Monday, October 10, 2005

Dennis Leone's investigative report on STRS May 16, 2003

May 16, 2003
MEMO TO: All STRS Board Members Herb Dyer, STRS Executive Director
FROM: Dennis Leone, Superintendent Chillicothe City Schools
SUBJECT: STRS Organizational Matters and Spending Practices

Over the past three months, I have studied information supplied to me by STRS staff in an attempt to better understand issues that have received considerable news media attention recently. It also has been my desire to learn the truth about numerous STRS financial issues that have been on the minds of many STRS active members, retired members, and employers.

I have reached the following conclusions:

1. Membership Issues: According to the STRS Comprehensive Annual Financial Report for fiscal year 2002, STRS has 424,171 total individual members. This includes 178,557 active members, 105,300 retired members, 15,730 re-employed retirees, 106,746 inactive members (eligible for refunds only), and 17,838 terminated members (eligible to receive a benefit at some point in the future). There also are 944 employers that send their portion of retirement contributions to STRS. The bulk of these (899) are school boards that represent public school districts, county ESCs, vocational schools, MRDD boards, and community schools - all of which have contributed 14% of every employee's annual salary to STRS since January of 1984.

CONCLUSION: The make-up of the current 9-member STRS Board really is not representative of its membership. Only one member of the Board represents retirees and no one represents the 944 employers that make the very existence of STRS possible. It would seem that the Ohio School Boards Association should either have a seat on the STRS Board or some official role in the STRS decision-making process. The 944 employers send more dollars to STRS than all active members combined, and therefore they need to have direct involvement and a voice in how the millions they send in are spent. Retirees, likewise, are under-represented and feel taken for granted.

2. Declining Assets: To set the record straight, STRS assets peaked on August 31, 2000 at $58.7 billion. Assets dropped significantly over the next 2 years - hitting a low of $41.6 billion on September 30, 2002 - before rebounding slightly six months later to $42.4 billion on March 30, 2003. The net $16.3 billion drop in assets between 8-31-00 and 3-30-03 represents a 28% loss in assets for STRS over the 2 ½-year period. Enron stock started declining continuously in the summer of 2001, prior to the September 11 tragedy. Unfortunately, nationally recognized external investment consultants utilized by STRS - some of which had been quite helpful is assisting STRS benefit from the stock market in the past - provided bad advice in this instance. Before STRS finally ceased buying Enron shares in late November of 2001, $66 million was lost. The Columbus Dispatch reported on April 18, 2003, that STRS "underperformed" most pension funds nationally in 2002 in the area of investments. The report, based on a national study conducted by Milliman USA, stated that the median loss in investment revenue for public employee retirement systems nationally in 2002 was 8%. The loss at STRS, however, was 11.6%.

CONCLUSION: Mr. Stephan Mitchell has served STRS for the past 30 years, the last 20 of which have been as Deputy Executive Director in charge of investments. It has been published that STRS employs twice as many investment specialists as PERS (even though PERS has greater assets). Mr. Mitchell also has acknowledged that STRS has the largest investment staff of any teacher retirement system in the nation. While the investment returns at STRS have not been good over the past 3 years, and while some argue that STRS should have had a "stop loss" provision in place to prevent the huge losses experienced in the Enron fiasco, STRS investments were quite successful prior to 2000. Mr. Mitchell has had a good track record at STRS and retired members have benefited greatly from the productive investments by his department. Due to the collapse of Enron and other corporations, STRS needs to reassess its policies and practices for investing the membership's money to help ensure that investments are better protected. Even if stock market advice received is normally reliable, it seems there needs to be greater consideration for the use of "stop loss" orders to trigger an investment pull-out at a certain point after the stock has declined (to protect prior gains and/or minimize continued losses).

3. Staffing and Administrative Expenses: According to the STRS Comprehensive Annual Financial Reports, administrative expenses climbed at STRS 17.4% per year during the 6-year period between 1996 and 2002. (Administrative expenses include such things as salaries and benefits of STRS employees, legal services, travel, supplies, printing, computer services, etc.) The Columbus Dispatch reported on November 3, 2002 that in the specific area of salaries, STRS costs went up 26% in one year alone between 2000 and 2001. During the same one year time period, the Dispatch reported that total administrative expenses at STRS went up 25%. During the 6-year period between 1996 and 2002 - according to data supplied by STRS staff - the number of people employed at STRS rose from 414 to 725, an increase of 12.5% per year. In a letter dated February 28, 2003 from STRS Executive Director Herb Dyer to the Ohio Retirement Study Council, Mr. Dyer wrote that 137 new employees were added in 2001 alone, and 69 of those were in administration.

