RECOMMENDATIONS ON INVESTMENT OVERSIGHT OF THE PERMANENT STATE SCHOOL FUND

Commissioned by the Utah State Board of Education on February 8, 2013 Submitted by the School Trust Investment Task Force on July 18, 2013

TASK FORCE MEMBERS: Rich Cunningham, RIA Sterling Jenson, CFA David Damschen, CTP Kent Misener, CFA David Hemingway, MBA Elizabeth Tashjian, PhD Jennifer Johnson, CFA, Chair

TABLE OF CONTENTS
TABLE OF CONTENTS ............................................................................................................. 2 TABLE OF FIGURES ................................................................................................................. 4 EXECUTIVE SUMMARY ........................................................................................................... 5 THE CREATION OF THE SCHOOL TRUST INVESTMENT TASK FORCE .......................................... 6
SCHOOL TRUST INVESTMENT TASK FORCE MEMBERS .....................................................................7 TASK FORCE STAFF .........................................................................................................................8 ATTENDEES AND CONTRIBUTORS ...................................................................................................8

TRUST BACKGROUND ............................................................................................................ 9

TRUST ORIGIN................................................................................................................................9 TRUST LAW ....................................................................................................................................9 TRUST ASSETS: LANDS AND FUND ................................................................................................ 10 CURRENT TRUST LANDS MANAGEMENT: SITLA ............................................................................. 11 CURRENT TRUST FUND MANAGEMENT: STATE TREASURER........................................................... 11

HISTORICAL SUMMARY OF THE INVESTMENT OF THE FUND ................................................. 12

HISTORICAL MISMANAGEMENT ................................................................................................... 12 RECENT CHANGES AND REFORMS................................................................................................. 13 POLITICAL RISKS ........................................................................................................................... 14

GROWTH OF THE PERMANENT STATE SCHOOL FUND ........................................................... 15

FUND GROWTH............................................................................................................................ 15 DISTRIBUTION POLICY .................................................................................................................. 16 Trust Fund Distribution History .......................................................................................................... 16 Impact of the Trust Fund Distributions .............................................................................................. 17 Leon Jones - Principal of Rose Springs Elementary in Tooele School District: ................................... 18 Dahlia Cordova - Principal of Backman Elementary in Salt Lake City School District: ....................... 18

INFORMATION GATHERING WORK OF THE TASK FORCE ....................................................... 19

STAKEHOLDER INPUT ................................................................................................................... 19 Dr. Martell Menlove, Utah Superintendent of Public Instruction...................................................... 19 Kevin Carter, SITLA Director ............................................................................................................... 19 Kim Christy, SITLA Deputy Director .................................................................................................... 19 Michael Morris, past SITLA Board Chair & past IAC Member ............................................................ 20 IDAHO CASE STUDY ...................................................................................................................... 20 Larry Johnson, CPA/CFA ..................................................................................................................... 20 PRESENTATION OF THE STATE TREASURERS OFFICE ..................................................................... 21

GOVERNANCE STRUCTURES OF OTHER STATES ............................................................................. 21 CORRESPONDENCE ON SOLE FIDUCIARY RISKS.............................................................................. 22 QUESTIONS CONSIDERED ............................................................................................................. 23

RECOMMENDATIONS .......................................................................................................... 24
CHARACTERISTICS OF AN IDEAL GOVERNING STRUCTURE ............................................................. 24 BEST GOVERNANCE STRUCTURE RANKINGS .................................................................................. 25 FUND DISTRIBUTION POLICY ........................................................................................................ 27 Characteristics of an Ideal Distribution Policy.................................................................................... 27 Analysis of Current Distribution Policy............................................................................................... 28 Recommendations Regarding Distribution Policy .............................................................................. 28 REPORTING REQUIREMENTS ........................................................................................................ 29 Why report ......................................................................................................................................... 29 Reporting to whom? .......................................................................................................................... 29 Reporting what ................................................................................................................................... 29 Reporting when .................................................................................................................................. 29 RISK TOLERANCE AND APPROPRIATE ASSETS ................................................................................ 30 AUDITS AND CUSTODY ................................................................................................................. 30

APPENDIX A: State Board Resolution Creating the Task Force .............................................. 31 APPENDIX B: Trust Law ........................................................................................................ 32 APPENDIX C: Detailed Funding Flow Chart ........................................................................... 33 APPENDIX D: Idaho Model ................................................................................................... 34 APPENDIX E: Statute on Delict of Treasurer .......................................................................... 35 APPENDIX F: Correspondence Regarding Sole Fiduciary Risks ............................................... 36 APPENDIX G: Minority Report to Utah State Board of Education School Trust Investment Task Force ................................................................................................................................... 45 APPENDIX H: Pension Fund Best Practices ............................................................................ 49 APPENDIX I: Analysis of Governing Structures ...................................................................... 51
OPTION 1: SITLA BOARD............................................................................................................... 51 OPTION 2: POLITICAL BOARD ....................................................................................................... 51 OPTION 3: STATE BOARD OF EDUCATION ..................................................................................... 52 OPTION 4: STATE TREASURER (STATUS QUO) ................................................................................ 52 OPTION 5: STATE TREASURER (WITH REFORMS) ........................................................................... 53 OPTION 6: BOARD OF INVESTMENT PROFESSIONALS WITH STATE TREASURERS OFFICE ................ 55 OPTION 7: BOARD OF INVESTMENT PROFESSIONALS OVER INDEPENDENT OFFICE ......................... 56

TABLE OF FIGURES
Figure 1: Trustee and Beneficiaries Diagram ________________________________________ 9 Figure 2: Current Funding Flow Chart _____________________________________________ 10 Figure 3: Current Target Asset Allocation __________________________________________ 14 Figure 4: Growth of the Fund ___________________________________________________ 15 Figure 5: SITLA Contributions and STO Investment Returns ____________________________ 16 Figure 6: School Land Trust Program Annual Distributions, 2002-2013 ___________________ 17 Figure 7: Academic Focus Areas for Plans of School Community Councils _________________ 17 Figure 8: Other States Governance Structures for their Trust Lands Funds ________________ 22 Figure 9: Task Force Members Rankings of Governance Structures _____________________ 26 Figure 10: Current Distribution Policy (All Interest and Dividends) ______________________ 28

EXECUTIVE SUMMARY
Utahs permanent State School Fund (the Fund) has grown from approximately $19 million in 1983 to a current market value of approximately $1.6 billion. According to a 2011 study by Callan & Associates, the Fund will have a market value of approximately $2.8 billion in 2021, with distributions of approximately $66 million per year. The State Board of Education unanimously passed a resolution to create the School Trust Investment Task Force on February 8, 2013, to study the appropriate and prudent investment oversight, process, and structure of the Fund and to submit legislative proposals, if necessary. The School Trust Investment Task Force held a total of 11 meetings, which were each two hours in length and open to the public. The minutes and audio recordings of the meetings, as well as other study materials, were all posted online and are available at http://www.schools.utah.gov/board/School-Trust-Investment-Task-Force.aspx. The Task Force members were all knowledgeable investment professionals with a diverse set of skills and backgrounds and were instructed to make their analysis and recommendations for the best interest of the beneficiary even if this conflicted with current law. The following are the formal recommendations from the School Trust Investment Task Force. 1. Create an independent board over an independent office as the governance structure for the permanent State School Fund. 2. Study changing the distribution policy from interest and dividends to a percentage of a rolling average of market value. 3. Enhance the reporting requirements. 4. Preserve the prudent investor rule for the board in statute. 5. Exclude the trust from the subscription to stock prohibition. 6. Require an annual audit under the appropriate authority and standards. 7. Take steps to require that assets be held by an independent third party custodian. Please do not hesitate to contact us if you have any questions. Jennifer Johnson, CFA School Trust Investment Task Force Chair Member, Utah State Board of Education jj@jenniferajohnson.com Timothy Donaldson, JD Director, School Childrens Trust Section Utah State Office of Education Timothy.Donaldson@schools.utah.gov 5

THE CREATION OF THE SCHOOL TRUST INVESTMENT TASK FORCE

The permanent State School Fund has grown in size to approximately $1.6 billion. There has been growing concern from the primary beneficiary representatives (the Utah State Board of Education and the School Childrens Trust Section of the Utah State Office of Education ) that the current governance structure where an elected fiduciary has sole control over investment governance, management, and operations poses significant systemic long-term risks. There are many examples, both historically and recently, from other states where such sole fiduciary governance structure weaknesses were cited after abuses and mismanagement was brought to light. There has been a trend in pensions, land trusts, and other long-term investments towards governing systems where governance, management, and operations are separated. These concerns were shared with Representative Mel Brown of the Utah Legislature, who sponsored several bills which created SITLA, created the School LAND Trust Program, put forward a ballot measure to allow the fund to be invested in stocks, and codified a prudent investor rule for trust investments. Representative Brown suggested that the Utah State Board of Education, as the primary beneficiary representative under Utah Code, create a task force to study the appropriate and prudent investment oversight, process, and structure of the fund and suggest reforms, if needed. At the February 8, 2013, Utah State Board of Education meeting this matter was discussed. The Task Force was created by the Utah State Board of Education. Jennifer Johnson, CFA, a member of the State Board, was appointed Chair, and the Task Force was comprised of members appointed for their investment experience and expertise. The Governor, the President of the Senate, the Speaker of the House, and the State Treasurer each made appointments to the Task Force, and the State Board appointed two additional members. Once selected, those members were sent an introductory packet with questions to ponder (see page 23).

