[This is an outline of my presentation to the Nassau Chapter of the New York State Society of CPAs.
Part 1 focuses on the financial statement audit, and draws heavily from the Audit Guide for Employee Benefit Plans (AICPA). I highly recommend that publication to practitioners who perform audits of employee benefit plans .
Part 2 focuses on IRS/DOL audits, and other recent government initiatives in this area.
The presentation was "current" as of May 1996, and has not been updated. Comments and corrections are, of course, always appreciated.

- John Cheek]

 

 

Topics Covered in Part 1:

A. Current Guidance

B. The Plan

C. Government Regulation

D. Level of Service - Audit Required? Full or Limited Scope?

E. Planning the Audit

F. Investments

G. Plan Obligations

H. Participants' Data

I. Contributions and Contributions Receivable

J. Benefit Payments

 

Part 2.

NYSSCPA- NASSAU CHAPTER 

Joint Meeting of Accounting and Auditing and Employee Benefits Committees

PENSION PLANS - ACCOUNTING, AUDITING, AND ERISA CONSIDERATIONS

MAY 22, 1996

K. Tax Status

1. Internal Revenue Code - When an employee benefit plan and its underlying trust qualify under the Code, certain benefits are available:

a) Contributions by plan sponsor are deductible currently, subject to certain limitations.

b) Participants are not taxed until benefits are distributed or otherwise made available.

c) Trust is exempt from income taxes, except tax on unrelated business income.

d) Distributions can qualify for favorable tax treatment, such as rollover, forward averaging.

2. A plan can lose its qualification; results can be disastrous. Audit procedures should include:

a) Review IRS determination letter or opinion letter from plan's legal counsel. If plan has been amended, review any new rulings issued by the IRS regarding the amended plan. If plan has not been amended recently, consider whether it should have been, to adopt changes required by new laws or regulations.

b) Become aware of applicable rules and regulations regarding prohibited transactions, nondiscrimination, limits on plan benefits. In evaluating the results of audit procedures in other areas, be alert to matters that could affect qualification of the plan.

c) Read the minutes.

d) Inquire about, and review, correspondence from IRS and DOL.

e) Request that the plan's attorney identify any situations that could affect qualification. (Some attorneys will not respond to this question)

f) Inquire of plan administrator about any plan activities that could cause the plan to lose its exempt status. Include in management's representation letter.

g) Consider requesting attorney (or actuary) to confirm that the plan has been timely amended as required by law and continues to be a qualified plan in form and operation.

 

L. Party in Interest Transactions

1. ERISA defines a "party-in-interest" to include fiduciaries and employees of a plan, any person who provides services to the plan, an employer whose employees are covered by the plan, an employee organization whose members are covered, a person who owns 50% of any such employer or employee organization, or relatives of any of the above. FASB 57 definition of "related parties" includes substantially similar concepts.

2. Certain transactions with parties in interest are prohibited transactions under Section 406(a) of ERISA. See Audit Guide Chapter 11 and Appendix A for more details.

 

M. Other Matters

1. Form 5500 Penalty for failure to comply with reporting requirements, $1,000 per day.

2. Edit Testing of Form 5500.

3. FDIC Coverage.

4. Compliance Matters:

 

N. IRS and DOL AUDITS

IRS and DOL share responsibility for enforcement of ERISA provisions. IRS bears primary responsibility for matters relating to qualification matters, minimum participation, vesting, and funding standards; DOL bears primary responsibility for matters relating to fiduciary conduct and prohibited transactions.

ERISA authorizes DOL to prescribe regulations necessary to carrying out ERISA's non-tax provisions, and DOL is charged with investigating violations of all non-tax aspects of ERISA.

Fiduciaries are required to discharge their duties solely in the interests of the plan participants and for the exclusive purpose of providing benefits and defraying reasonable plan expenses. This requires fiduciaries to exercise the skill, prudence and diligence of a prudent man, 2) in accordance with plan documents and instruments, and 3) to diversify plan investments to minimize risk of loss.

Violation of Fiduciary Duty:

- "prudent man" investing

- concentration of investments

- denial of benefits and appeal procedures

- pursuit of delinquent contributions

A fiduciary is liable to the plan for any losses resulting from a breech of fiduciary responsibility, as well as his profits from misuse of plan assets; a civil penalty of 20% of amounts recovered is imposed on the fiduciary.

DOL doesn't do "audits", it conducts "investigations". Don't expect the investigators to be accountants; most often, they're attorneys.