CONCLUSION: While it is true that a number of new employees were needed to staff the new STRS headquarters in the areas of security, information technology, and various membership services, it is hard to accept these types of increases at a time when the total assets at STRS have plummeted a staggering 28% ($16.3 billion). When the school boards that send dollars to STRS experience declining assets on the home front, they do things like freezing salaries, cutting supplies, laying off employees, and even closing schools. In a nutshell, they reduce expenses by instituting cost-cutting measures. The STRS Board and administration have not satisfactorily demonstrated that they have reduced costs in their "house." While the administration is to be commended for reducing the total number of STRS employees in recent months to 707 (after peaking at 735 in February of 2003), much more needs to be done. To begin with, there needs to be a shift in what the STRS Board considers as priorities. The Board currently is not in touch with the managerial principles and fiscal realities from which their members and employers must operate under in order to survive. The STRS Board and administration are living a professional lifestyle that is completely foreign to their own membership. They need to emulate their membership. They need to set an example, and show they understand how it important it is to do so. This situation must change.

4. Costs Associated With New STRS Headquarters: An STRS summary of construction costs for the new and renovated building that opened in September of 2001 shows that a total of $94.2 million was spent. Included in this very nice facility is a fitness center for STRS employees that the staff estimates cost $426,000, and a child care center for STRS employees that the staff estimates cost $818,000. Also included in the cost for the new building was $869,235 for sculptures, artwork, and polished stones. One sculpture cost $378,500, another cost $168,125, another cost $112,500 and yet another cost $100,000.

CONCLUSION: The membership of STRS is NOT sending in a portion of their annual salaries to enable the Board and the administration to spend an incredible $869,235 on sculptures, artwork and polished stones. The new STRS building is not a museum, is it? It is outrageous that these purchases were allowed to occur. There is simply no acceptable answer for it. The need for the new STRS building to have a costly fitness center and a child care center is a subject for debate. What is not a subject of debate is that there are substantial annual STRS operating costs associated with the child care center. When Board members have been asked about the child care center at regional meetings, some have implied that the operating costs for the child care center are covered by the fees that are charged to the users in the STRS building. While it is true that fees are charged, they only covered 46.6% of the total child care center operating costs in 2002 - according to data supplied by STRS staff. The other 53.4% of the operating costs associated with operating the child care center in 2002 - according to data supplied by STRS staff - is picked up by STRS. And how much did this cost in 2002? The STRS Board offered up $487,560 to operate the child care center. STRS members and their employers do NOT pay their required retirement contributions so the STRS Board can annually pick up 53.4% of the operating costs of a child care center for STRS staff members. If Latch Key programs operated by school districts do not pay for themselves through fees, then they're discontinued. The $869,235 that was spent by the STRS Board on sculptures, artwork, and polished stones, and the $487,560 that was spent by the STRS Board in 2002 to operate a child care center were simply wrong. Both represent a managerial and fiscal embarrassment. The STRS Board seems to forget that their members are in a period of financial decline.

5. The 13th Check: For 21 consecutive years starting in 1981 and ending in 2001, STRS awarded a 13th check to retired members. This check was not based on prior retirement contributions of retired members or their former employers. It was based on positive STRS investment earnings each year - earnings that occurred from the utilization of the prior contributions of retired members and the current contributions of active members. According to data supplied by both STRS and the Ohio Retirement Study Council in Columbus, the total amount awarded during this 21-year period was $711 million. If one adds the lost investment income to that amount, the total price tag for the 13th check was $1.4 billion. On December 11, 1996, a Joint House/Senate Legislative Committee of the Ohio General Assembly released its 8-month study of Ohio's public retirement plans. Included in this committee's final report was a proposal from the Ohio Retirement Study Council. It recommended that the 13th check to retired STRS members be disbanded. Despite this recommendation, the STRS Board continued to hand out the 13th check for 5 more years at a total cost of $233 million. (And this total does not include another $52 million that was lost in interest earnings during the same 5-year time period.)