Representative Mel Brown Utah House of Representatives

Debra Roberts, Chair Utah State Board of Education

Dave Crandall, Vice Chair Utah State Board of Education

SCHOOL TRUST INVESTMENT TASK FORCE MEMBERS

Task Force Chair Jennifer Johnson, CFA Utah State Board of Education

Governors Appointment Sterling Jenson, CFA Wells Capital Management

State Treasurers Appointment David Damschen, CTP Utah State Treasurers Office

President of the Senates Appointment David Hemingway, MBA Zions Bancorporation

State Board Appointment Kent Misener, CFA Deseret Mutual Benefit Association

Speaker of the House of Representatives Appointment Rep. Rich Cunningham, RIA Utah State House of Representatives

State Board Appointment Elizabeth Tashjian, PhD University of Utah, Dept. of Finance

TASK FORCE STAFF

Margaret Bird, Director School Childrens Trust, USOE (Margaret Bird retired July 1, 2013)

Tim Donaldson, Director School Childrens Trust, USOE tim.donaldson@schools.utah.gov

ATTENDEES AND CONTRIBUTORS

Bruce Williams, Paula Plant, Karen Rupp, Utah State Office of Education Karen Peterson, Tracy Miller Utah PTA Betsy Ross, Allen Rollo, Utah State Treasurers Office Jill Flygare, Tenielle Young, Governors Office of Management and Budget Jay Blain, Utah Education Association Kristina Kindl, Attorney Generals Office

TRUST BACKGROUND
TRUST ORIGIN
As a part of the process whereby Utah became a state, the United States Congress granted approximately six million acres of land in trust to support public schools. The state of Utah is the trustee over both the lands and the income generated off the lands. Under the trust arrangement, the state has legal title to the lands and funds; however, beneficial title is with the public school beneficiaries.

TRUST LAW
The trust lands and trust funds must be managed with the single focus of financially supporting public education (see Figure 1). The trustee has fiduciary duties to administer the lands and funds in the most prudent and profitable manner possible. Self-dealing is strictly forbidden, and the trustee has a duty of undivided loyalty. This means that the state may not use these lands or funds for any other purposes, no matter how meritorious.
Figure 1: Trustee and Beneficiaries Diagram

The trust is perpetual. This means that policy makers must remember that the interests of todays beneficiaries must be balanced against all of the future beneficiaries, forever onwards, under the principle known as intergenerational equity. It should be noted that as the Utah State Board of Education, which represents the school beneficiaries, commissioned this task force all recommendations were to be made solely in the best interests of the beneficiaries. (For an overview of Trust Law as it applies to this trust, see APPENDIX B: Trust Law.)

TRUST ASSETS: LANDS AND FUND

The trust is composed of two types of assets, land resources and fund assets. Originally the entire trust assets were land assets. However, in order to accommodate the need for the trust requirement of intergenerational equity, the net cash proceeds of the land go into an endowment-like fund of which only the interest and dividends have gone to the beneficiaries. Initially, beneficiaries received only interest until equities were added and the Utah constitution was amended to allow dividends to be included in the distribution policy (See Figure 2). For more detail see APPENDIX C: Detailed Funding Flow Chart.
Figure 2: Current Funding Flow Chart

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CURRENT TRUST LANDS MANAGEMENT: SITLA

Since 1994, the School and Institutional Trust Lands Administration (SITLA) has managed all Utah trust lands. Previously the state land board managed the lands. SITLA is a quasiindependent agency of state government, to which has been delegated the task of optimizing long-term profits from the land. A seven-person fiduciary board of trustees hires and fires a Director, who also has fiduciary duties, and carries out the policies of the Board. The board is a governing entity that sets SITLAs policies, budget, and appeals processes. Each member of the SITLA board also is bound by fiduciary duties to ensure that the trust mandate is strictly followed. The Governor has one direct appointment to the board to serve at the pleasure of the Governor. The other six Board members serve six-year terms, with one member replaced annually. The Governor makes appointments to the SITLA Board from a list of at least two qualified names submitted by the SITLA Nominating Committee, which represents beneficiaries and land users. Candidates are chosen based on integrity and professional expertise in areas relevant to SITLAs revenue areas. This governance structure and appointment process was created with the intent to prevent politicization of the SITLA Board of Trustees and to ensure the highest levels of expertise and integrity.

CURRENT TRUST FUND MANAGEMENT: STATE TREASURER

Net income earned from the school trust lands is deposited in the permanent State School Fund (the Fund). Currently the State Treasurer manages the Fund. The State Treasurer is elected every four years in a statewide, partisan, general election. By Utah Constitution, the only requirements for a candidate to run for the office of State Treasurer are to be 25 years old, to be a legal resident of the state for 5 years, and to be a registered voter. In addition to management of the fund, the State Treasurer is the states chief financial officer and is responsible for the management of more than ten billion dollars of state, county, and city taxes and funds. The State Treasurer is currently charged with the investment of the fund under the prudent investor rule. An Investment Advisory Committee (IAC), a statutorily created body of investment professionals, meets quarterly and provides investment advice to the Treasurer. However, the Treasurer remains the sole fiduciary. Two of the IAC members are appointed by 11

the State Superintendent, one by the Utah PTA, one by the Utah Education Association, one by the SITLA Board of Trustees, and two by the Universities who also have trust lands funds managed by the State Treasurer. The current members of the IAC are Jeff Cardon, CFA Chief Executive Officer, Wasatch Advisors Sterling K. Jenson, CFA Regional Managing Director, Wells Capital Management1 David T. Cowley Vice President for Business & Finance, Utah State University Arnie Combe Vice President of Administrative Services, University of Utah Kimo Esplin EVP and Chief Financial Officer, Huntsman Corporation Steven B. Ostler Vice Chairman, The Boyer Company Jeff Roylance President, Summit Capital Advisors

HISTORICAL SUMMARY OF THE INVESTMENT OF THE FUND

HISTORICAL MISMANAGEMENT
Utahs school trust funds were not always managed well nor operated in a manner consistent with basic trust principles. For the first century that Utah was a state, not all land proceeds always made it into the permanent State School Fund. Even for the funds that did make it into the permanent school fund in the early years of statehood, loans were often made from the trust corpus to counties and cities in Utah as well as to individuals for farm loans for less than market rates. In 1937 the state legislature actually passed legislation to cancel some debts owed to the permanent State School Fund. Audit reports in 1916, 1929, 1931, 1944, and 1946 pointed to definite losses sustained by the Fund and recommended legislation to reimburse the funds and prevent further losses, under the Constitutional provision that provided for the fund to be guaranteed against loss or diversion. One audit report mentioned records so maliciously mutilated with intent to defraud that it was impossible to give an accurate accounting. Beginning with the passage of the Enabling Act in 1894 and for almost 90 years, the permanent fund was invested by the land office. Many lawsuits were heard by the Utah Supreme Court regarding those loans, but the authority of the land board to invest the money was never questioned. In the 1970s the land boards investment of the fund was questioned, specifically duration management on fixed income investments. Criticism of the land boards failure to
1

Sterling Jenson was also a member of this Task Force

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benefit from rapidly climbing interest rates on bonds prompted the legislature to reassign the investment of the permanent school fund to the State Treasurers Office in 1981. A statewide budget shortfall in 1982 led to a substantial raid on the permanent State School Fund. Jensen v. Dinehart, a friendly lawsuit between the State Auditors Office and the State Lands Division, was filed. The Auditors Office prevailed and the Utah Supreme Court ruled that deposits to the permanent fund derived from mineral royalty could be liquidated and distributed to the beneficiaries. The effect of the ruling was that $42 million in financial assets were liquidated at a loss, and only $32 million was distributed. After the liquidation, the remaining balance of the permanent State School Fund was less than $19 million. Education groups subsequently convinced the legislature to promulgate a constitutional amendment to deposit all future net revenue in the fund.

RECENT CHANGES AND REFORMS

As recently as 1994 the permanent State School Fund was entirely invested in bonds. Education groups advocated for, and the legislature subsequently passed, legislation including the following: A statutory change for the investment strategy, adopting a 65% equity strategy with retention of all capital gains in the fund for growth, The creation of the Investment Advisory Committee, Inflation protection provisions in the Utah Constitution, The repeal of the inflation protection provisions in the Utah Constitution, and finally A prudent investor rule in code for the investment of the fund.

In 2007 the State Treasurer invested in real estate partnerships, which was the first, and remains the only, alternative investment made with the permanent State School Fund.
Callan & Associates, the outside consultant to the Treasurer, conducts an asset allocation and spending study for spending study for the fund every five years. The most recent study by Callan was completed in 2011. As show 2011. As show in

Figure 3, the target allocation is currently: 47% domestic equities, 20% international equities, 13

23% fixed income, and 10% real estate.

Figure 3: Current Target Asset Allocation

Global (ex-US) Equity, 20%

Domestic Fixed Income, 23%

Broad Domestic Equity, 47%

Real Estate, 10%

POLITICAL RISKS
Safeguarding the trust from political risk is a paramount concern for the future of the trust. Most other states have little to nothing left in their land trust funds2. Historical precedent in Utah also points to the need to safeguard the trust from political risks, as well as trust-violating proposals seen in recent years, including using school trust dollars to finance the construction of the Lake Powell Pipeline, facilitate relocating the prison and developing the current site, assist with state costs related to the UEP land trust (polygamous) litigation settlements, build an office building for non-beneficiaries, such as SITLA and the USOE, fund litigation against the federal government, and lend funds to the state to offset falling tax revenues. Other states have had successful candidates for State Treasurer who were not qualified to be a prudent long-term investor of a multiple billion dollar permanent fund. The incentives for a

Today, twenty-three states continue to manage what is left of their trust land conveyances: Alaska, Arizona, Arkansas, California, Colorado, Hawaii, Idaho, Louisiana, Minnesota, Mississippi, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Texas, Utah, Washington, Wisconsin, and Wyoming. Several of these states have retained only a tiny fraction of the original grant lands; Nevada, for example, retains only around 3,000 acres of its original 2.7 million acre grant. By contrast, Alaska, Arizona, Montana, and Wyoming have each retained between 85 and 90 percent of their original land grants. Culp, S. (n.d.) State Trust Lands Today. In State Trust Lands. Retrieved July 18, 2013 from http://www.statetrustlands.org/about-state-trust-lands/state-trust-lands-today.html

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State Treasurer may be short term and political in nature, whereas investment of a permanent fund must be focused only on the long-term best interests of the beneficiaries.