DOL generally targets plans which appear to have the highest potential for abuse, using office reviews of Form 5500, corporate annual reports, public records, and other sources. IRS referrals and participant complaints are often the trigger for an audit. DOL investigators are instructed to be alert for evidence of age, sex, or race discrimination, for possible referral to EEOC.

 

O. WHAT'S HOT

 

PWBA Assessment of Audit Quality:

A 1989 study found numerous audits that failed to comply with professional standards. In 1995 DOL conducted a new study, with similar results. DOL suggested these audit deficiencies resulted from inadequate training of auditors conducting plan audits, auditors whose practice did not include many audits, a lack of awareness by auditors of the uniqueness of EB plan audits, and the failure of auditors to understand the limited scope exception.

PWBA has established an ongoing quality review program; auditors deemed by PWBA to have performed substandard work are referred to state licensing boards or to the AICPA Professional Ethics Division. Through 1995, over 300 such referrals have been made.

In addition, PWBA continues its aggressive reporting compliance program; through 1995, it has rejected over 4,200 filings and imposed over $64 million in civil penalties. Another 590 late or non-filers have been assessed over $49 million in late/non-filing fees.

 

Benefit Distribution Annuities

Annuities purchased to settle plan liabilities: especially in the wake of insurance company failures (Executive Life, etc), DOL takes the position that the selection of annuity provider is a fiduciary act that requires the selection of the SAFEST AVAILABLE annuity provider. Prudence requires that fiduciaries conduct an objective, analytical search, evaluating creditworthiness, quality and diversity of investment portfolio, size of provider relative to proposed contract, level of provider's capital and surplus, lines of business, use of guarantees or separate accounts, etc. Reliance solely on insurance rating services would NOT satisfy this requirement.

 

Plan Investment in Derivatives

In March 1996 DOL stressed the fiduciary duty implications regarding investment in derivatives: fiduciaries are required to evaluate various risks, to consider how the derivative fits with the plan's investment policy, what role derivative play's in the portfolio, and the plan's potential for loss. Characteristics of derivatives include extreme price volatility, a high degree of leverage, limited testing by markets, and difficulty in determining market value due to illiquid market conditions. Fiduciaries who invest in derivative must secure sufficient information to understand the investment and evaluate the risks.

Participant Directed 401(k)s

1. By complying with regs under 404(c), plan sponsor can avoid fiduciary responsibility for losses resulting from participant's exercise of control. Compliance involves offering variety of investment vehicles meeting different investment objectives and bearing different risk characteristics.

2. 404(c) protection is easily lost if sponsor assumes too much responsibility, so sponsors were reluctant to educate their participants, even though it is commonly recognized that participants are in dire need of education. In January 1996 DOL issued "Interpretive Bulletin Relating to Participant Investment Education", clarifying the difference between nonfiduciary education and fiduciary investment advice. Bulletin lists four categories that constitute education rather than advice:

 

Participant Contributions

DOL is very concerned that participant contributions are being diverted for other purposes, and is proposing rules to cut down the period of time an employer can hold participant funds. Current rules require that funds be deposited to the plan as soon as possible, but in no event longer than 90 days. DOL's proposal that deposit be required to follow timing of payroll tax deposits will probably not stick, but a 15-30 day requirement is likely. Late remittance is a prohibited transaction requiring supplemental schedule disclosure. [update: final rule requires that funds be deposited as soon as it is practical to segregate, but in no event later than the 15th day of the month following the month the funds were withheld.]

Pension payback: DOL offered a six month grace period, through Sept. 7, 1996, to catch up on delinquent remittance of participant contributions. Sponsors who voluntarily come forward they can avoid civil and criminal penalties.

 

Plan Loans

IRS issued proposed regs addressing plan loans, deemed distributions vs. offsets, grace periods, etc. Since an offset may be an impermissible distribution affecting plan qualification, auditor needs to be familiar with these rules.

 

401(k)s Targeted

IRS recently identified 550 401(k) plans for detailed review of ADP and ACP testing, distributions and allocation of investment income.

 

Pension Simplification Act of 1995

Act did not become law, but many of its provisions are likely to reintroduced in 1996. Key provisions we may see soon include elimination of the limited scope exception for bank-certified investments, imposition of specific CPE requirements on plan auditors, require reporting of irregularities to plan administrator and DOL, five day notice on termination of an auditor, $100,000 penalty on auditor for not complying with these disclosures. [As of 7/98 none of this has come about]

 

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