Massachusetts Advisory Opinions May 29, 2001: AGO 00/01-03 (May 29, 2001)

AGO 00/01-03.

Dear Mr. Connarton:

A. PERAC's Statutory Authority

In analyzing this issue, I start with an overview of the relevant statutory provisions. PERAC's predecessor was established by Chapter 630 of the Acts of 1982 as a division within the Executive Office of Administration and Finance to improve the administration of the public retirement systems operating in Massachusetts.(fn1) G.L. c. 7, §§ 4A, 49, 50. PERAC, which was created by Chapter 306 of the Acts of 1996, has general responsibility for the administration of the public employee retirement systems under G.L. c. 32, see Barnstable County Retirement Bd. v. Contributory Retirement Appeal Bd., 43 Mass. App. Ct. 341, 345 (1997), and has promulgated a comprehensive series of rules and regulations governing the administration of such systems. See G.L. c. 7, § 50; G.L. 32, § 21(4); 840 C.M.R. §§ 1.00-27.04. In addition to the Teachers' Retirement Board and the State Board of Retirement, which serve the Massachusetts State Teachers' and Employees' Retirement Systems ("MASTERS"), there are more than one hundred county, district, and municipal retirement boards (collectively, the "local boards").

Among its responsibilities, PERAC is charged with overseeing the administration of benefits by retirement boards, G.L. c. 32, § 20, and is authorized to review certain pensions granted by such boards. Id., § 21(1)(d). Several of the rules and regulations promulgated by PERAC govern the administrative procedures, financial operations, records and reports of the retirement boards, see, e.g., 840 C.M.R. §§ 4.01-4.04 (financial operation/standard methods of accounting); id. §§ 5.01-5.05 (records and reports), including the administration of benefits.(fn2) See, e.g., 840 C.M.R. §§ 6.00-6.14 (rules of disclosure of personal information), id. §§ 7.00-7.13 (elections in county and regional retirement systems), id. §§ 10.00-10.21 (rules for disability retirement). By setting forth methods for the local boards to account for cash receipts, for example, PERAC places such boards on the same footing and allows for ready comparisons of investment results. Barnstable County Retirement Board v. Contributory Retirement Appeal Bd., 43 Mass. App. Ct. at 347. PERAC also produces an annual report of the investment portfolio, the return on investment, and the management performance of each retirement system. G.L. c. 32, § 21.

In addition to overseeing the administration of benefits, PERAC is also authorized to conduct field examinations of each board:

The Commissioner of PERAC or his agent shall conduct an in-depth field examination of each board at intervals not exceeding three years to ascertain its financial condition, its ability to fulfill its obligations, whether all parties in interest have complied with the laws applicable thereto, and whether the transactions of the board have been in accordance with the rights and equities of those in interest.

G.L. c. 32, § 21(1)(a). In this context, the statutes governing the respective duties and responsibilities of PERAC and the PRIM Board, as well as the rules and regulations promulgated by PERAC, constitute "laws applicable" to the parties in interest. PERAC has promulgated regulations governing field examinations, at 840 C.M.R. §§ 25.01-25.73. Such examinations, conducted in accordance with generally accepted auditing standards, are intended "to determine the [retirement] system's financial condition, to monitor performance under the terms of its legal, contractual and fiduciary requirements, and to examine the system's effectiveness in achieving the intended results established by M.G.L. c. 32." 840 C.M.R. § 25.01. After conducting such an examination, PERAC issues an audit report setting forth the results of the examination, including any noted deficiencies. See, e.g., 840 C.M.R. § 25.60 (regarding notes to audit report).