GROWTH OF THE PERMANENT STATE SCHOOL FUND

FUND GROWTH
The permanent State School Fund grew rather significantly during the first decade of its existence. During the subsequent decades up until 1983 there was very little relative growth. Since the reforms that have been discussed which began in the early 1980s there has been significant growth as shown in Figure 4.
Figure 4: Growth of the Fund
3

Contributions from the management of the land have been the primary source of the growth of the permanent State School Fund until most recently. The addition in 1994 of equities as an authorized asset class has contributed both to the growth and volatility of the Fund. Another reason for the slower growth of the Fund prior to 1995 was the legal requirement for the

Permanent State School Fund Growth (log scale)

$10,000,000,000 $1,000,000,000 $100,000,000 $10,000,000 $1,000,000 $100,000

The Legislature liquidated $43 million from the fund in 1982.

12/31 12/31 11/30 11/30 11/30 11/30 11/30 6/30/26 6/30/30 6/30/34 6/30/38 6/30/42 6/30/46 6/30/50 6/30/54 6/30/58 6/30/62 6/30/66 6/30/70 6/30/74 6/30/78 6/30/82 6/30/86 6/30/90 6/30/94 6/30/98 6/30/02 6/30/06 6/30/10

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distribution of all of the interest income at a time when fixed income was the only authorized asset class. Figure 5 below shows the contributions from the operations of SITLA on the land and the market value adjustments from the State Treasurers Offices management of the permanent State School Fund since 1990.
Figure 5: SITLA Contributions and STO Investment Returns

$250.0 $200.0 $150.0 (in millions) $100.0 $50.0 $$(50.0) $(100.0)

Annual Changes to the Permanent School Fund

Contribution from SITLA Fund Market Value Adjustment

1994

2001

2008

1990

1991

1992

1993

1995

1996

1997

1998

1999

2000

2002

2003

2004

2005

2006

2007

2009

2010

2011

Fiscal Year ending in June

DISTRIBUTION POLICY
Trust Fund Distribution History The current distribution policy as defined in the Utah constitution is to distribute all income and dividends. The cash distribution as a percentage of fund market value averaged 2.42% the past 13 years The lowest distribution was 1.56% of market value The highest distribution was 3.06% of market value

2012

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The market returns, distribution policy, fund asset allocation, and securities selections all deeply affect the distribution to current and future beneficiaries as shown in Figure 6.
Figure 6: School Land Trust Program Annual Distributions, 2002-2013

School LAND Trust Program Annual Distributions (FY01-FY13)

$40 $35 $30 $25 Millions $20 $15 $10 $5 $0 FY 2001 FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY2014

Distribution has grown by an average of 16.9% per year the past 12 years. The biggest annual decline was 10.3% The biggest annual increase was 44.2%

Impact of the Trust Fund Distributions The interest and dividends are distributed to schools through the School LAND Trust Program. All schools hold an election and create a school community council, which must have teachers elected by teachers, the principal, and a two-person majority of parents. The councils evaluate test score data and create a plan, using the funds for academic purposes only. Plans are currently concentrated in the following areas: reading, math, writing, science, arts & music, social studies, foreign languages, and health as seen in Figure 7.
Figure 7: Academic Focus Areas for Plans of School Community Councils

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Academic Focus Areas

900 800 700 600 500 400 300 200 100 0 Foreign Language Social Studies Science Writing

Art & Music

Reading

The following are two of many testimonials regarding the immediate and important use of the trust benefits for todays beneficiaries:

Leon Jones - Principal of Rose Springs Elementary in Tooele School District: Utah School Trust Land moneys are making an amazing difference for elementary students in Tooele School District. Most schools have elected to hire curriculum specialists in areas such as reading, math, art, music, computers, and Professional Learning Community (PLC) interventions. We are excited and appreciative as we begin to envision and provide adequate instructional support for all students.

Dahlia Cordova - Principal of Backman Elementary in Salt Lake City School District: School Land Trust moneys have been vital for students at Backman Elementary. These funds have been used to support technology and to fund a staff position in the computer lab. We have also used the funds to purchase software and other publications for our students - such as Weekly Reader for grades K-3 and National Geographic for students 46.

Technology

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Health

Math

INFORMATION GATHERING WORK OF THE TASK FORCE

STAKEHOLDER INPUT
The School Trust Investment Task Force began most meetings by hearing from the most important and knowledgeable stakeholders in trust management. Dr. Martell Menlove, Utah Superintendent of Public Instruction At the first School Trust Investment Task Force meeting, State Superintendent of Public Instruction Martell Menlove, Ph.D, spoke to the members of the Task Force. Dr. Menlove thanked the investment professionals for giving their time and service to help the State Board find what is best for Utahs public schoolchildren, today and in the decades to come. The trust, Dr. Menlove said, is doing great things in schools throughout the state, and is tremendously important to all stakeholders in Utahs public education system.

Kevin Carter, SITLA Director Kevin Carter, Director of the School and Institutional Trust Lands Administration, spoke to the Task Force. Mr. Carter has been involved with the trust lands since 1981, and has been SITLA Director since 2003. He said that there was a long history of the land trust management, before SITLA, being governed under various boards, which included unqualified political appointees. Mr. Carter said that a professional board of qualified members has allowed for a consistent single-minded focus on what is in the best longterm interests of the beneficiaries.

Kim Christy, SITLA Deputy Director Kim Christy, Deputy Director of the School and Institutional Trust Lands Administration, spoke to the Task Force. He shared his experiences working with the task force that created SITLA in the early 1990s. Mr. Christy emphasized to the Task Force that, through SITLAs 20-year history, it has been important that a volunteer board of professionals have governing authority and bring a single-minded focus on the mission of the 19

trust. This focus has allowed the agency to function like a business, and the results have been far in excess of expectations. At the same time, the agency has to be transparent and accountable to the beneficiaries and Utah Legislature, and seek collaborative win-wins with other stakeholders as often as possible.

Michael Morris, past SITLA Board Chair & past IAC Member Michael Morris spoke to the Task Force. Mr. Morris was a member of the SITLA Board of Trustees and served on the Investment Advisory Committee. He is currently a senior Vice President at Zions Bank. Mr. Morris said that he found the board structure at SITLA one that allowed him, and other board members, to make significant contributions, but he did not have the same experience on the Investment Advisory Committee. He stated that an independent board over an independent office would be a better structure and allow for better returns and better risk management.

IDAHO CASE STUDY

Idaho has a land grant trust fund that is nearly identical in size to the Utah permanent State School Fund, but a much different governance structure. Idahos land grant trust funds are invested by the Endowment Fund Investment Board. That board consists of investment professionals who meet quarterly and have authority to hire and fire the Chief Investment Officer. Larry Johnson, CPA/CFA Larry Johnson is the Chief Investment Officer for that office. Mr. Johnson came to a Task Force meeting and discussed Idahos model, operations, and practice. Mr. Johnson is one of four employees of that office, which is self-funded from their trust fund, and costs approximately $700,000 a year. Idahos returns have been impressive (see APPENDIX D: Idaho Model).

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PRESENTATION OF THE STATE TREASURERS OFFICE

The State Treasurers Office (STO) presented a comprehensive background of the current governance structure and procedures. The STO receives expert advisement from the Investment Advisory Committee (IAC) that is composed of investment professionals who meet with the STO at quarterly meetings. Investment policies are developed in consultation with the Investment Advisory Committee and the outside consultant, which is currently Callan & Associates. Information on the Fund is included in the Comprehensive Annual Financial Report (CAFR) and audited annually. The STO annually delivers the State School Fund Report to the Education interim committee. The State Treasurers Office pointed to Utah Code 67 -4-11 (see APPENDIX E: Statute on Delict of Treasurer) which has a process for an Auditor and Governor to suspend a State Treasurer for derelict actions with respect to the office.4 There was discussion regarding the possibility of adding requirements for candidates to be a State Treasurer. A past study of other states did not indicate any evidence of a good method of doing that, nor would doing that adequately ensure the intended protections for the trust fund. The Treasurers Office has a preference for passive management strategies, with the selective use of active strategies within targeted asset classes such real estate. At present, equity investments utilize enhanced index funds. The time horizon on the fund is measured in centuries. Current practices and policies regarding rebalancing were explained with the acknowledgement that active management would require additional staff for due diligence and oversight.

GOVERNANCE STRUCTURES OF OTHER STATES

Recent years have seen many western states pass major reforms in the structure of their trust fund investments, distributions, and other policies. Below in Figure 8 is a simplified depiction of how other western states are structuring the investment of their permanent school trust funds.

The Task Force Chair queried the State Auditor, Governors Office, and Treasurers Office, and it appears that this code provision has never been utilized and would likely be challenged in the courts if ever implemented.

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Figure 8: Other States Governance Structures for their Trust Lands Funds

Unique
The State Board of Education oversees the investment of the fund

Land Board
The office charged to make money on the land is also assigned to invest that money

Treasurer
One of the many duties and powers of an elected State Treasurer or Commissioner of Revenue is to invest the trust funds.