CONCLUSION: While retired members deserved the 13th check as a way to help deal with inflation, some now feel that all of those dollars really should have been put into the STRS health insurance fund or in a rainy day fund. According to NEA, no other state has done anything close to what Ohio has done with its 13th check. Only four other states provide bonus checks to retirees, and all of those do so intermittently and/or only with specific legislative approval on an annual basis. It deserves noting that immediately after STRS received the recommendation in December of 1996 to disband the 13th check, literally thousands of teachers and retirees wrote to legislators and STRS Board members to voice their opposition to the proposed disbandment. In fact, OEA urged its members to write letters at that time. While the 13th check seemed like the right thing to do at the time, whether it should ever have started is now being questioned. Had STRS honored the recommendation it received in 1996 regarding this fund, the projected deficit for the STRS health insurance fund for 2004 would not be there. In fairness to STRS, what the Board did in 1996 is what some school boards and collegiate trustee boards do - they respond to the vocal and written pressure of their constituents.

6. Cash Reimbursements for Unused Sick Leave and Vacation Leave: Existing Board policies permit STRS employees to receive reimbursement on an annual basis for up to 9 days of unused sick leave and 9 days of unused vacation time. Employees must have a balance of at least 20 sick leave days and 5 vacation days to qualify. In 2002, according to data supplied by STRS staff, the STRS Board paid out $701,948 in sick leave reimbursements and $342,980 in vacation leave reimbursements. Collectively, this employee benefit cost the STRS budget $1,044,928.

CONCLUSIONS: How many school districts provide all full-time employees an annual cash reimbursement for unused sick leave and unused vacation leave? It would be one thing to provide such a benefit to a select few, but to provide it to all full-time employees is inconsistent with the practices of the overwhelming majority of STRS members that are employers. It is common for school districts to provide a sick leave severance check to employees when they retire. It also is common for school districts to award a small cash amount of a few hundred dollars to employees who have perfect attendance. What STRS does is not common. These two policies need to be dropped, except for perhaps a few individuals. It deserves noting that until 2002, the STRS Board paid 100% of the family health insurance premiums of employees. Last year was the first time in STRS history that employees had to pay a portion of the Board's total premium cost. The number of STRS employer members that pay 100% of their employees' family health insurance premiums is, indeed, very rare.

7. Annual Bonus Checks to STRS Employees: There are 3 major types of bonus checks that STRS administrators and investment personnel are eligible to receive on an annual basis on top of their base salary and base salary raise. Investment employees are eligible to receive two major bonus checks annually, while non-investment administrators are eligible to receive one major bonus check per year. According to data published in the STRS 2002 Staffing, Compen-sation, and Benefits Review, the following summarizes the total number of full-time STRS employees who received these bonus checks over just the 2000-2001-2002 three-year period:

Year Employees Receiving Bonus Total STRS Cost 2000 290 $3,534,002 2001 345 $6,168,175 2002 395 $5,752,233

3-Yr. Totals 343 avg. per yr. $12,274,410

In 2002, according to data supplied by STRS staff, there were 82 STRS employees with total salaries (base salary plus bonus checks) in excess of $100,000. Thirty Three (33) STRS employees received total salaries in 2002 that were larger than the current 2003 salaries of the governor and the chief justice of the State Supreme Court. In other words, 33 STRS employees earned in excess of $155,000 in 2002. Fifteen (15) of these cleared $200,000. The following represents the distribution of bonus checks that STRS employees received in 2002:

Total Bonus Amount Number of Employees Receiving $10,000 - $19,999 55 $20,000 - $29,999 17 $30,000 - $39,999 14 $40,000 - $49,999 7 $50,000 - $59,999 2 $60,000 - $69,999 7 $70,000 - $79,999 7 $80,000 - $89,999 1 $90,000 - $99,999 3 $100,000 - $109,999 1 $110,000 - $119,999 5 $120,000 - $129,999 1

Total Receiving Bonuses Over $10,000: 118

In 2001, there was one investment employee who received single bonus checks of $110,000 and $68,880 on top of her base salary of $164,000. This brought her total STRS salary in 2001 to $342,880. And according to Mr. Dyer's February 28, 2003 letter to the Ohio Retirement Study Council, all investment personnel also received a 3.2% base raise in 2001. CONCLUSION: It is almost incomprehensible that during a three-year time period when STRS total assets declined a huge 28% ($16.3 billion), the STRS Board spent $12.2 million on bonus checks for employees. The dollar amounts associated with the bonus checks are mind-blowing. For the 944 employers that send STRS employee contributions each month, the bonuses represent fantasyland finances. Who could have guessed that one STRS employee received single bones checks in 2001 of $110,000 and $68,880 on top of her $164,000 base salary? Who would have thought that 34 STRS employees would receive bonus check totals in excess of $40,000 in 2002?

