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SR-07-14-2015-11AID Report City of I Council Santa Monica' City Council Meeting: July 14, 2015 Agenda Item: I I -A To: Mayor and City Council From: Elaine Polachek, Assistant City Manager Subject: Establishment of an Audit Committee Recommended Action Staff recommends that the City Council: 1) Adopt the attached resolution of the City of Santa Monica establishing an audit committee; and 2) Appoint members to serve on the audit committee. Executive Summary Following the City's FY 2014 -15 internal controls assessment, Council recommended establishing an audit committee in accordance with best practices in financial management. The recommended structure, responsibilities, and suggested first year schedule reflect input from the City's current internal and external auditors, are consistent with common practices in other cities, and are based on the principles of the Sarbanes- Oxley Act, which sets forth safeguards against accounting errors and fraudulent practices. This report presents a resolution to establish the committee and identify its role in the City. Background The City currently contracts with independent external and internal auditors, and has practices for Council and staff review and oversight of financial transactions. In its routine actions, Council approves vendor selection, purchases and contracts over certain thresholds, appropriates budget, and is kept apprised of the use of fund reserves. Internal and external auditors also present reports showing the results of their work to Council. These reports identify any findings of weakness in financial reporting or controls that could expose the City to financial loss. These practices provide some limited assurance on the integrity of the City's financial practices and stewardship of public funds. 1 On January 27, 2015, following a discussion about the audit committee function, Council requested staff to return with a discussion of current city auditing practices and a description of best practices in other city governments. On March 17, 2015, staff presented this information to Council along with the results of the City's internal controls assessment. At that time, Council voted to form an audit committee and requested that staff return with a proposed internal audit work plan. Staff has consulted with government finance experts and researched other city practices to put forward the following structure, contained in the resolution for Council approval. Discussion Audit Committee Background The audit committee function exists in the private and public sector. The purpose of an audit committee, in general, is to support and enhance accountability. The Sarbanes- Oxley Act, a 2002 federal law that set new or enhanced standards for all U.S. public company boards, management and public accounting firms, requires audit committees for publicly traded companies. This requirement does not extend to the public sector, but states, cities, and counties independently establish audit committees by law, charter, or municipal code. Governments draw from Sarbanes -Oxley language to establish audit committee guidelines and responsibilities. The Government Finance Officers Association (GFOA), Institute of Internal Auditors (IIA), and Association of Local Government Auditors (ALGA), among other professional organizations, recommend audit committees as a financial management best practice. Ideally, an audit committee facilitates the governing body's independent review and oversight of its organization's financial reporting processes, internal controls, and independent auditors. To meet this goal, the committee must be independent, and must have basic knowledge of governmental financial reporting and auditing, or have access to an expert with this knowledge. The committee's structure should provide for candid 2 communication between the governing body and the city's auditors and other interested parties. This report presents general guidelines for audit committees based on these goals, and then recommends a specific structure within these parameters for the City of Santa Monica. General Guidelines The general guidelines below provide direction for cities setting up an audit committee. Within these general guidelines, audit committees vary greatly. There is no consensus among government finance professional organizations about what specific structure or organization of a committee best achieves audit committee objectives. Cities should set up committees to meet oversight and accountability goals given the organization's structure and needs. The proposed resolution offers Council a simple Audit Committee model with a delineated scope that allows for changes initially or over time should the need for a different or increased scope arise. Staff researched best practices as outlined by the Sarbanes -Oxley Act, the U.S. Securities and Exchange Commission (SEC), the American Institute of Certified Public Accountants (AICPA), IIA, GFOA, and ALGA, as well as guidelines set forth by major public accounting firms, to develop general recommendations to help meet accountability goals, as follow: - Structure. Membership should be at least three and no more than six individuals, to encourage debate without making meeting and consensus difficult. - Membership. Governing body members should make up the majority, or all, audit committee members. Other possible options include members of the community or a technical expert. Some cities include Finance Directors or City Managers as members. - Responsibilities. An audit committee should review financial information and reports, and interact with and oversee the City's auditors. The committee can be 3 more or less involved or responsible for each of these items depending on the entity's structure and existing practices, and committee member expertise. - Method of Establishment. Committees should operate under a formal mandate, with sufficient authority to complete their assigned direction Other Cities Staff surveyed other California cities regarding audit function, including membership, roles, meeting frequency, and relationship to internal and external audit function. Results demonstrate variability in how cities exercise audit functions, even among cities with a formal audit committee. Of 13 area cities for which staff received detailed information, five reported a formal audit committee, four did not have an audit committee, and four reported either a subcommittee or advisory group structure that operate to varying degrees in the same manner as an audit committee. Cities with