part of the ongoing process of modifying and
improving accounting, control and other financial and administrative
practices and procedures.
Very truly yours,
ARTHUR ANDERSEN & CO.
Conversion of Mortgage
Accounting to Computer System In April, 1978, the Board
began implementation of a new
electronic data processing system for mortgages administered
by the Public Employees Retirement System ( PERS ) . At that
time, PERS discontinued their manual system of accounting
for mortgages. The computer implementation developed problems
and consequently was not able to provide the Board with
accurate information regarding mortgage activity in May and
June. The Board was forced to estimate the breakdown of
principal and interest for mortgage payments received in May
and June .
We recommend that the Board reconcile all mortgage
activity from April through the date the computer system
becomes fully operational and proves to be error free. This
reconciliation should be done on a bank by bank basis in
order to ensure that the temporary loss of control over PERS
mortgages has not resulted in any significant errors. We
also suggest that when the Teachers Retirement System mortgages
are transferred to the computer system, that a parallel
manual system be maintained until the conversion is complete
and has proven to be reliable.
Agency Reply - We concur with the recommendation.
-16-
Automation of the Short-Term
Investment Pool
The Board is scheduled to
begin conversion of the manual
accounting system used for the short-term investment pool (STIP)
to an electronic data processing system in late 1978.
This move should prove beneficial to the Board in terms of
increased efficiency and ability to access supplementary
information not now readily available. However, as in almost
all cases of implementing a new computer system, often
it takes a considerable amount of start up time before the
new system becomes fully operational and reliable. Therefore,
we suggest the Board continue to operate the present manual
system as a parallel system until such time as the new
computer system proves to be fully operational and error free.
Agency Reply - We concur with the recommendation.
-17-
Physical Examination
of Mortgages
During our examination of mortgages
and supporting documentation purchased
by the Board and held by the mortgage agency, we noted the
following items, details of which we have previously furnished
to the Board:
1. One instance in which the investment was not in
compliance with the criteria for permissible investments
as established in Montana Code Section 79-310( f )( i ) .
2. Nine mortgages remained partially unsupported as
no mortgage note was available for examination.
3. Numerous cases where the mortgage note had not
been restrictively endorsed over to the proper fund.
4. Three instances in which the assignment of the
mortgage had been misfiled or lost.
We recommend that the Board inform the agencies of
their concern relating to mortgage files and accounting
records. Also, the Board should investigate the specific
case in which they are not in compliance with Code Section
79-310(f)(i) relating to permissible investments and resolve
the non-compliance.
Agency Reply - We concur and letters of compliance
have already been sent to the servicers which are
responsible .
-If
Mo rtgage Interest Purchased Occass ionally , the Board
will purchase mortgages
with accrued interest. Normal procedure for purchased
interest is to subtract the amount purchased from the
interest income recorded when the first interest payment is
received. During our audit, it was noted that there were
cases where this mortgage interest purchased was not deducted
from the first interest payment received and was still listed as
purchased interest receivable at year end.
We suggest that the purchased interest receivable
detail schedules be reviewed periodically as well as at year
end to ensure that no amounts reported as purchased interest
receivable which should have been received are included in
purchased interest receivable.
Agency Reply - we concur with the recommendation.
-19-
STATE OF MONTANA BOARD OF INVESTMENTS
PRIOR YEAR RECOMMENDATIONS
The State of Montana Board of Investments (Board)
is in substantial compliance or is in the process of complying
with the recommendations discussed in the 1977 audit report.
Following is a brief discussion of the 1977 recommendations
which have not been fully implemented.
Mortgage Accounting
The Board is in the process of assuming the accounting
and control for mortgages purchased. It is contemplated
that the Board will have the system fully implemented by