Investment Council or Board

A board of trustees oversees the investment of the fund

Texas

North Dakota Oklahoma California

Arizona Utah Colorado Nevada Alaska

New Mexico Idaho South Dakota Nebraska Minnesota Washington Montana Oregon Wyoming

The task force also considered the structures and policies employed by state pension investors, university endowments, and private foundations.

CORRESPONDENCE ON SOLE FIDUCIARY RISKS

At the May 20, 2013, meeting of the Investment Advisory Committee to which the Task Force members were invited, Jeff Cardon, Chair, asked if the beneficiaries could provide examples of significant losses that occurred in other states due to the sole fiduciary structure. Tim Donaldson, School Childrens Trust Director at the Utah State Office of Education, drafted a memo with recent examples from New York, Connecticut, and Ohio. Richard Ellis, State 22

Treasurer, wrote a response, stating his view that transparency and accountability are adequate avenues to protect against such risks. Tim Donaldson wrote a response sharing his view that a system that implemented strong checks and balances would be the best policy for the longterm interests of the trust beneficiaries. The Task Force was copied on all of this correspondence. (See APPENDIX F: Correspondence Regarding Sole Fiduciary Risks).

QUESTIONS CONSIDERED
Before the first meeting the Task Force was presented with the following seventeen questions to consider. 1. Are there preventable weaknesses that have been inadvertently designed into this system? 2. Is it prudent for the investment manager of the fund to be an elected official (partisan or otherwise)? Pros and cons? 3. What are the pros and cons of the investment manager being hired/ fired by the Utah State Board of Education? 4. What are the pros and cons of the investment manager being hired/ fired by another board? 5. What other oversight structures should be considered? 6. What structure for investment oversight is most likely to protect the fund from sub-par returns? From concentrated risks? From conflicts of interest? From political pressures to invest locally? From political pressures to do anything not in the best interests of the beneficiaries? From political pressures to make investments based on political correctness? 7. What legal counsel can the investment manager use? Only the Attorney General? 8. What requirements and annual disclosures from the SEC/FINRA for fund managers make sense for the fund? 9. How would you write the Investment Policy Statement (such as risk and return objectives, benchmark, reporting frequency and audience, rebalancing policies, prohibitions, legal constraints, etc.) for the fund? 10. Are alternative investments appropriate for the fund? (Should the consideration of alternative investments be made with or without a consideration of the risk and return characteristics of the trust lands?) 11. What is the appropriate distribution rate/formula? 12. How should cash and cash flows be treated?

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13. How should the investment manager and his or her staff be properly compensated/ incentivized? Should constraints be used? If so, how and by whom? 14. Should consultants be used? If so, how much and how frequently? By whom? 15. Should the other trusts be managed by the same investment team? 16. Should the asset allocation and strategy followed by the investment manager take into account the land assets held in the fund, i.e., energy, minerals, and real estate? 17. Amongst all these considerations, which items should be part of statute?

RECOMMENDATIONS
The Task Force made the following formal recommendations. 1. Create an independent board over an independent office as the governance structure for the permanent State School Fund. 2. Study changing the distribution policy from interest and dividends to a percentage of a rolling average of market value. 3. Enhance the reporting requirements. 4. Preserve the prudent investor rule for the board in statute. 5. Exclude the trust from the subscription to stock prohibition. 6. Require an annual audit under the appropriate authority and standards. 7. Take steps to require that assets be held by an independent third party custodian. Greater detail about each of these recommendations follows in this section and in APPENDIX I: Analysis of Governing Structures.

CHARACTERISTICS OF AN IDEAL GOVERNING STRUCTURE

The Task Force created a list of the characteristics of an ideal governing structure for the permanent State School Fund. The list of those fifteen characteristics is below. 1. 2. 3. 4. Independent of politics Independent of lobbying Independent of all state budget pressures Responsive to current beneficiary input while balancing current and future beneficiary needs 5. Transparent and accountable 24

6. Aiming to provide consistent and stable distributions with periodic study of intergenerational balance on the land and fund components of the trust 7. Managed under an investment policy statement (IPS) which allows a broad array of investments, both active and passive, with appropriate risk parameters in place, and in view of a long time horizon 8. Clear on short and long term goals and objectives in the governing documents 9. Coordination between land managers, fund managers, and beneficiary representative on efficient fund transfers to seek optimal risk adjusted returns 10. Trust fund managers invest in consideration of risk exposures from land assets 11. Investment managers are prudent regarding costs as they hire and monitor managers, produce investment reports net of fees, and perform other functions 12. Using consultants regularly to review asset allocation, spending, best practices, and other reviews 13. Annual external audit by qualified firm in addition to State Auditor reviews 14. Using an external custodian of funds 15. Consistency of philosophy and process over time

BEST GOVERNANCE STRUCTURE RANKINGS

The Task Force created a basic description of seven different possible governing models, and created a pros and cons list for each one. (See APPENDIX I: Analysis of Governing Structures). Kent Misener created a single page memo detailing the pension fund best practice of separating authority over funds into three levels: governance, managing, and operating. (See APPENDIX H: Pension Fund Best Practices). The seven options considered were for the investment management of the fund: 1. SITLA Board: Many states still have their permanent funds managed by the same land board which manages the lands. Utah did this until 1981. 2. State School Board: This model is based on Texas, where the State Board of Education has governing authority over another board, which invests the land grant trust fund. 3. Political Board: The Governor, Treasurer, Attorney General, and other elected and appointed figures in some states comprise a board responsible for the investment of the fund. Some states do this. 4. State Treasurer (Status Quo): Under this model, no changes would be recommended. 5. State Treasurer (with Reforms): This model would leave sole fiduciary authority with the elected State Treasurer, while enhancing statutory reporting requirements to the IAC, the legislature, and the Utah State Board of Education, as well as requiring formal IAC votes on recommendations made to the Treasurer. 25

6. Investment Board with State Treasurer: This model would place certain fiduciary duties of governance authority with a board of investment professionals, while maintaining the other fiduciary duties of management and operations responsibility with the State Treasurers Office. 7. Independent Board over Independent Office: This model would place governance authority with a board of investment professionals, and place management responsibility with a chief investment officer (CIO) hired and fired by the board. The CIO would oversee a small office with operations responsibility. Each Task Force member ranked his or her top three preferred governance structures as shown in Figure 9.
Figure 9: Task Force Members Rankings of Governance Structures

Task Force Member Sterling Jenson Kent Misener David Damschen* Rich Cunningham Elizabeth Tashjian Jennifer Johnson David Hemingway*

1st Place Vote 7 6 5 7 7 7 6

2nd Place Vote 6 7 4 6 6 1 1

3rd Place Vote 5 5 6 5 5 3 5

* Members included in Minority Report

Six of the seven task force members recommended creating a board of investment professionals with governance authority as their first choice (options 6 and 7) with four favoring a fully independent board as their first choice and two favoring a board with governance authority, but leaving management with the State Treasurers Office. As mentioned in the note in APPENDIX I: Analysis of Governing Structures, OPTION 6: BOARD OF INVESTMENT PROFESSIONALS WITH STATE TREASURERS OFFICE, there was a legal question raised about option 6 that went unanswered. Some task force members believed this might have affected the ranking. The possibility was discussed in the last meeting of the task force. In 26

that last meeting an attendee asked the question about whether anyone would change his or her ranking. Not one member changed. Though task force member David Hemingway was absent, he had already ranked option 6 as his first choice. Task force member David Damschen presented a minority report voicing concerns about the affect of the legal question upon the validity of the ranking process and invited task force members to add their names to the report if they concurred. Task force member David Hemingway added his name. This minority report in contained in APPENDIX G: Minority Report. Aggregating the votes,5 the Task Forces combined ranking of most preferable alternatives is 1. Independent Board over independent office (14 points and four of the seven Task Force members ranking this as his or her first choice) 2. Investment Board with the State Treasurer (13 points with two of the seven Task Force members ranking this as his first choice) 3. State Treasurer (with reforms) (8 points and only one Task Force member ranking this as his first choice)

FUND DISTRIBUTION POLICY

Characteristics of an Ideal Distribution Policy

The Task Force created this list describing characteristics of an ideal distribution policy. 1. Reasonable predictability in distributions 2. Intergenerational Equity 3. The policy does not provide incentives to bias portfolio structure to anything other than total return net of costs within appropriate risk parameters 4. Protection of purchasing power 5. Independent of political pressures 6. Independent of budget pressures 7. Informed by demographics, economic conditions, market factors, projected SITLA contributions 8. Appropriate for and responsive to differing economic and market conditions

A first place voted counted as 3 points, a second place vote as 2 points, and a third place vote as 1 point.

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Analysis of Current Distribution Policy

The Task Force provided some analysis of the current distribution policy as shown in Figure 10.
Figure 10: Current Distribution Policy (All Interest and Dividends)

PROS
Independent of budget pressures and political swings Doesnt force the sale of assets in a negative environment Dividends and interest are incremental cash returns

CONS
Inadequately addresses intergenerational equity Spending policy could dictate portfolio allocation6 Growth in income streams does not necessarily match growth in principal values Steady growth in income is preferred by beneficiaries Macroeconomic changes create uncertain cash flow streams for beneficiaries No discretion to address current investment environment as it affects the distribution

Recommendations Regarding Distribution Policy The Task Force unanimously recommends that the distribution policy be studied further, towards a possible change to an adjustable percentage of a multi-year rolling market value average, similar to the common endowment practice. The Task Force unanimously recommends that the study carefully balance what portions of the distribution policy should be in the Utah Constitution, statute, and/or policy, to mitigate the risks of the fund being depleted under challenging conditions, while allowing flexibility through time.