an audit committee fall within the general guidelines for membership and responsibilities. All cities except one include at least two Council members on the committee, and all have a role in reviewing and approving internal and external auditor reports. Three of the five cities participate to some extent in external auditor selection. However, no cities operate in exactly the same manner. Committees report meeting from once per year to monthly; three committees include city staff members, and one is composed entirely of residents with technical backgrounds. Three approve auditor work plans, while others do not. Cities reporting Council subcommittees or City advisory committees exercising some audit committee functions are similar in being composed of Council members, reviewing audit reports and work plans, and participating to some degree in auditor selection. Survey results demonstrate that cities establish audit committees or similar functions to best fit in with each city's structure and manner of operating, but keep to recommended main function of government body membership, and auditor review and oversight. ET Using general guidelines, and drawing from other city experience and discussions with professional organizations and the City's auditors, staff recommends the structure outlined in the following section. Recommended City of Santa Monica Structure Structure. Staff recommends a three - member group, with three required meetings per year. Members would attend all meetings. This is consistent with general guidelines, and fits in with Council direction and frequency of internal and external audits and financial reports. Two members would serve for four -year terms, and one for a two -year term, with staggered terms ensuring continuity. Committee members would elect a chairperson annually. Membership. Staff recommends the committee be comprised of exclusively Council members, functioning as a subcommittee of the City Council. This is consistent with GFOA recommendations, the Sarbanes -Oxley Act, and other cities' practices. The committee would have access to technical expertise as needed from the City's internal and external auditors, and from relevant City staff. Role /Responsibilities. Staff recommends the following responsibilities for the Audit Committee, organized around the City's existing audit functions. - Consult with internal auditor on projects and workplans, receive and review reports, and receive updates on implementation of prior recommendations. - Assist in external auditor selection, consult with the external auditor on project scope, receive and review annual financial reports prior to finalization and presentation to full Council and community. - Receive information from staff on ongoing internal and external audit issues. Function as an independent body to receive internal whistle blower complaints. 5 Function as an independent body to receive requests or reports from the community related to financial processes or reporting concerns. Facilitate internal and external audit report presentation in public meetings. Method of Establishment. Staff recommends the City establish its audit committee through resolution. This provides the necessary mandate and authority for the committee to operate, and is more direct and efficient than modifying the City's charter. The resolution contains the committee's scope and authority for operation. It is included as Attachment A to this report. Audit Committee Member Appointment and Next Steps Staff recommends the Council appoint three Council members to serve on the audit committee. Staff recommends that the first Audit Committee meeting occur in September 2015, with future winter and spring meetings scheduled with one month's notice. The proposed schedule and agenda, below, provides an overview of some of the topics that could be discussed in the meetings, based on regular financial cycles. Staff does not have a specific recommendation on how often the Audit Committee should report back to the full Council, and has therefore not included this structure in the proposed resolution. The Committee may choose to report to the Council at regular intervals, after each Audit Committee meeting, and to allow for additional reporting based on need. Meeting 1 (Fall) - Appoint a chairperson - Receive internal controls training - Approve Internal Audit work plan* for FY 2015 -16 - Receive an update on internal controls work plan - Receive and review planning communication from external auditors - Review and provide input on a request for proposals for the City's next external auditor selection. ( *see Internal Audit work plan section below) 6 Meeting 2 (Winter) - Review the consolidated annual financial report (CAFR) executive summary (if available) - Receive an update on internal controls work plan and progress on internal review findings - Review recommendations for the new external audit firm. Meeting 3 (Spring) - Review the City's final external audit - Receive and review required communications from external auditors on the performance of the financial statement audit - Receive an update on the internal auditor work plan and progress on internal review findings - Review results of completed internal auditor work plan items. Internal Audit Work Plan for FY 2015 -16 At the March 17, 2015 meeting, the City's internal auditor presented the Internal Controls Review, a report providing a comprehensive overview of the City's fiscal operational controls. This report also provided a starting point for the development of an internal audit work plan that will delve deeper into specific high -risk operations. Council had requested that staff return with the work plan when it was completed. Staff is proposing to present the FY 2015 -16 Internal Audit Work Plan to the Audit Committee at its September meeting, and could present the work plan to the Council at the following meeting if so directed by Council. 7 Financial Impacts & Budget Actions There is no immediate financial impact associated with the recommended action. Staff has included contingency amounts in internal and external auditor contracts to cover additional technical support which may be required throughout the year. Staff will monitor needs on an ongoing basis and return to Council with a request if additional funds are needed. Prepared by: Stephanie Lazicki, Principal Administrative Analyst Elaine Polachek Assistant City Manager Attachment: Forwarded to Council: P Rick Cole City Manager A. Resolution of the City of Santa Monica Establishing an Audit Committee Reference: Resolution No. 10897 (CCS)