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There have been several events in the last few years, which should cause fiduciaries of employee benefit plans to take particular notice:
- E-fast2 has made every financial statement, which is attached to Form 5500, public information. This means that anyone with a computer can review any plan’s Form 5500, along with the financial statements that have been attached to the 5500.
- The Department of Labor (DOL) has recently hired as many as 1,000 new inspectors to inspect employee benefit plans, and these inspectors are armed with analytical information, collected from the Form 5500 on the e-Fast2 database.
- The recent fee disclosure rules for covered service providers (ERISA Section 408(b)(2)) and participant fee disclosures (ERISA Section 404(a)(5)) have also increased transparency of fees in employee benefit plans, resulting in further increased transparency of a fiduciary’s performance for their employee benefit plan.
If these events were not compelling enough, there have also been several high profile court cases against plan fiduciaries (most notably Tussey vs. ABB). The decisions in these court cases have set the stage for future challenges against plan fiduciaries. Put all these events together, and the message is clear. Fiduciaries need to be on top of their game when it comes to publicly reported information related to their employee benefit plans.
How can a fiduciary be “on top of their game”? The answer to this question should ultimately result in having a comprehensive and robust process at the plan to deal with the various fiduciary issues that face the plan. Notwithstanding this robust process, one easily implemented process is to identify “low hanging fruit”, or obvious potential issues in a plan’s financial statements, which could trigger challenges to the fiduciary with respect to their responsibilities over the plan. The following serves to provide three examples of such low hanging fruit, for which plan fiduciaries should be mindful, when reading their plan’s publicly reported financial statements.
While these few examples are certainly not all-inclusive, it does illustrate the need to actively review financial statements for obvious potential financial reporting issues.
LOW HANGING FRUIT EXAMPLE #1:
USING AN INCORRECT AUDITOR’S REPORT
New for calendar year 2012 employee benefit plan financial statements, (note: the actual effective date is for years ending after December 15, 2012), a new set of auditing standards, known as the clarity standards, will be effective.
One of the more significant aspects about these new “clarity” auditing standards is that both full-scope and DOL limited scope audit engagements will each require a new independent auditor’s report, which are both distinctly different from their predecessor auditor report issued for 2011 plan financial statements.
Each of the new auditor’s reports, which are to be used for “non-public” plan financial statements, has distinct wording changes and is highlighted by the inclusion of specific section headings, which have not been seen in prior auditor reports. These section headings include, but are not necessarily limited to, management’s responsibility for the financial statements, the auditor’s responsibility, the auditor’s opinion, and other matters. It is also important to note that plan financial statements filed on Form 11-K with the Securities and Exchange Commission will not use this report, but instead will continue to use a report specifically required by the Public Company Accounting Oversight Board.
Using the incorrect auditor report could raise questions about the expertise of the plan’s auditor, which in turn could raise questions about the fiduciary’s prudence in selecting the auditor.
LOW HANGING FRUIT EXAMPLE #2 :
INCORRECTLY DISCLOSING CERTIFIED CONTRIBUTIONS / DISTRIBUTIONS
Approximately 70% of the financial statements submitted to the Department of Labor are considered “limited scope audit engagements”. These engagements, which are filed with the DOL pursuant to Code of Federal Regulation, 29 CFR 2520.103-8 provides a scope exception for financial statements issued with the DOL that the audited financial statements do not require the audit of certified investments in a plan, and limit an auditor’s procedures of investments to primarily comparing certified investment data to amounts reported in the financial statements.
It is important to note that in order for the certification to be acceptable to the auditor, the underlying investment data must be certified as complete and accurate, and must be received from  a bank, trust company or similar institution or  an insurance company, since these entities are subject to regulatory oversight. Further, the limited scope exemption does not extend to other non-investment assets or activity.
Accordingly, an acceptable certification would not extend to plan contributions or distributions, since this activity is not investment related. Any financial statements, which disclose contributions or distributions as certified financial statement data, contradicts the regulations and demonstrates a lack of prudence over financial reporting.
LOW HANGING FRUIT EXAMPLE #3:
BEWARE THE PARTIAL TERMINATION!
During difficult economic times, significant workforce terminations can be a common occurrence. Plans should be mindful that such terminations could impact the operations of their retirement plans. A large termination of a workforce could result in an issue, known as a “partial termination”. The significance of a partial termination is that all affected employees would immediately 100% vest in any employer contributions to their retirement plans. Plans that do not properly account for partial terminations, could erroneously overstate their plan’s forfeitures and understate the vested retirement plan balances for the terminated participants. The generally accepted benchmark for identifying a partial termination is a termination of 20% or more of a company’s workforce, resulting from the termination initiative. It is important to note, that such terminations are not required to happen within any given year (e.g., terminations could overlap over several years).
Fortunately, there is a quick and easy metric that a fiduciary can use that may identify whether there might be a partial termination. This metric compares the relationship of distributions per the statement of changes in net assets available for benefits (the numerator) to total beginning of the year net assets (the denominator).
If distributions represent 10% or more of total beginning net assets, it is worth additional inquiry to determine whether there may have been a partial termination at the company. Using this lower percentage helps to account for partial terminations which may overlap between years or terminations of employees with smaller retirement plan balances. If the ratio of distributions to beginning of the year net assets is 20% or more, fiduciaries should ask the question more often and with greater emphasis. This issue should be discussed with the plan’s legal counsel.
Utilizing this easy to calculate and effective metric can potentially stem off an operating issue for the plan and helps demonstrate strong fiduciary oversight.
LOW HANGING FRUIT: LESSONS LEARNED
The three examples presented above are far from all-inclusive. Instead, they represent just a few obvious indicators of potential issues facing the plan. So what global lessons can be applied from considering these few examples?
- Actively review your plan’s publicly reported documents. It is important to remember, that your plan is on public display, for anyone with a computer to see and as a result, these aspects of the fiduciary’s performance are also on display. It is important that plans be mindful of this fact, and act accordingly when displaying public information. If an issue doesn’t seem typical or appears to be improper, it might be low hanging fruit and should be evaluated.
- Ask your plan professionals. To paraphrase a famous advertising slogan from several years ago, “An educated fiduciary is our best client!” A plan’s professionals (auditors, attorneys, actuaries, fiduciary advisors, etc.) all stand ready to help their clients become better educated in their responsibilities as plan fiduciaries. Ask your professionals questions about potential low hanging fruit issues to increase your knowledge base. Better education benefits everyone and helps better ensure that plans are acting in the best interest of the participants. This philosophy certainly applies to publicly reported financial information for the plan.
- Document your process. In today’s world, documentation is everything! It is the best way to demonstrate that procedures were actually performed, and it serves as a great reminder of those processes, which should be performed on a continual basis. Maintaining well-organized, referenced and documented processes and resolutions to potential issues serves overall plan quality. You value what you measure!
Implementing and maintaining a quality fiduciary process can be thought of as a journey, which begins with a single step. Dealing with the low hanging fruit of publicly reported financial statements is an ideal way to begin that journey!