Could incentivize investments in income securities to raise distributions (biases for value stocks and lower rated fixed income securities or in the extreme, value-trap stocks and junk bonds or low liquidity alternative investments)

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REPORTING REQUIREMENTS
The Task Force considered recommendations for reporting requirements. These recommendations were organized in the following categories: Why, To Whom, What, and When. Why report Oversight and performance evaluation Transparency Policy making Planning purposes Reporting to whom? Investment Board Beneficiaries (State Board, School Childrens Trust, school community councils) Legislature (Committees) Governors Office General public Reporting what Different audience would get different reports Efficient Information targeted to appropriate audiences GIPS Standards Policy compliance Performance reports relative to appropriate benchmarks Risk reports (draw down, retracement, etc.) Absolute return measurements relative to appropriate peers Transactions and cash flow history (contributions, commitments, and distributions) Estimated distributions Separated by trust Asset valuation methodologies Reporting when Quarterly to board Annually to Governors Office, Legislative Committee(s), school community councils Monthly electronic statements Ad hoc upon request Event-driven requirements at certain thresholds 29

RISK TOLERANCE AND APPROPRIATE ASSETS

The Task Force shared the following ideas about the appropriate asset classes and risk tolerance for the Fund Status quo allows prudent investments except for potential legal issues with subscription to stock (private equity) Current holdings include equities, bonds, cash, real estate Rapid innovation in financial market products and strategies makes forbidding categories by statute challenging and could unintentionally prohibit appropriate, returnenhancing, risk-mitigating investments A thorough risk tolerance assessment should be developed and included in the investment policy statement, taking into consideration o Intergenerational equity o Current predictable distributions o Long term nature of the fund

The Task Force recommends unanimously to preserve the prudent investor rule for the board in statute, and taking steps to exclude the trust from the subscription to stock constitutional prohibition.

AUDITS AND CUSTODY

The Task Force recommends unanimously that an annual audit should be conducted by the appropriate authority, and should be conducted under generally accepted accounting standards. The Task Force recommends unanimously that steps should be taken to require assets to be held by an independent third party custodian.

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APPENDIX A: State Board Resolution Creating the Task Force

31

APPENDIX B: Trust Law

The beneficiaries are entitled to the benefit of the trust arrangement. Because beneficiaries depend upon the trustee to act in their interest, certain protections are in place in the law with the intent to ensure that the benefit of a trust is, in fact, flowing to the beneficiaries. A trust beneficiary has both legal rights against the trustee and equitable rights in the property itself. Beneficiary rights include: 1. Right to inspect records, documents, and securities and the right to receive accountings 2. Right to skill and prudence in trustee administration of the land and funds 3. Right to receive undivided loyalty in the execution of the trust 4. Right to have the trustees defend the trust against attack 5. Right to not have the various trusts commingled There are numerous other trustee duties, such as the duty of the trustee to make the property productive, to review investments, to not commingle investments of the trust with other entities, to make payments to the beneficiary, to allocate income, and to retain trust documents. The beneficiary has the right to hold the trustee accountable for any wrongful acts or omissions that affect the beneficiaries interests. In the case of the school trust lands, however, the beneficiarys ability to recover against SITLA, the State Treasurer, or the State of Utah, ultimately, is severely limited. Statutes of limitation, governmental immunity, and funding shortages all might act to constrain such remedies. It is therefore of great importance for beneficiary representatives to proactively seek to prevent injury to the trust. If the trustee is preparing to commit a breach of trust, the beneficiary need not sit idly by and wait until damage has been done. He or she may sue in a court of equity for an injunction against the wrongful act. Beneficiaries can seek such a remedy to prevent a trustee from acting in violation of their duties, such as preventing the trustee from selling trust property for an improper purpose, under improper conditions, or for an unreasonably low price. With the School Childrens Trust, beneficiary representation and involvement has been responsible for bringing the neglected trust to light, discovering cases of breach, and creating a system with a higher degree of proper oversight. The Utah Attorney Generals Office championed the trust in recent decades, but has needed the cooperation and information provided by the School Childrens Trust to defend it legally. Tim Donaldson Director of The School Childrens Trust Section, Utah State Office of Education 32

APPENDIX C: Detailed Funding Flow Chart

Courtesy of the Utah State Treasurers Office

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APPENDIX D: Idaho Model

Source: Institutional Investor Magazine

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APPENDIX E: Statute on Delict of Treasurer

67-4-11. Delict of treasurer Duties of an auditor and governor Suspension (1) The state auditor shall notify the governor if the state auditor examines the books of the state treasurer, and finds that: a. The books do not correspond with the amount of funds on hand; b. The books do not show the actual condition of the funds; c. Money belonging to the state has been embezzled, diverted, or in any manner taken from the treasury without authority of law; or d. The state treasurer has been guilty of negligence in keeping the books or in taking care of the public money. (2) Upon receipt of the notice, the governor shall: a. Take possession of all books, money, papers, and other property belonging to the state in the possession of the state treasurer; and b. Temporarily suspend the state treasurer from office. (3) a. The state auditor shall: i. Examine the books, papers, and all matters connected with the office of the suspended state treasurer; and ii. Notify the governor of the findings b. If, based upon the examination, the auditor concludes that the state treasurer has embezzled or converted to personal use the public money, the governor shall appoint another person to replace the suspended state treasurer. c. The new state treasurer shall execute an official bond, and enter upon the office of state treasurer, as provided by law. d. The governor shall report all of the acts done under this section to the Legislature. (4) The new state treasurer shall hold office until the suspended state treasurer is restored or until successor is elected and qualified. Amended by Chapter 342, 2011 General Session Source: Utah Legislative Code

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APPENDIX F: Correspondence Regarding Sole Fiduciary Risks

The following is a string of email correspondence. The first message is from Tim Donaldson to Jeff Cardon regarding statements made at an Investment Advisory Committee meeting in which Jeff Cardon had asked a question about examples where sole fiduciary risks were an issue causing harm. Members of the Investment Advisory Committee were copied as they had been invitees to that meeting. The second is a response from Utah Treasurer Richard Ellis questioning the examples provided. The third is a response from Tim Donaldson seeking to clarify areas of difference and commonalities between the State Treasurers Office and The School Childrens Trust Section at The Utah State Office of Education. 1- From Tim Donaldson to Jeff Cardon, CFA, chair of the Investment Advisory Committee, May 21, 2013 (Emphasis of highlights retained from the original) Hi Jeff, The question was asked at yesterdays Investment Advisory Committee meeting- could we could provide some examples of situations where a sole fiduciary in the public realm, over significant sums of money, had led to serious problems. I have listed 6 examples below. Let me add- I know this has been phrased as merely a rogue treasurer idea, and that is a significant concern, but I think that is overly reductionist. There are dangers in potentially having an unqualified Treasurer (an Arizona treasurer once told Margaret and Paula that she knew only how to get elected and nothing about investing.) There is danger in having a politically sophisticated scheming treasurer who was making investments that helped out local governments or local companies. Reporting that to the Governor and Legislature might not be a real fix if the Governor and Legislature like those investments. The intent of the Task Force is to look at ways to find the ideal structure that best protects against all of those risks, while making sure that we continue to have the fund managed as prudently and possibly as possible. 1. Alan Hevesi was the New York State Comptroller, which is the states chief fiscal officer (Treasurer equivalent). He was the sole fiduciary over $125 billion. He steered $250 million to a California private capital fund, in exchange for over $1 million in campaign donations and illegal gifts made by investment company 36

2.

3.

4.

5.

6.

relatives and friends. He also sought to have Californias CALPERS invest with the same company. http://www.nypost.com/p/news/local/jailbird_hevesi_is_free_634YQ0TuxXYmr6 jv2zETbK Paul J. Silvester was the Connecticut State Treasurer. He was the sole fiduciary over the $20 billion pension fund. He had an investment advisory committee but simply ignored their recommendations. He pled guilty to corruption charges. He admitted that he elicited kickbacks for himself and his friends in exchange for steering state investment money. At least 5 companies were involved, in addition to lobbyists, fundraisers, and staffers for the Governor. Jobs were arranged for Treasurers office staff if he lost an election, which he did. http://www.nytimes.com/2003/06/21/nyregion/ex-treasurer-says-schemeaided-campaign.html Hank Morris was an outside consultant within the office of the New York State Comptroller. He received $19 million in pay to play kickbacks from investment companies to invest the state pension. He claimed in his defense that he was not a public employee and that he checked with the US Attorney first and was told when he was ok. He also defends the performance of the companies he brokered deals with. He was sentenced to 4 years in prison and was the biggest conviction resulting from Andrew Cuomos probe that resulted in numerous arrests and settlements. http://www.nydailynews.com/new-york/pension-fundscammer-hank-morris-denied-parole-article-1.1024027 The Ohio Workers Comp Fund did their own custody arrangements. They invested $50 million in rare coins. Only $12-13 million of the coins could be accounted for. Tom Noe was convicted of false accounting and theft, and the scandal became known as Coingate. http://en.wikipedia.org/wiki/Coingate_scandal The Florida Board of Administration had approximately $150 billion under management. A political appointee at a salary of $100,000 a year was in charge. The person put the local government investment pool in the highest yielding AAA bonds available, which seemed reasonable. The problem is, they were the riskiest AAA bonds, and closest to the AA borderline, which is why they paid the most. Innocent error led to huge losses and a freeze in money available to local governments when a flight to safety happened in the market. Florida subsequently fired that employee, tripled the salary for the position, and hired a qualified manager. The pay to play scandal forced the New Mexico State Investment Council to undertake a dramatic overhaul of its investment and governance 37

policiesseveral individuals had been enriched by politically motivated investmentsallegedly in collusion with state investment officer Gary Bland and certain other politically-connected individualsThe main problem that the old SIC had was a concentration of power, where you had one individual or two individuals one of those being the Governor, who appointed the state investment officer who had the ability to call the shots and had the ability to push through investments if they wanted to, NMSIC spokesperson Charles Wollman told Private Equity International. believes received investments in exchange for political favors, including payments to Marc Correra and other politically connected individuals, according to the states motion to approve the settlement. This is a significant recovery of money for the taxpayers of New Mexico, and it demonstrates how diligently this Council has worked over the past two years to bring a measure of accountability following a deeply disappointing chapter in New Mexico history, Governor Susana Martinez said in a statement. http://www.privateequityinternational.com/Article.aspx?article=71792