When a board retains a certified public accountant ("CPA") to conduct an audit, PERAC may elect to accept such audit in lieu of a field examination, subject to certain conditions. G.L. c. 32, § 21(1)(a); see also 840 C.M.R. § 25.01. The protocol adopted by PERAC to determine whether to accept an audit conducted by a CPA in lieu of a field examination by PERAC is designed to assure that the examination is conducted pursuant to the statutory requirements. See PERAC Memo #47/1999 (Guidance on Retirement Systems Audits Performed by Certified Public Accounting Firms).(fn3) If PERAC determines that such audit was not conducted in accordance with its procedures, then it may elect to perform a supplemental field examination for any remaining issues. G.L. c. 32, § 21(1)(a); 840 C.M.R. § 25.01; PERAC Memo #47/1999 at ¶ 4. The apparent purpose of this protocol is to avoid the need for PERAC to duplicate work already completed by a CPA, while at the same time providing assurances that the CPA conducted such work in accordance with PERAC's requirements. If PERAC elects to accept a CPA's audit, then said audit "shall be deemed to be the [field] examination required by [G.L. c. 32, § 21(1)(a)]." Id; see also 840 C.M.R. § 25.01.

B. The PRIM Board and the PRIT Fund

The PRIM Board was created by Chapter 661 of the Acts of 1983 to improve the investment returns on pension assets and to reduce the unfunded pension liabilities of the Commonwealth. This legislation also established the Pension Reserves Investment Trust ("PRIT") Fund as an investment fund for the Commonwealth, to be managed by the nine-member PRIM Board. G.L. c. 32, § 23(2A) (2000 ed.). By statute, each of the local retirement systems may elect to invest some or all of its pension assets in the PRIT fund. G.L. c. 32, § 23(2)(b) (2000 ed.). In 1997, the trust that held the assets of MASTERS merged with the PRIT Fund, Chapter 315 of the Acts of 1996, which became the sole investment vehicle for MASTERS assets. G.L. c. 32, § 22(8)(a). As of December 31, 1999, the aggregate market value of the retirement system investments exceeded $43.8 billion, of which 72% was managed by the PRIM Board and the remaining 28% by the local retirement boards. See State Auditor's Report No. 99-1315-3 at 3, 5.

By statute, the PRIM Board is authorized to employ such investment advisors, legal counsel, and consultants as it deems necessary. G.L. c. 32, § 23(2A)(e)(iii). Each year, the PRIM Board files quarterly reports with the House and Senate Committees on Ways and Means, G.L. c. 32, § 23(2A)(e)(xi), and files its annual budget for approval by these committees. Id., § 23(2A)(e)(vi). The quarterly reports include a listing of brokerage transactions and of fees paid to investment managers and consultants, as well as a detailed investment portfolio analysis describing all holdings in the PRIT fund. Id., § 23 (2A)(e)(xi).

C. PERAC's Investment Oversight of Boards Prior to 1987

In the same legislation that created the PRIM Board and the PRIT Fund, the Legislature established a pension advisory unit of PERAC, which is responsible for advising local retirement boards on investments, measuring the investment performance of the retirement systems, establishing fund management policies, and granting qualified boards an exemption from certain statutory restrictions on investments. G.L. c. 7, § 50, as amended by Chapter 661 of the Acts of 1983. As authorized by statute, PERAC has promulgated rules and regulations to implement its oversight of investment management decisions made by local retirement systems. G.L. c. 7, § 50; see, e.g., 840 C.M.R. §§ 16.00-16.10 (investment advice and management); id. §§ 17.00-17.04 (standard rule for the formation of investment policy and statement of investment objectives); id. §§ 18.00-18.03 et seq. (formation of investment policy and statement of investment objectives); id. §§ 19.00-19.05 (exemptions from investment restrictions); id. §§ 21.00-21.01 (prohibited investments); id. §§ 26.00-26.06 (standard rule for the retention of consultants).

