Weathering Audits

Art by Lisk Feng

Retirement plan sponsors with more than 100 participants in their 401(k) or 403(b) Employee Retirement Income Security Act (ERISA) plans are required to provide an annual financial audit corresponding to their Form 5500 filing. Moreover, the Department of Labor (DOL) has ramped up enforcement efforts concerning ERISA plans and an adviser may have clients that receive a letter initiating an investigative DOL audit.

What should plan advisers know about these audits, and how can they help a client that needs to undergo one?

Annual Financial Audits

According to Jason Roberts, CEO of the Pension Resource Institute and managing partner with Retirement Law Group in San Diego, California, what the annual financial audit covers depends on whether it is a limited- or full-scope audit. He explains that if investments or plan assets are held with a qualifying financial institution, bank or trust company and if that company is willing to certify the value of investments, then the plan auditor will perform a limited-scope audit. Otherwise, a full-scope audit will be performed, and the auditor will evaluate the safeguarding of investments.

Roberts says ever since the DOL issued guidance that plan sponsors should look for auditors with expertise in ERISA plans, his firm has seen audits become more in-depth and plan sponsors needing to make more corrections. For example, he says, a plan may say employees can make deferrals on their regular salary and bonuses, but the bonuses may be paid through a different channel than salaries, and, as a result, deferrals on the bonuses may be missed.

Further, over the last few years, Certified Public Accountants (CPAs) performing plan audits have delved deeper into plan sponsors’ fiduciary duties, Roberts says. They are looking at the processes plan sponsors use to make fiduciary decisions, receipt of 408(b)(2) plan sponsor fee disclosures, and whether plan sponsors have documented that they have reviewed service provider offerings and fees.

He adds that CPAs are armed with questionnaires about plan objectives, plan design, parties in interest to the plan, participant census data, plan documents, IRS determination letters, proper monitoring of assets, internal controls and fraud risk determination testing. CPAs also do a test sample for eligibility, deferrals and loans.

Jim O’Shaughnessy, managing partner, Sheridan Road Financial, in Northbrook, Illinois, says the average adviser is, generally, not part of an annual audit, outside of helping to gather information and documents upon the auditor’s request. He says what is more important is the work advisers do to guide plan sponsors in relation to their fiduciary responsibilities throughout the year.

With all clients, his firm provides fiduciary training and encourages them to take minutes at meetings, review how the plan is being administered, look at plan design and make sure the plan committee understands how the plan should be operating. O’Shaughnessy says such reviews should be done periodically, and the processes should be documented as much as possible. Sheridan Road facilitates the storing of information by providing an electronic fiduciary vault for its clients.

According to Roberts, advisers do not need to get involved in the audit. Instead, they might reach out to whomever is in charge of payroll at the company and educate that person or team about what the plan committee does and make sure the plan is administered according to the plan document.
He says a full-scope audit, if the plan sponsor is prepared in advance, can take as little as 20 to 30 days, but if the CPA flags something as deficient and requires follow-up, the audit can drag on until the accountant has enough information to finish the audit process.

DOL Investigative Audits

Besides the annual audits, plan sponsors might find themselves facing the DOL in an investigation.
The DOL could choose to investigate a plan in several ways, Roberts says. There may be a participant complaint. Or the agency may see a response on Form 5500 that is inconsistent with another response, or it could not like a sponsor’s answer on a compliance questionnaire. Sometimes, audits are just routine and random.

He also notes that the DOL has multiple enforcement projects underway: The agency is evaluating employee stock ownership plans (ESOPs); investment conflicts; distribution deals with terminated, vested participants; distressed plan terminations; and abandoned plans. In addition, he observes, if a plan sponsor files for bankruptcy, it is likely to be investigated.

Roberts says the DOL will request a range of documents and ask approximately 36 standard questions. Typically, the audit goes back three to four years, but if the DOL finds something questionable, it may go back further. The agency wants to see that the plan is operating as specified by the plan document. It will study the documents creating and describing the plan, plan reporting, plan administration, fidelity bonds, participant statements, contributions, loans, meeting minutes, assets and accounting, summary payroll reports and schedules of loans.