Thank you, Tim Donaldson School Childrens Trust Specialist (801) 538-7709

2. From Richard Ellis, May 24, 2013 From: Richard Ellis, Utah State Treasurer To: Members, Investment Advisory Committee Jeff Cardon Dave Cowley Arnie Combe Kimo Esplin Jeff Roylance Sterling Jenson Steve Ostler Members, State Board of Education School Trust Investment Task Force 38

Cc:

Cc:

Jennifer A. Johnson David Hemingway Elizabeth Tashjian Rich Cunningham David Damschen Kent Misener Staff, School Trust Investment Task Force Timothy Donaldson Eric Hutchings Response to Tim Donaldson email dated May 21 entitled Risks of a Sole Fiduciary

Re:

Date: May 24, 2013

The question has arisen, in the setting of a task force created by the State School Board (Task Force), whether there is a better investment structure for the states school and institutional trust land funds than that of the Office of the State Treasurer in conjunction with advice from the Investment Advisory Committee (IAC). It has been suggested that the Treasurer, as a sole fiduciary, has the opportunity for unchecked misconduct, and that the IAC, because it is advisory only with no fiduciary responsibility, may not take its role as seriously as it would if it were a true board. Staff for the Task Force, Tim Donaldson, has provided you an email (the May 21 email) reflecting his position that a sole fiduciary has a causal relationship to illegal and inappropriate behavior. The Treasurers Office response follows. The May 21 email presents six examples purporting to support the argument against a sole fiduciary/advisory committee structure. Two of the examples, numbers 1 and 3, are actually the same example from New York State, number 1 referencing the state comptroller, and number 3 the outside consultant involved with that comptroller. Of the remaining four, Connecticut, rather than supporting the argument against a sole fiduciary/investment advisory committee, is an argument for the success of such a structure. It was Connecticuts Investment Advisory Council (Council) that played an important role in uncovering the misconduct of Silvester, the governor-appointed treasurer, as referred to here in an excerpt from current treasurer Denise Nappier 39

before a legislative committee in January 2000: In many respects, they *the Council+ are the heroes of the Paul Silvester scandal. Through their diligence and courage, Silvester was unmasked and brought to justice. And, notwithstanding the extraordinary pressures associated with the scandal, they, the Investment Advisory Council, never lost sight of their fundamental goal and purpose. That is, to protect and grow the Connecticut Retirement Plans and Trust Funds. They are to be co mmended. The other three examples are not examples of pure sole fiduciaries. Ohio involved a Board of Directors (Ohio Workers Compensation Fund), Florida a Board of Administration and New Mexico a State Investment Council. There are limitless examples exposing misconduct by trustees in the care of funds under their control that do not involve sole fiduciaries. 1. Legislative bodies, or any group of individuals with the power and inclination, can work in unison toward their individual benefit at the expense of the greater good. The City Council of Bell, California had the highest salaries in the nation, due to the passage of a bill to eliminate salary caps. Before being discovered and ousted, the officials, including the police chief, head DA, and mayor, siphoned about $6.7 million of public funds. 2. One can always target a single member, or multiple members, of a legislature or a board, with the result of misconduct. In Detroit, a former mayor and an ex-city treasurer accepted gifts in an influence-peddling scheme involving pension funds. As an SEC official said, Youve got a *pension+ board that was making a decision of $100 million-plus, while at least two of the members were potentially influenced by things like Vegas trips, a Prince concert and massages. These examples, those from the May 21 email and the additional ones above, reflect a legitimate concern with the opportunity for misconduct in the management of public dollars. Where we disagree with the May 21 email is that we believe misconduct can occur regardless of the governing structure, not because of it. No structure contains the magic bullet protecting against misconduct. 7
7

Also referenced in Tuesdays IAC meeting was the fact that there have been raids in Utah of school and institutional trust funds in the past. This activity occurred prior to the State Treasurers management of those funds, and were unrelated to investment. At the time of the misconduct, the funds were being managed by the Division of State Lands and Forestry, and the incidents in question involved selling trust lands at below market

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The issue is not structure, it is the controls in place to protect against abuse. And the best control against misconduct is transparency. Connecticut learned that lesson from its Corrupticut scandal noted in paragraph 2 of the May 21 email. Connecticuts response has been the creation of Open Connecticut, a published collection of data from state agencies regarding state tax revenue, borrowing, financial projections and spending. That is why the Utah Treasurers Office is proposing amendments to the IAC statute that would require more reporting from the Treasurer to the IAC, and from the IAC to the governor, the legislature, the beneficiaries, and the general public. We agree with the State Board of Education that improvements can and should be made to bolster the current structure. Rather than promoting a disruptive and expensive change in structure, however, the effect of which is unknown against a history in Utah of a successful and impeccably honest treasurers office, we should be talking about improving transparency so that any hypothetical rogue treasurer, unqualified treasurer, or politically sophisticated scheming treasurer would be exposed. It is through greater government transparency and accountability, the bedrocks of democracy, that misconduct will be thwarted.

3. From Tim Donaldson to Utah State Treasurer Richard Ellis, May 24, 2013 Richard, 24, 2013 May

Thank you for your perspective and feedback to me, the IAC, and the Task Force. In my six years of working with you and the IAC I have learned a lot and I appreciate your work. The Task Force, Investment Advisory Committee, and interested legislators should know the points whereon we agree and disagree, so as to focus the discussion going forward.

values or use of the fund by the governor or legislature to plug budget holes. Since taking back his rightful role as investor of the funds, the State Treasurer has protected the fund assets on more than one occasion from pressure to make investments that were a violation of his fiduciary duty.

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I agree with the State Treasurers Office more than you seem to realize. We agree that: 1. There is legitimate concern with the opportunity for misconduct in the management of public dollars. 2. Misconduct can occur regardless of the governing structure 3. No structure contains the magic bullet protecting against misconduct. 4. The State Treasurer has protected the fund assets on more than one occasion from pressure to make investments that were a violation of his fiduciary duty. 5. Improvements can and should be made This is all true. As I have said and will continue to say, you and your predecessor Mr. Alter have been excellent public servants of high integrity and should be honored and commended for that. For 32 years, the school trust fund has been in good hands. I respectfully disagree on the following points. 1. The example from Connecticut highlights, for me, the safety function of an Investment Advisory Committee. But, should a similar problem arise in Utah in 2017 or 2047, rather than hope for IAC members to be involved enough to uncover misconduct, and over a lengthy time period exhibit diligence and courage to unmask the extent of the abuses, withstand extraordinary pressure to stop, and never lose sight of their goal, hoping that huge sums of schoolchildrens money is not forever lost in the meantimeI would prefer that the person making the investments have to answer their boards questions satisfactorily and be immediately fired if they couldnt. I would think the advisory council members in Connecticut wished they had firing authority as that unfolded. 2. Those who tried to clean up and mitigate the damage done in New Mexico indicated repeatedly that the crux of the problem was too much power concentrated in the hands of one or two people, and that subsequent reforms were made specifically to reduce the risks of concentrated power. 3. Your footnote states Since taking back his rightful role as investor of the funds The Treasurers Office was assigned the responsibility to invest the land trust funds, by statute, in 1981. You can only take back something which you originally had. The Treasurers Office did not invest these funds before 1981. The courts have said the Constitutional purview of your office is what it was at statehood, and your argument seems to be that it should have included this at statehood. It didnt, and the courts will likely focus on that fact. 42