Prior to 1987, such investment oversight of boards by PERAC excluded the PRIM Board, because the Legislature had initially defined the term "board" in G.L. c. 32 as meaning each retirement board established under Section 20 of the statute having jurisdiction of any contributory retirement system established under Sections 1 to 28 of the statute. G.L. c. 32, § 1. The PRIM Board did not fall within this definition, unlike the local boards. The subsequent amendments to Chapter 32 are discussed below. Prior to December 20, 1983, the local boards were allowed to invest in a limited group of investments, those on an approved list. At the same time that it established the pension advisory unit of PERAC, the Legislature also relaxed the prior restrictions on the range of investment options for the local boards. G.L. c. 7, § 50, as amended by Chapter 661 of the Acts of 1983.

While the revised statute is less confining than the prior list of approved investments, the statute nonetheless limits the range of possible investment vehicles by the local boards. For example, with respect to investment in securities, the assets of a retirement system (with certain exceptions) may be invested only in those securities that are legal for the investment of funds by savings banks, as determined by the Commissioner of Banks. G.L. c. 32, § 23(2)(b)(I). In addition, there are provisions requiring the diversification of investments between securities and other investments on the one hand, and among specific securities on the other hand. See, e.g., G.L. c. 32, § 23 (2)(b)(I)(A) (no more than 20 per cent of the assets of any retirement system shall be invested in railroad obligations, with no more than 2 per cent of the assets invested in the obligations of any one railroad).(fn4)

D. The 1987 Amendments to Chapter 32

The present inquiry by PERAC arises from two changes made by the Legislature to Chapter 32 in 1987. First, the Legislature added the PRIM Board to the definition of the term "board" in Chapter 32, thereby subjecting the PRIM Board to PERAC's authority to conduct field examinations under G.L. c. 32, § 21(1)(a). Id., § 1 (2000 ed.), as amended by Chapter 697 of the Acts of 1987. Second, at the same time, the Legislature exempted PRIM's investment policies from PERAC's rules and regulations that govern the investment of funds by the local boards: "The investment and fund management policies adopted by the PRIM board shall not be subject to any rules or regulations promulgated by [PERAC] governing the investment of funds by the retirement boards." G.L. c. 32, § 23(2A)(h) (2000 ed.), as amended by Chapter 697 of the Acts of 1987.

Both before and after the 1987 amendments, Chapter 32 has contained the following directive on the investment of funds by the PRIM Board. "Subject to the approval or ratification of the PRIM Board, the executive director shall invest and reinvest such funds held by such board to the extent not required for current disbursements, as much as reasonably possible to benefit and expand the economic climate within the commonwealth so long as such is consistent with sound investment policy and the other requirements of this section." Id., § 23(2A)(h) (2000 ed.).(fn5) This directive applies solely to the PRIM Board. It is in the context of this directive that the Legislature made the second change to Chapter 32 in 1987, thus ensuring that the investment and fund management policies adopted by the PRIM board would not be subject to any rules or regulations promulgated by PERAC that govern the investment of funds by other retirement boards. The issue presented by PERAC involves the interpretation of this provision in light of PERAC's statutory authority to audit the PRIM Board under G.L. c. 32, §21(1)(a).

After the Legislature added the PRIM Board to the definition of the term "board" in Chapter 32, PERAC conducted two field examinations of the PRIM Board's financial condition, the first for the period from 1988 through 1990, and the second for the period from 1991 through 1993. These two field examinations are not at issue here, nor is PERAC's authority to conduct field audits directed to the PRIM Board's financial condition. Although neither of these examinations included a review of the PRIM Board's contracts with investment managers or advisors, PERAC indicated in December of 1999 that its third examination, covering the period from 1994 through 1999,(fn6) would include such matters.(fn7) In particular, PERAC stated that the scope of this field examination would include all contracts, including those with investment managers and advisors; that the review would be a sampling to insure that PRIM adopted and followed a procurement process; and that PERAC would review the selection process, the signed contracts, and the fees paid by the PRIM Board, in order to determine that such fees were paid in accordance with the contracts. After the PRIM Board objected,(fn8) PERAC sought an opinion on this matter.