STRS Board members and administrators defend the bonus checks awarded for several reasons. First, they say, the money used for the bonuses for the investment personnel comes from a pool of dollars that was received when investment earnings were positive in years past. They say that since investment revenue has declined, money will not be available for these bonuses for very long in the future. We shall see. Secondly, and most importantly, they state firmly that the bonuses for investment personnel have been based on the employee's ability to achieve both an individual investment benchmark and a total fund investment benchmark. Under this standard, an investment employee still could receive a bonus check even if STRS assets decline, as long as the performance of the stock he/she is managing doesn't decline as much. A third reason STRS Board members and administrators defend the bonuses is they risk losing valuable employees to the private sector (where they can receive the bonuses and higher salaries). While this concern could very well be valid, it is not fair or reasonable to expect the STRS membership to accept it given the realities of the financial problems facing everyone else.

In 2002, 65 STRS administrators received bonus checks. Since they had nothing to do with the investment earnings, why did they receive the bonuses at all, given the overall decline in STRS assets? All of them received a base salary increase. While maybe there is some logic in providing a few top STRS employees some type of small bonus for exemplary work, it defies logic for bonuses to be awarded to 395 employees in 2002…..and big bonuses at that. There are a lot of excellent school treasurers in Ohio who invested money very well for their school districts in the 1990's. Did any of them get big bonuses for bringing interest earnings into their school district? If any did, it was a rare circumstance and it likely was a very small bonus. Properly investing the school district's money is part of the treasurer's job. That is why they receive a base salary. The large number of bonuses STRS gives its administrators must stop immediately. Bonus checks for so many investment personnel must stop as well. It they must be given, they should go to a select few, and they should more realistically reflect the realities facing the 944 employers and the thousands of individuals who are members of STRS. On November 13, 2002, according to the STRS 2002 Staffing, Compensation and Benefits Review, a company called Buck Consultants recommended that STRS do a better job of "establishing a clear link between individual performance and overall organizational success." The consultants analyzed recent STRS practices for bonuses, and wrote:

"The absence of a direct linkage among organization-wide performance and absolute performance (versus indexed) and incentive payouts is inconsistent with best practices."

To an outsider, the above would seem to mean that if STRS is failing to show profits with its investments, employees shouldn't be receiving bonus checks. Ultimately and unfortunately, it will be the STRS Board who determines what constitutes organizational success, not the membership. Is there any wonder how a membership survey would turn out if the STRS Board took the time to ask their membership what they feel about these issues?

8. Travel-Related Expenses for STRS Board Members: According to data supplied by STRS staff, $177,009 is expected to be spent in 2003 on travel-related expenses for Board member/administrator development, training, professional seminars, and conferences, and for investment transactions, plus real estate transactions. In the three previous years, the total amounts spent were $186,116 (2000), $174,167 (2001), and $170,001 (2002). On May 31, 1995, the Cleveland Plain Dealer called into question the fact that Board members were turning in bills for trips to places like Hawaii and Palm Springs, for lodging at the nation's top hotels, for dining at expensive restaurants, and for beach bar bills. The article said that one Board member named Jack Chapman, who is a current Board member, spent $36,736 the previous year all by himself. According to the article, a planned trip by STRS Board members to China two years earlier was cancelled after the State Attorney General Office complained that such a trip would create an image of "junketeering." In recent years, while no STRS Board member has spend money like the Plain Dealer claims Jack Chapman did in 1994, Board members still spend a great deal of membership money on out-of-state travel expenses. The total travel-related expenses and the number of trips requiring airfare over the past 3 years are shown for each Board member below:

Total Expenses Paid Number of Trips in 2000, 2001, & 2002 Requiring Airfare Hazel Sidaway $54,216,60 25 Jack Chapman $49,647.11 34 Eugene Norris $47,148.00 21 Deborah Scott $39,916.30 16 Gloria Gaylord $32,941.87 14 Joe Endry $11,727.43 7 (2-yrs.) Rick Moore $10,437.95 10 Michael Billirakis $ 9,923.28 7

Paul Shreve $ 8,174.91 4 (2-yrs.)