4. You apparently disagree with the idea that the IAC, because it is advisory only with no fiduciary responsibility, may not take its role as seriously as it would if it were a true board. The IAC members do take their responsibility seriously- limited as it is. But several members of the Task Force and several members of the Investment Advisory Committee (current and past), have provided the perspective that they find that where council/committee/board members lack significant responsibility or opportunity to contribute, their value-add is limited and they dont worry too much about it. It is worth noting that a lack of a quorum present to conduct business has been a growing problem in recent years for the IAC. We are very thankful for the service of those who have sat or do sit on the IAC- it would be my hope that any reforms which are made would strengthen those who sit on a committee/council/board to be able to make even more of a contribution. 5. You state that Option #6 (a board of investment professionals) would be a disruptive and expensive change in structure. I do not believe changes need to be disruptive nor expensive. Idaho has a professional board, governing a staff of 4, and that office costs approximately $700,000 a year, which is selffunded through the investments by legislative appropriation. I believe their total costs are about 37 basis points where ours are 24 basis points- and Idaho seems to be consistently, over time, performing 1-2% per year better than we are in Utah. I would welcome correction of these facts if my understanding is incorrect. In terms of disruption, for my two cents worth- I wouldnt want to see any sudden nor dramatic shifts in asset allocation or anything like that- and I would support a structure which made the State Treasurer a board member by statute (just like URS). 6. Finally, you conclude by saying we should be talking about improving transparency so that any hypothetical rogue treasurer, unqualified treasurer, or politically sophisticated scheming treasurer would be exposedIt is through greater government transparency and accountability, the bedrocks of democracy, that misconduct will be thwarted. I agree that improved transparency and accountability are good things. However, I do not think that requiring reports and notice to certain entities so that one might be exposed is enough. If we expose, six months into his or her term, that a new Treasurer is unqualified- what is the solution? I would want something more than to hope that three and a half years later a different one is elected. I think as a matter of trust law the beneficiaries are entitled to more than that, and as a matter of policy in a state that has such challenges in funding 43

education we all should demand that this system which flows over with enormous potential- be structured better than that. If we expose that a treasurer is buying bonds in a Utah municipality at favorable rates, or making investments in Utah companies in Senator So and Sos district to create jobs, what is the solution? These are just a few known unknowns. I am reminded of the wisdom of the Founding Fathers in designing a system that did not leave too much power isolated in any one person or even one branch of government. They did not and could not have foreseen what perils would come over the centuries, but they knew history, they knew where others had gone wrong. They realized with soberness that they werent hypotheticals I would add that most states have no land trust funds left, so these arent far fetched worries. The Founding Fathers sought to build a system that provided checks and balances by dispersing powers broadly. As one Task Force member said in one Task Force meeting, It is good to have a king if you could always have righteous kings I do not want to bet the future of the schoolchildrens trust on that. Ultimately, the question is not whether any structure eliminates all risks; it is whether there is a better structure which can reduce the risks and consistently provide for the most prudent and profitable investment of billions of dollars. I dont believe that investment management for these trusts properly involves political questions. As such, it probably should not be left in the political arena as a matter to be decided through political campaigns. In short, it doesnt make sense to me to elect a single fiduciary over billions of school dollars and rely on the political system for the incentives, retention, compensation, removal, and so on. Hopefully this helps. Respectfully and gratefully, Tim Donaldson

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APPENDIX G: Minority Report to Utah State Board of Education School Trust Investment Task Force
The parties whose signatures are appended below wish to present this minority report in response to the report provided by the Chair to the State Board of Education School Trust Investment Task Force. The reason for this minority report is as follows8: Confusion as to Legal Issues has Inappropriately Influenced the Recommendations At the beginning of the Task Force proceedings, the chair, Jennifer Johnson, directed that the work of the Task Force would not be inhibited by legal considerations, but would focus on the ideal structure for the investment of the school land trust funds. Discussions proceeded in that fashion until the presentation of Option 6, the option for which there would be a sharing of investment authority between an independent board and the state treasurer. At that time, at the introduction of staff member Tim Donaldson, and with the assent of the chair, the legal viability of Option 6 was questioned. Mr. Donaldson suggested that it was appropriate to consider the legal merits of Option 6 and not Option 7, because any legal problems with Option 7 could be corrected either statutorily or constitutionally; the legal problem with Option 6, according to Mr. Donaldson, was insurmountable.9 Thus, there was never a discussion of the legal impediments to implementation of Option 7, per Ms. Johnsons directions, while there was discussion of the legal impediments to the implementation of Option 6, to such an extent that the pros and cons to Option 6 were not drafted until the last meeting of the Task Force (wherein a finalizing review of the report was conducted), and after the vote on the preferred models had already been taken.

For the purposes of this minority report, reference is made exclusively to Options 6 and 7, the two top options in terms of points scores (13 points to 14 points). Option 6 contemplates an independent board structure working in conjunction with the State Treasurers Office. Option 7 contemplates an independent board overseeing an independent office. 9 The chair requested a legal opinion from the Attorney Generals Office, which opinion was not available prior to the final vote. In a draft report, staff indicated that additional attorneys had the same concerns as Mr. Donaldson as to the insurmountability of legal impediments to Option 6, and named those concerned as Betsy Ross of the Treasurers Office, and Kristina Kindl of the Attorney Generals Office. Both Ms. Ross and Ms. Kindl asked to have their names removed as supporting Mr. Donaldsons position. Attached to this minority report is the email correspondence between Ms. Ross and Ms. Kindl to address any concerns that there was inappropriate communication.

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In fact, there has been presented to the Task Force no legal opinion, nor is there informal agreement, that Option 7 is any different in terms of legal issues than Option 6. Each would potentially pose an incursion into the constitutional duties of the state treasurer, resulting in the possible necessity either for a court decision or constitutional amendment. Given that there are legal impediments to each Option, the fact that Option 6 was singled out as the one option with legal problems may have affected the vote of some Task Force members. As a result, the recommendations are flawed.

Recommendation We recommend that both Option 6 and Option 7 be considered the top options of the Task Force, and that, due to inaccurate legal representations that potentially affected the vote of Task Force members, any differentiation in terms of preference between the two options be nullified. We suggest that the report be amended to present as the recommendation of the Task Force these top two choices, with an explanation that no preference for one over the other can be inferred due to the issues presented above. Emphasis should be placed on the fact that there was agreement on the preference for a structure that included, in some fashion, an independent board. Respectfully submitted this 19th day of July, 2013 by: David Damschen David Hemingway

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Attachment to Minority Report toUtah State Board of Education School Trust Investment Task Force Email Communications, Ms. Ross and Ms. Kindl Below in their entirety are the email communications between Ms. Ross and Ms. Kindl as referenced within the Minority Report:

Kristina Kindl <kkindl@utah.gov> Jul 17 (2 days ago) to Betsy [Ross], Brian [Farr], Thom [Burr], me, RICHARD [Ellis], Allen, Jenny [Johnson], David Jennifer: Betsy Ross and I just had a conversation about the investment task force, and its report. Initially, let me clarify that I have not received a copy of the report. However, Betsy indicated that somewhere in the report it states: "Kristina [Kindle] [sic] and Tim [Donaldson] voiced concerns that there may be insurmountable legal hurdles regarding a structure that tried to merge responsibility with both an elected official and a board." That is not an accurate reflection of my concern; I believe that in relation to this issue the legal hurdles are significant insofar as obtaining a constitutional amendment would be a significant legal hurdle. However, "significant" is not synonymous with "insurmountable." Accordingly, I am requesting that my name stricken from that statement; this is especially important because I understand that statement, and my opinion, was relied upon in voting for or against certain options. Also please clarify for any individuals that I am not legal counsel for the task force; rather David Jones is the designated AAG to the task force. Sincerely, Kristina L. Kindl Assistant Attorney General Education DivisionHeber Wells Building160 East 300 South, 5th Floor P.O. Box 140853 Salt Lake City, Utah 84114-0853 tel: (801) 366-0279fax: (801) 366-0242 Confidentiality Notice: This email may contain attorney work product, attorney client privileged communications, and/or confidential information which may be protected under the Individuals with Disabilities Education Act, the Family Education Rights and Privacy Act, and/or the Goverment Records Access Management Act. The contents of the email are intended only for the sole use of the intended recipient. If you are not the intended recipient of this email, or the employee or agent responsible for delivering this to the intended recipient, you are hereby notified that any unauthorized review, use, distribution, disclosure, dissemination or copying of this email is strictly prohibited. If you have received this email in error, please notify me at (801)

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366-0279 or by reply email, and then please delete and destroy all copies of this message. Please contact me if you have any questions. Thank you.

On Wed, Jul 17, 2013 at 9:29 AM, Betsy Ross <betsyross@utah.gov> wrote: Kristina, I left you a phone message, but thought I should give you a preview of what I wanted to discuss. The quote from the final report will read something like: "Analysis including the pros and cons of this option was going to be done by the Task Force following the receipt of legal advice from the Attorney General's office, the official legal counsel to the Task Force. The reason for this caution as recorded in the minutes from that meeting was that "Kristina [Kindle] [sic] and Tim [Donaldson] voiced concerns that there may be insurmountable legal hurdles regarding a structure that tried to merge responsibility with both an elected official and a board." This legal advice is not available at the time of the writing of this report." I do not agree that the issues are "insurmountable," and wonder if you really do, as reflected in the report. Here are my thoughts: 1. If the constitution is interpreted to exclude the custody of these funds from the Treasurer's constitutional duties (as Tim argues), there would be no issue with the legislature adding the investment responsibility to the Treasurer with the oversight of a board; or 2. If the constitution is interpreted to include the custody of these funds within the Treasurer's constitutional duties, the constitution could be amended to make the office of the Treasurer appointed, not elected, to address Tim's concern with the Hansen v. Utah State Retirement Bd. case. I am not suggesting either of these solutions necessarily. I present them only to show that presentation of the legal issues surrounding the option of shared investment responsibility with the Treasurer and an independent board as "insurmountable," is misleading. Looking forward to chatting with you. Betsy

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APPENDIX H: Pension Fund Best Practices