E. Determining the Proper Scope of PERAC's Field Examination of the PRIM Board

The issue presented is whether including the procurement of investment management services in the scope of a field examination by PERAC would violate G.L. c. 32, § 23(2A)(h), by making the investment management policies adopted by the PRIM Board subject to rules or regulations promulgated by PERAC.(fn9) With respect to the scope of a field examination by PERAC, the PRIM Board differs from the local boards in one material respect.(fn10) Several PERAC regulations derive from its role in oversight of investment management decisions made by local retirement systems. See, e.g., 840 C.M.R. §§ 16.00-19.05; id. §§ 21.00-21.01; id. §§ 26.00-26.06. In conducting field examinations of local boards under G.L. c. 32, § 21(1)(a), PERAC has authority to review and evaluate the board's investment management decisions, in order to monitor the board's performance and the retirement system's effectiveness in achieving the statutorily intended results, 840 C.M.R. § 25.01.

This difference between the PRIM Board and the local boards is material to my analysis. Sections 21(1)(a) and 23(2A)(h) of Chapter 32 must be read together in determining the permissible scope of a field audit by PERAC of the PRIM Board. The reasoning employed by the Supreme Judicial Court in another case involving PERAC is instructive here, given that the case also involved the interpretation of two statutes, one general and the other specific:

Where one provision is more restrictive in a particular area, then that provision controls in that area. All areas covered under the general provision and not covered by the particular provision are unaffected by the particular provision. This way, both provisions can be given effect, with neither rendered nugatory.

Plymouth County Retirement Ass'n v. Commissioner of Pub. Employee Retirement, 410 Mass. 307, 312 (1991). In that case, the Court determined whether PERAC had authority to review two local boards' approvals of applications for accidental death benefits, as opposed to accidental disability pensions. In asserting that it had such authority with respect to benefits, PERAC pointed to its general authority to review determinations made by boards under G.L. c. 32, § 21(4). Id. at 309-10. The two boards noted, however, that the more specific grant of authority to PERAC for review accidental and ordinary disability pensions, G.L. c. 32, § 21(1)(d), "conspicuously did not include review of accidental death benefits," id. at 311 (emphasis added), and the boards asserted that the more specific provision should apply. Id. at 310. The Court harmonized the broad grant of review authority conferred on PERAC under G.L. c. 32, § 21(4), to review determinations made by boards, on the one hand, with the more specific grant of authority to review accidental and ordinary disability pensions under G.L. c. 32, § 21(1)(d), on the other hand. Id. at 312. The Court found that the Commissioner had authority to review local boards' approval of applications for death benefits under G.L. c. 32, § 21(4), reasoning that "§ 21(1)(d) controls § 21(4) only to the extent that review of accidental and ordinary disability pension determinations is concerned." Id. at 311-12.

F. Conclusions

In like manner, Section 23(2A)(h) of Chapter 32 is the more specific provision with respect to the investment and fund management policies adopted by the PRIM Board, while the more general provision, Section 21(1)(a), governs other aspects of PERAC's field examinations. Thus, while PERAC has the authority to include a review of executed contracts as part of its field examination of the PRIM Board pursuant to G.L. c. 32, § 21(1)(a), and 840 C.M.R. § 25.01, the scope of field examinations of the PRIM Board must be more limited than the scope applicable to local boards, such that PERAC lacks authority to review the process adopted by the PRIM Board for the selection of particular investment managers or advisors, or to assess the results of such selection. Applying such a limitation ensures that the investment and fund management policies adopted by the PRIM Board will not be subject to any rules or regulations adopted by PERAC governing the investment of funds, consistent with G.L. c. 32, § 23(2A)(h).(fn11)

Sincerely,

Thomas F. Reilly

1. PERAC was formerly the Division of Public Employee Retirement Administration. For consistency, I will refer to this agency as "PERAC" throughout.