According to O’Shaughnessy, the DOL will look for documentation of processes and to see who is responsible for them; the timing of contribution deposits—a big area of focus for the agency right now; fiduciary training; the possible presence of an investment policy statement (IPS); and confirmation that the plan document is up to date and accurate.

This is where that fiduciary vault is useful. Roberts says one of the most helpful things advisers can do is to educate plan sponsors about what documents should be retained in their files. The Pension Resource Institute has a sample fiduciary file to show sponsors what should be saved and how to organize it. The institute has also compiled a list of the documents the DOL will request and the questions it will ask. The questions are catalogued, so a plan’s adviser can tell the sponsor, “This is what the DOL is asking for. Could you respond, and where are your documents?”

To not overwhelm plan sponsors, the institute divides plan sponsor fiduciary duties into three buckets: investments; service provider selection; and monitoring, administration and reporting. “If the DOL sees a haphazard, ad hoc approach to keeping documents, or if the plan sponsor tells the DOL it needs more time to produce information then still doesn’t have documents, that itself is a red flag,” Roberts says.

His firm tells plan sponsors, complying with these duties is not as difficult as it sounds. The sponsor does not have to be perfect, just prudent, considering the best interest of its participants.
For each of the three buckets, plan sponsors should have an objective description of the decisions they have made. Roberts says a benchmarking or request for proposals (RFP) is not a process; it is part of a process. What is a process, for example, is making sure loan repayments and contributions are remitted on time. Creating documentation that shows plan sponsors are following a process is the best defense, which will result, most likely, in the DOL moving on.

Some plan sponsors without advisers tend not to know where to go for documentation, he says, so, for advisers, this is an extremely vital value proposition.

Advisers Under the Mictroscope

The Department of Labor (DOL)’s Employee Benefit Security Administration (EBSA) has been investigating the receipt of improper or undisclosed compensation to ensure that plan fiduciaries and participants receive comprehensive disclosure about service provider compensation and conflicts of interest. Some retirement plan advisers have been the target.

Jim O’Shaughnessy with Sheridan Road Financial says his Employee Retirement Income Security Act (ERISA) practice was such a target of investigation. He stresses that the DOL’s particular area of interest was which of the firm’s services were settlor functions and, thus, were ineligible to be paid for by commissions or from ERISA plan accounts.

“They focused on the whole area around settlor functions and expenses, making sure if settlor functions were being provided by us that we were always paid for them directly by plan sponsors,” he says. “They wanted to make sure there was a very transparent process concerning how that is structured with clients.”

O’Shaughnessy says he now believes the retirement plan industry’s interpretation of “settlor function” is not black and white and contends the DOL has a different definition of the term than advisers do. He points out that many advisers in the retirement plan industry, whether broker/dealers (B/Ds) or registered investment advisers (RIAs), view helping with plan design as part of their value proposition; they also help with mergers and acquisitions (M&As). Both are settlor functions, according to the DOL.

Advisers cannot be paid through plan assets if they are providing what the DOL deems settlor functions. For example, O’Shaughnessy says, if a broker receives commissions as payment from a 401(k) or 403(b), but consults on how the company match is structured or on making the plan a safe harbor plan, the DOL deems those to be settlor functions; in those cases, being paid with commissions is a prohibited transaction and that broker should be compensated in a different way.

Sheridan Road has set up its fee structure so that a portion of fees is paid directly by plan sponsors. O’Shaughnessy says this is a best practice if an adviser or broker/dealer will, at any time, work on settlor functions, but most do not receive direct payments; they receive either 12b-1 fees or are paid through an ERISA account.

He says DOL investigators were very patient and thoughtful. “I always felt they were really just trying to determine whether we had clients’ best interests at heart,” he says.
There were steps the agency wanted Sheridan Road to take as a follow-up that are now best practices for the firm.

O’Shaughnessy says, “We had already been working on new client agreements, to comply with the DOL fiduciary regulations. The DOL reviewed those new agreements and felt they were more direct and transparent, especially concerning the settlor issue. The agency asked us to update all clients to them in an expedited manner, and we finished that up this spring.”