Dear Task Force Members, While I do not know how helpful the best practices in Pension fund governance structure are to a political trust environment, there are some similarities and I share these concepts in case they may prove useful. These concepts are probably articulated best by Keith Ambachtsheer. His group looked at performance data, and are not just theorizing, and although the data is a bit noisy, it does validate some issues and the conclusions seem to make intuitive sense. Below is a brief synopsis of some of the more pertinent issues they isolated. Within best practices of pension governance there are general speaking three sectors of governance responsibilities. They are: 1. Governing fiduciary: This is a group of individuals whose responsibilities are viewed from the macro level of the plan. They are primarily responsible for the broad policy issues. Included in these would be issues like goals of the plan; capital markets beliefs; spending and contribution issues and policies; liquidity guidelines; and asset allocation policy. 2. Managing fiduciary: This is an individual or team that takes the guidelines and policies from the governing fiduciaries, and develops and executes a plan of implementation for the fund. These would relate to issues like tactical asset allocation process if allowed; credit tilts and other biases that may be built into individual asset classes; and manager selection. Also a reporting structure is developed to assess whether the goals of the plan are being met, and policies are within compliance. They also develop a process and reports to assure the operating fiduciaries are performing as expected. 3. Operating fiduciary: These groups are the ones that actually buy the assets. They are typically the individual managers hired by the managing fiduciaries. These are typically external managers, however there are times when operating fiduciaries are also part of the managing fiduciary group. (Internal asset management) This proved to be the best governance structure for pension plans, however there was a key element that is critical to the success of the plan. While the reporting nature of the different levels can appear to be something similar to a policing structure, this should not be the primary purpose. The best functioning governance structures were those with a strong trust and team 49

work orientation between the various fiduciaries. To function otherwise leads to damaging influences on behavior and a significant reduction in results. While there are a lot more details to the summary listed above, and these studies were specifically directed towards pension governance, there may be enough similarities to be of some use in our discussions. It is a pleasure to serve with you all. Thanks, Kent

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APPENDIX I: Analysis of Governing Structures

OPTION 1: SITLA BOARD PROS
Coordination with all trust assets

CONS
Different expertise required for board members managing land than for those managing investments Blurred mandate of diverse operations without synergies Lack of staff expertise/ different skills needed for investment Potential conflicts of interest Lacks a separation of powers

States similar to this model: North Dakota, Oklahoma, California

OPTION 2: POLITICAL BOARD PROS

Increased awareness from key policy makers

CONS
Controlled by politics Short term motivations and incentives Lack of expertise Blurred fiduciary mandate

States similar to this model: Idaho (technically, their Investment Board is under their Land Board, which itself consists of statewide elected officials)

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OPTION 3: STATE BOARD OF EDUCATION PROS

Knowledge of needs Commitment to students

CONS
Lack of investment and trust knowledge Short term motivations and incentives could undermine intergenerational equity Lack of independent trustee- separation of powers is lost Board members are elected on political considerations Frequent turnover- lack of consistency of process and policy

States similar to this model: Texas

OPTION 4: STATE TREASURER (STATUS QUO) PROS

POLITICAL Election every 4 years can provide accountability Political risk: who gets elected in a process largely ignored by most voters? Hire and fire authority is with voters and Senate impeachment process Treasurer is sole fiduciary; may lack financial acumen and expertise Risk of political pressure on Treasurer regarding investment choices

CONS

ROLE OF INVESTMENT ADVISORY COMMITTEE Investment Advisory Committee- wellqualified members who can raise concerns if needed Institutional memory within current State Treasurers Office and IAC IAC ultimately is advisory only and lacks enforcement capacity Structure does not allow shared responsibility for IAC members

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SUSPENSION/FIRING MECHANISM There is a process for Auditor and Governor to suspend Treasurer High hurdle for suspension process (negligence & political necessity) which doesnt account for some violations of prudent investor standard and does not necessarily provide expert management of the funds during the suspension period

GOVERNMENT COST FOCUS Reduced costs Treasurer compensation limitations- might prevent attracting and retaining adequate talent Budget constraints of government might inhibit best practices OTHER Independence- Clear separation of powers Stability of investment process and philosophy between Treasurers Office and SITLA, through time could be compromised beneficiaries, Legislature, other government entities States similar to this model: Arizona, Colorado, Nevada, Alaska

OPTION 5: STATE TREASURER (WITH REFORMS)

Explanation of Possible Reforms: Enhance the Investment Advisory Committee to receive reports from the State Treasurer and to provide reports to other entities. Ultimate investment authority remains with the elected State Treasurer. 1) Require audited reports from Treasurer to IAC on actions related to: a) Investment policy statement, b) The selection of investments in new mandates, c) Re-balancing transactions in excess of pre-defined limits, d) Deviations from target asset allocations which exceed the State Treasurers pre-defined limits, e) Custody reports. 2) Require the IAC input to be reported to the State Board, beneficiaries, and executive branch officials regarding trust investments, including guidelines on specific actions that should be reported to the legislature and other parties (ad hoc as they occur) if/as they are.

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3) Require Investment Advisory Committee to vote on significant actions and record the recommendations.

PROS
POLITICAL Election every 4 years can provide accountability

CONS

Political Risk: who gets elected in a process largely ignored by most voters? Hire and fire authority is with voters and Senate impeachment process Treasurer is sole fiduciary; may lack financial acumen and expertise Risk of political pressure on Treasurer regarding investment choices

ROLE OF INVESTMENT ADVISORY COMMITTEE Investment Advisory Committee- wellqualified members who can raise concerns if needed IAC ultimately is advisory only and lacks enforcement capacity and decision-making authority. The governing fiduciary is the same as the managing fiduciary (e.g.- the IPS currently is voted upon by the IAC, but ultimately is set by the same entity that does the investing) Structure does not allow shared governance responsibility for IAC members

Institutional memory within current State Treasurers Office and IAC Enhanced Treasurer reporting requirements to IAC IAC Input required to be reported to Legislature and Beneficiaries IAC advice votes are recorded

SUSPENSION/FIRING MECHANISM There is a process for Auditor and Governor to suspend Treasurer High hurdle for suspension process (negligence & political necessity) which doesnt account for some violations of prudent investor standard and does not necessarily provide expert management of the funds during the suspension period, Utah Code for suspension has legal uncertainties

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GOVERNMENT COST FOCUS Reduced costs- synergies and resource efficiencies in place, Office is data magnet, Treasurer on URS Board Treasurer compensation limitations- might prevent attracting and retaining adequate talent Budget constraints of government might inhibit best practices OTHER Independence- Clear separation of powers between Treasurers Office and SITLA, beneficiaries, and other government entities Managing the trust funds is one of many duties for the Treasurers Office; divided focus

Stability of investment process and philosophy through time could be compromised States similar to this model: Arizona, Colorado, Nevada, Alaska

OPTION 6: BOARD OF INVESTMENT PROFESSIONALS WITH STATE TREASURERS OFFICE

Explanation of Possible Reforms: Enhance the Investment Advisory Committee to become a formal governing fiduciary board. The board receives reports from the State Treasurer and is to provide reports to other entities. Ultimate investment authority is shared with the elected State Treasurer. 1) Independent Board has governing fiduciary responsibilities such as: a. Investment Policy Statement b. Asset allocation ranges c. Eligible asset classes d. Risk management framework e. Spending policy f. Liquidity policy g. Reporting requirements to ensure goals are being met h. Budget/staff levels 2) State Treasurers office retains the managing fiduciary responsibilities such as: a. Manager selection b. Tactical asset management within policy ranges c. Rebalancing of asset allocation d. Risk management e. Liquidity management

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PROS Separates governing fiduciary from managing fiduciary Likely less expensive to beneficiaries than an independent office Creates fiduciary responsibilities for an independent board Helps with consistency of investment philosophy through election cycles Accountability to an audience (the Board) that has expertise and some power to effect change

CONS Lack of explicit mechanism for enforcementpossible turf battles Possible compensation limitations Governing fiduciary lacks the ability to remove Treasurer

Analysis including the pros and cons of this option was performed in a less detailed manner by the Task Force at its last meeting. The Task Force had been awaiting receipt of legal advice from the Attorney Generals Office, the official legal counsel to the Task Force. The reason for this caution as recorded in the minutes from an earlier meeting was that: Tim [Donaldson] voiced concerns that there may be insurmountable legal hurdles regarding a structure that tried to merge responsibility with both an elected official and a board. Formal legal advice was not available at the time of the writing of this report.

OPTION 7: BOARD OF INVESTMENT PROFESSIONALS OVER INDEPENDENT OFFICE

Explanation of Possible Reforms: 1. A board, comprised of qualified investment professionals, would be established to oversee a small office of at will employees, charged with investment of the Fund. Board members would be unpaid but receive per diem allowances. 2. A careful selection and removal process for board members would be created by statute, with Board members appointed by the Governor from a qualified list submitted by beneficiary groups Senate confirmation required The State Treasurer is automatically a member of the Board

3. Board members would receive training in their legal responsibilities 4. Board members would be protected from personal liability through governmental immunity and a limited scope of responsibility (see #5) 5. Board has a specified, narrow area of power atop the structure, including responsibility to 56

hire and fire the Director/CIO establish and periodically update the investment policy statement: including asset allocation, liquidity, return objectives, risk tolerance, contributions establish a prudent focus on costs vs. benefits set distribution policy establish and periodically review compensation for the Director/CIO set governance policies review audits and consultant reports set budget for the office, which is appropriated from the funds

6. A Director/CIO oversees staff and participates in board meetings 7. Transparency, accountability, and reporting are required At least quarterly board meeting Annual reporting to State Board and Legislature Public report required online

8. There is a clear division of responsibilities between the board and the staff Staff hires/manages/monitors/fires outside managers Processes prohibit board members from micromanaging

PROS
Board of experienced professionals with oversight authority Diffusion of political influence

CONS
Increased costs to beneficiaries Consistency of philosophy and practice over time could be compromised through frequent hiring/firing of the Director/CIO Potential disruptions of transition

Ability to hire professional Chief Investment Officer (CIO) Multiple fiduciaries CIO and Staff exclusively devoted to investing these funds Ability to Fire CIO for underperformance, misconduct, etc. Allows for performance incentives Independence- Clear separation of powers between Investment Board and SITLA, beneficiaries, and other government entities

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Director/CIO Required to report to Board Board required to report to Legislature and beneficiaries Governing fiduciary is separate from the managing fiduciary States similar to this model: New Mexico, Idaho, South Dakota, Nebraska, Minnesota, Washington, Montana, Oregon, Wyoming.

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