CONCLUSION: While there certainly are valid reasons for Board members and administrators to attend professional seminars and be properly trained, and while the STRS membership wants to be effectively represented at real estate/investment transactions, was it really necessary for Board members to spend so much money for so many out-of-state trips over the past 3 years? The STRS Board and administration say yes. The STRS membership says no. One would think that after the Plain Dealer wrote the article in 1995 about STRS Board member expenses for out-of-state trips, and after a 28% decline in assets ($16.3 billion) since August of 2000, maybe - just maybe - expensive trips to places like Hawaii would cease. Not so. Board members Eugene Norris, Deborah Scott, and Hazel Sidaway spent thousands of dollars to go to Honolulu in 2000. Board members Jack Chapman and Gloria Gaylord spent thousands of dollars to go to Kiawah Island off the coast of South Carolina in 2001. Chapman liked it so much that he went back in 2002. Board members Michael Billirakis and Joe Endry spent thousands of dollars to go to Anchorage, Alaska in 2002. Perhaps, in the minds of Board members, the dollar amounts spent and the out-of-state trips taken are not excessive or exorbitant. The STRS Board just simply doesn't understand that if the boards representing the 944 employers that are members of STRS took trips like these at a time when their organization was experiencing financial difficulties and/or declining assets, they'd be run out of town. The public wouldn't stand for it. The "public" that represents STRS is the membership - 178,557 active members, 105,300 retired members, 15,730 rehired retirees, and 944 employers.

Recommendations: The $100,000 sculpture sitting outside the STRS Board room on the 6th floor is entitled "Integrity." The inscription under the sculpture reads:

"Integrity…..guiding all that we do at STRS Ohio, from retirement Board actions to counseling members and investing money. This sculpture symbolizes integrity through the bronze figure representing members, intertwined with the stainless steel figure providing the security so highly valued by members and benefit recipients alike. The spiraling shape captures the boundless energy and strength that characterizes the system's mission and vision."

1. If the STRS Board truly believes it has the "integrity" to "provide security so highly valued by members," then NOW is the time for the Board members and the administration to have a new priority, a new focus, and a new philosophy regarding their past spending practices. No one is blaming STRS for the downturn in the nation's economy or for the national health care crisis. But when your assets have declined by a huge 28% ($16.3 billion) over just 2 ½ years - and you tell your membership at the same time that there's no longer enough money to pay for health insurance or an inflationary increase (the 13th check) - you need to fully understand that:

" The Board cannot spend $869,235 for sculptures, artwork, and polished stones in a new/renovated $94.2 million building.

" The Board cannot increase administrative expenses 25%, increase administrative salaries 26%, and hire 69 new administrators in the same year.

" The Board cannot give STRS employees annual cash reimbursements totaling $1,044,928 for portions of unused sick leave and unused vacation leave.

" The Board cannot spend $487,560 per year to provide child care services for STRS employees in a center that the Board spent $818,000 to construct.

" The Board cannot give 395 employees gigantic bonus checks every year (34 of them over $40,000 in 2002 alone) totaling $12.2 million over 3 years.

" The Board cannot give out bonus checks, period, except to very select few, and only if STRS assets exceed the asset high that was achieved in August of 2000. What the Board has done in the immediate past is tell the retired membership that it didn't have funds for a 13th check, but then came up with the funds for its own internal 13th check - the one that's a huge bonus increase for 395 employees.

" The Board cannot take trips so many trips in a single year, go to places like Honolulu, Anchorage, and Kiawah Island, or allow single Board members to have 10-15 airfares and travel-related expenses totaling anything close to $36,767 in one year.

2. It is recommended that dollars currently set aside for future employees bonuses be put into the STRS health insurance fund.

3. It is recommended that you seek legislation to change the make-up of the STRS Board in such a way that there is increased representation from retired members and new representation from the 944 employers.

4. It is recommended that you lay off employees, cut costs internally, and initiate steps to reduce total administrative expenses to their pre-August of 2000 level - which is when the total assets at STRS started to decline.

5. It is recommended that you receive serious in-service training (at a Columbus location) from managerial experts who can help you better relate to the financial conditions currently facing your individual members and employer members, how your membership is dealing with said conditions, and how STRS can help them.

6. It is recommended that you survey your entire membership - as corporations do with their stockholders - specifically to see how they feel about the seven bullet points on pages 11 and 12 of this memorandum. You might be surprised at the answer.

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