2. Unlike the local boards, the PRIM Board has no responsibility for the administration of pension benefits.

3. For example, the CPA conducting the audit must complete an internal control questionnaire developed by PERAC, 840 C.M.R. § 25.10; PERAC Memo # 47/1999 at ¶ 3; must file the examination with PERAC within ten days of making the report to the board, G.L. c. 32, § 21(1)(a); and must meet with representatives of PERAC within thirty days of filing the report, while providing copies of the work papers and schedules at the time of the meeting. 840 C.M.R. § 25.01.

4. Upon application by a retirement board, PERAC is authorized to exempt the board from these restrictions on investment options if PERAC determines that the board's record of investment management merits broader investment powers. G.L. c. 32, § 23(2)(g); 840 C.M.R. §§ 19.00-19.05.

5. The 1987 amendment added to this directive a separate provision that prohibits PRIM from investing the assets of the PRIT Fund in companies doing business with the Republic of South Africa or companies engaged directly or indirectly in certain military transactions with Northern Ireland. G.L. c. 32, § 23(2A)(h) (2000 ed.), as amended by Chapter 697 of the Acts of 1987. The Legislature had previously imposed the same restriction on MASTERS assets, effective in 1983. See G.L. c. 32, §23(1)(d) (1989 ed.).

6. Although G.L. c. 32, § 21(1)(a), calls for triennial field examinations, the third field examination of the PRIM Board was delayed, and PERAC thus sought to conduct a single examination for the period from 1994 through 1999.

7. The third field examination also included the PRIM Board's financial condition. The PRIM Board elected to retain CPAs to conduct audits regarding its financial condition during the period from 1994 through 2000, and PERAC was given access to the CPA's work papers in accordance with the protocol by which PERAC may elect to accept an audit conducted by a CPA in lieu of a field examination under G.L. c. 32, § 21(1)(a). See 840 C.M.R. § 25.01 et seq; PERAC Memo #47/1999. The present inquiry thus does not involve this portion of the third field examination.

8. In 2000, the PRIM Board also retained a CPA to perform additional audits regarding the process for procurement of services by PRIM, including investment management and advisor services, for the same time period. The CPA issued audit reports for theses periods on December 1, 2000. The PRIM Board declined to provide PERAC with access to the CPA's work papers.

9. PERAC is not estopped from seeking to include contracts in the scope of its field audits of the PRIM Board, despite the omission of such matters from the first two audits, any delay in conducting the third audit, or any prior statements made to the PRIM Board, see, e.g., Harrington v. Fall River Housing Auth., 27 Mass. App. Ct. 301, 308 (1989), nor does the position now taken by PERAC contravene a consistent, long-continued interpretation of the relevant statute. Cf. DiGianni v. Contributory Retirement Appeal Bd., 421 Mass. 350, 355-56 (1995).

10. Also, because the PRIM Board has no responsibility for the administration of pension benefits, portions of the questionnaire developed by PERAC as part of the protocol by which it may accept an audit by a CPA in lieu of a field examination, 840 C.M.R. § 25.10, do not apply. For example, the sections of the questionnaire covering membership and disability procedures are directed to the administration of benefits. See 840 C.M.R. §§ 25.32, 25.33. These issues should not be included in the field examinations of the PRIM Board, and the PERAC regulations that govern the administration of benefits are inapplicable to the PRIM Board. See, e.g., 840 C.M.R. §§ 6.00-7.13; id. §§ 10.00-10.21.

11. The same limitation applies where, as here, the PRIM Board has elected to retain a CPA to conduct an audit regarding the process for procurement of services by the PRIM Board. In determining whether to accept that audit in lieu of a field examination, PERAC lacks authority to review those work papers of the CPA that relate to the PRIM Board's decision to select particular investment managers or advisors, while retaining authority to review the remaining work papers that relate to the performance of contracts issued by the PRIM Board, including the payment of fees under those contracts with investment managers and advisors.