Department of Labor investigations of employee benefit plans can be challenging experiences for employers. The time demand can be a significant drain on the business, and the employer needs to be concerned about potential issues the investigator may raise. We believe the best defense is a good offense: we like our clients to take their responsibilities seriously well before an investigation. But employers are sometimes surprised that an investigator asks questions that were not asked by the auditors who conducted independent financial statement audits over the years. As a JD/CPA (double geek) I can tell you this audit is only one step in the ERISA fiduciary due diligence process. But, I thought it would be helpful to seek the input of a CPA who has been a member of both the Executive Committee of the American Institute of Certified Public Accountants (AICPA), Employee Benefit Plan Audit Quality Center, and the AICPA Employee Benefit Plans Expert Panel – James E. Merklin, partner in charge of Assurance Services at Bober Markey Fedorovich, an independent CPA firm. Jim was gracious enough to share his perspective, as follows:
When ERISA was enacted in 1974, one of the provisions required (in general) that plans in excess of 100 participants provide audited financial statements with their annual reports. Some plan sponsors will consider an audit to be akin to an insurance policy that their plan is in good shape and would meet the scrutiny of regulatory authorities if examined. But audits were never intended to serve in that kind of capacity and so there is clearly an expectation gap between what these plan sponsors think they are getting with the annual audit and the service that plan auditors are actually rendering. But – if there are indeed compliance problems, would you rather catch these yourself or let the regulators find them on examination and come in with Thor’s hammer to resolve the problems?
The purpose of an audit of the financial statements is to allow an auditor to express an opinion as to whether the financial statements and related footnotes and supplemental schedules for a benefit plan are prepared in accordance with accounting principles generally accepted in the USA. Auditors are required to follow procedures that are dictated by the American Institute of CPAs and/or the Public Companies Accounting Oversight Board in arriving at their opinions covering the financial statements of the benefit plan. In many cases, the auditor doesn’t even express an opinion on the financial statements – there are provisions within ERISA that allow the plan sponsor to limit the scope of the audit to exclude work on investments, investment income and investment transactions if the investments are certified by a qualified institution (a bank, an insurance company or a regulated trust company.) When the audit is limited as described here, the auditor cannot express an opinion on the financials due to the significance of what has been excluded from the audit scope.
Again, the main focus of the financial statement audit is on the presentation in the financial statements. One of the assertions underlying a financial statement is that the plan is a qualified plan and thus exempt from income taxes, and in support of that assertion auditors will perform some testing to look at compliance with the plan document and regulations. However, this level of testing is not intended to provide absolute assurance that any deviations would pass the scrutiny of the regulators (Internal Revenue Service and/or Department of Labor) but rather to identify for the auditor as to whether there is a sign that the plan is so grossly in violation of terms or law that their tax status would be at risk, or that any material misstatements to the financial statements whether due to error or fraud, are identified and reflected appropriately therein. Remember IRS/DOL penalties are the responsibility of the plan sponsor / administrator and not of the plan itself, so the plan’s financials would not be misstated if there were no mention of such risks within those financial statements.
So – are there risks to the plan that might be reasons to dig in to a plan deeper than a financial statement audit might? Absolutely – following is just a sprinkling of some areas that would be worth paying attention to.
- What is the correct definition of compensation per plan document? Is the plan actually applying this definition correctly?
- Are there any instances of late remittances of participant contributions and loan repaymentss?
- Are there any instances of failure to comply with participant elections?
- Are there any instances of improper application of eligibility provisions of the plan?
- Have there been any instances of calculations of improper vesting and employee distributions?
- Has there been turnover among your employees who have responsibilities relating to the plan, and are the current personnel adequately trained? How do you make certain that the plan is being operated in accordance with the plan document? Who is responsible for making certain that the plan document is timely amended and restated?
- What oversight does the plan sponsor perform with regard to third party administration of the plan?
- What is the plan’s stated investment strategy? How is that reflected in the investments offered to participants?
Many benefit plan auditors are capable of helping you with an assessment of these and many other compliance risks to your plans. I would recommend that, if you wish to use your plan auditor to assist you with an assessment, you verify first that they have the qualifications to be positioned to do so. That means that not only are they are doing a lot of benefit plan audit work but also a lot of tax reporting and compliance work. And I also strongly recommend that such assessments be conducted in conjunction with the plan’s qualified ERISA legal counsel; in fact, performance of compliance assessments under the attorney’s privilege would be most protective to the plan’s interests.
We appreciate the input! James E. Merklin’s biography, and his contact information, are here. DOL guidance on ERISA fiduciary responsibilities is here.