401k Audit Changes – 3 Key Issues to Ensure Your Clients are Prepared
It may come as a surprise to many that over one-third of 401(k) audits are inadequate. New DOL 408(b)(2) regulations have dramatically changed the 401(k) retirement plan arena and auditors need to ensure that they are protecting their clients when performing a 401(k) audit. While there have been lots of discussions and articles regarding fee transparency and disclosure, less light has been shed on the areas of prohibited transactions and conflicts of interests. SAS 104-111 calls for thorough documentation of the 401(k) audit. The plan sponsor can face financial penalties if the audit is deemed deficient because the documentation was incomplete. Some of the common audit deficiencies cited by the Department of Labor are related to party/prohibited transactions where no related parties were noted in work papers and there was a lack of understanding as to what prohibited transactions are and who parties-in-interest are. Moreover, the Employee Benefit Plan Audit Quality Center found that 401(k) audits had improper valuation of investments, especially alternative investments. As a CPA, ERISA auditor or an Independent Qualified Public Accountant (IQPA) here are 3 key factors that need to be addressed in order to ensure that you are shielding your clients from being subjected to fines, fees and costly lawsuits.
1. Investments/Fee disclosure and transparency - The main point is that the fees that are being charged actually need to coincide with the services that are being rendered. As a plan trustee, you are responsible for ensuring “reasonable fees for reasonable services.” Even a small difference in fees can have a huge impact on the overall size of a retirees final 401(k) account balance. Two key areas of concern with respect to investment options are annuities and retail share classes. Annuities are generally the least transparent and most costly option whereas share classes are used to facilitate payment options to service providers. Because each share class is part of the same portfolio, by default, the least expensive share class has the highest return. Moreover, retail share mechanisms cause “friction” and are a needlessly inefficient service provider compensation method. “A recent federal District Court ruling should make fiduciaries of self-directed retirement plans think twice before offering retail share classes as investment options when less expensive institutional share classes are available”. The fiduciaries in charge of a company plan ought to know that they can ask for fee waivers or for admittance to a particular share class. Click the following link for more information on the Bechtel Corp. lawsuit. http://www.bankrate.com/financing/retirement/fees-can-ravage-retirement-plan/
Bechtel has to pay $18.5 million for offering retail share classes when they could have offered institutional shares, greatly reducing the costs to their plan participants. Bechtel isn’t the only company to have made this faux pas. Last year, Caterpillar agreed to a $16.5 million settlement and General Dynamics to a $15.1 million settlement in their respective excessive 401(k) fee suits.
2. Prohibited Transactions – Both ERISA 406 and IRS Code 4975 prohibit certain listed transactions. The prohibited transaction rules apply not only to the obvious situations, like embezzlement or blatant misuse of plan assets, but also to situations that might be less obvious ( for example, paying persons who perform little or no actual services or loaning money to a financially troubled sponsoring employer). In addition, many of the ordinary transactions in which a plan must engage are prohibited transactions (for example, contracting for administrative services) though generally there are exemptions that provide relief for these ordinary business transactions. The prohibited transaction rules prohibit fiduciaries from entering into transactions with parties that have a significant relationship with the plan. ERISA uses the term “parties in interest” to describe plan-related persons whose actions may result in excise tax penalties under the IRS Code 4975. Prohibited transactions have no statute of limitations so as an auditor you have to be thorough. Some possible prohibited transactions are: a sale, exchange or lease between the plan and a party in interest; lending money or other extension of credit between the plan and party in interest; furnishing goods, services or facilities between the plan and party in interest. Other prohibitions relate solely to fiduciaries who use the plan’s assets in their own interest or who act on both sides of a transaction involving a plan.
3. Conflicts of Interests –This goes hand in hand with verifying all “parties in interest”. Certain transactions are prohibited under the law to prevent dealings with parties who may be in a position to exercise improper influence over the plan. In addition, fiduciaries are prohibited from engaging in self-dealing and must avoid conflicts of interest that could harm the plan. Prohibited parties can include the employer, the union, plan fiduciaries, service providers, and statutorily defined owners, officers and relatives of parties in interest.
In summary, as stated by the Department of Labor, the challenges facing CPAs, ERISA auditors and Independent Qualified Public Accountants auditing 401k plans are:
- Misunderstandings on how to audit investments
- Lack of Audit procedures for parties in interest and prohibited transactions
- Identifying conflicts of interests
If you are a plan sponsor, trustee or fiduciary, ensure that the CPA you work with has all the tools to uncover any 401(k) hidden fees, prohibited transactions and any conflicts so that your firm isn’t exposed to costly lawsuits, fines and fees that could have been avoided. If you are an ERISA auditor or a CPA that audits 401(k) plans, you should make sure that you have procedures in place that allow you to meticulously evaluate your client’s 401(k) plan.
For a free copy of our CPA 401k Auditor Workpaper Enhancement Conflict & Cost Report or to participate in our ERISA Audit Enhancement Program where you can earn CPE credits while learning the most progressive methods available today to allow you not only to protect, but also grow your audit business, please contact info@cjmfiscal.com
About Charles Massimo
Recognized as industry expert and guest speaker at national industry conferences, Charles Massimo is a published author and media subject expert on topics ranging from wealth/asset management to investment and financial planning for high net worth families.