With regulators focused more than ever on a plan's controls, it is imperative that plan sponsors have the proper procedures and controls in place. This fourth in a series of articles on the importance of internal controls for employee benefit plans looks at controls for party-in-interest transactions.
The Employee Retirement Income Security Act (ERISA) includes certain prohibited transaction rules to prevent dealings with parties who may be in a position to exercise improper influence over plan assets and to prevent plan fiduciaries from taking actions with respect to a plan that involve self-dealing and/or conflicts of interest. A party in interest is defined by ERISA to include any plan fiduciary (administrator, officer, trustee or custodian), the employer or any affiliate, any employee of such employer, any service provider to the plan (attorney, auditor, etc.) whether paid by the plan or not, or an owner of 50 percent or more of the stock of the employer, among others. It should be noted that ERISA's definition of a party in interest is broader than a related party as that term is defined by U.S. GAAP.
ERISA prohibits various types of transactions between a plan and a party in interest, including sales or leasing of property, lending money or extending credit, providing goods or services, using the income or assets of the plan, and holding employer securities or real property that do not meet certain conditions. In addition, a plan fiduciary is prohibited from using the plan's assets in its own interest or acting on both sides of a transaction involving a plan. Due to the risk of self-dealing, such transactions are illegal—regardless of the intentions of the parties to do what is best for the participants. One of the most common prohibited transactions involving the plan fiduciary is the failure to timely remit participant deferral contributions and loan repayments to the plan in accordance with U.S. Department of Labor (DOL) regulations.
Some party-in-interest transactions are permitted with certain restrictions and conditions. Such "exempt" transactions include: loans to plan participants or beneficiaries; the provision of services necessary for the operation of a plan for no more than reasonable compensation; loans to employee stock ownership plans; deposits in certain financial institutions; contracts for life or health insurance; and distribution of the assets of the plan in accordance with the terms of the plan. If the law or other administrative rulings do not allow a transaction with a party in interest, the plan must ask for permission from the DOL prior to executing the transaction or face the risk of having the transaction undone and penalties imposed on the applicable party in interest.
ERISA and DOL regulations require transactions with parties in interest, other than exempt transactions, to be reported on schedules to the Form 5500, Annual Return/Report of Employee Benefit Plan, which is publicly accessible. ERISA also provides for specific monetary penalties for violations of party-in-interest rules. Such penalties cannot be paid with plan assets.
Summary of procedures
In determining that the plan has the appropriate practices and procedures established to comply with the ERISA party-in-interest regulations, the plan sponsor should:
- Be aware of potential prohibited party-in-interest transactions.
- Identify all parties in interest by name, or by class, and distribute the list to all persons responsible for the plan's operations. Provide for periodic updates of such list.
- Have a clear and well-documented understanding of the restrictions and conditions for common party in interest transactions.
- Have controls in place that require additional approval for any plan transactions with parties in interest and where applicable, any conditions for the exemption have been satisfied.
Currently, there are three areas related to party in interest transactions that are subject to regular evaluation by the DOL upon examination. Those areas are: the timeliness of deposit of employee salary deferrals or loan payments; participant loan programs; and the reasonableness of service provider fees. The remainder of this article examines in depth the types of processes and procedures that should be in place in each of those common areas.
Timeliness of deposit of employee salary deferrals
Untimely deposits of employee salary deferrals or loan payments are considered prohibited transactions because DOL regulations provide that employee deposits become plan assets as soon as they can reasonably be segregated from the general assets of the employer. That means if the employer (a party in interest) holds the funds for a longer time period, they are holding plan assets in the company's account, unprotected from general creditors and may be benefiting from income on the assets held in its depository account.
This has been the subject of DOL scrutiny since the regulations on this topic were first effective in 1997. Only recently, however, has the DOL inquiry focused on the processes and procedures surrounding the timeliness of deposits. RSM's experience in examination has been that the DOL is more willing to accept the employer's assertion on timelines where it is evident that there is a clear set of procedures that are uniformly applied and demonstrate a deposit pattern that is as fast as reasonable. In contrast, where there is no evidence of such procedures and deposit timing ranges from the day before payroll to two weeks or more following payroll, we have consistently seen the DOL select the first day deposits are made after the payroll date and use that timing as the definition of when plan assets can be reasonably segregated from plan sponsor assets. This results in all later deposits being subject to correction and where applicable, the assessment of a 15 percent excise tax on lost earnings for each year that the error has been outstanding.
What procedures are expected to demonstrate timely deposit? This cannot be a complete list as the procedures and controls will vary with the specific facts, but consider the following:
- Consistent with the discussion in our prior article on plan operations, are controls in place to make sure that participants enter the plan on time, the correct compensation is used for determining salary deferrals, and participant initial deferral elections or subsequent changes to deferral elections are accurately reflected in the plan administration system? These controls are necessary for basic plan operations, but when such controls are functioning, they reduce the amount of time spent reviewing the deferrals calculated for each pay period. One of the most common deposit delays we encounter during plan audits is the need to do several reviews, reconciliations and corrections of the deferral calculations prior to deposit because there was not sufficient assurance that those controls on general plan operations were working effectively.
- If an outside payroll service is used, do they provide a data file on the employee deferrals and loan payments that is in the correct form for use by the employer or the investment service provider? Though less common than in the past, we still see situations where someone from HR or payroll is required to translate the data file received from one service provider into a format useable by another service provider. Such manual manipulation increases the risk of error and takes additional time. Where such action is currently required, the employer should document why and what steps they have taken to speed up the process. Further, if such a step is required, another step would be necessary to review the results before transmitting the modified data.
- Are procedures in place to enroll participants immediately upon eligibility? Another common source of delay in the timeliness of deposit of employee salary deferrals is that the investment service provider has not established an account for new participants soon enough to accept their initial deposits. Such controls would include the delivery of enrollment notices to the service provider on the first day of the initial pay period; follow up solicitation of required information from the participant before the deposit date; the authorization of the deposit of funds into the plan's default investment account pending receipt of participant salary direction; and the verification of the establishment of the accounts prior to the end of the initial pay period. Related to this issue is the matter of renewing enrollments for rehires, persons whose deferrals were halted due to the hardship distribution requirements of the plan and persons returning from leave. Procedures must be in place to re-enroll these parties. Frequently, their entry dates and deferral election procedures vary from new participants. Thus, the controls must be designed to recognize the participant's status for purposes of setting entry and deferral amounts.
- Are the specific duties of each person in the chain of command for processing salary deferrals outlined, with back-up plans for situations where one or more persons are unavailable? Planned absences are not a reason to delay the deposit of employee funds. It is expected that procedures be in place to ensure that another person will cover each required task during any planned absences, for example, vacations and holidays.
- Are controls in place to ensure that the deposit, once approved, is actually made and delivered? With fully automated systems, it is all too common to assume that once the information is entered, the process is completed. Experience has taught us that it is not reasonable to assume that the service provider receiving the funds will notify the employer if a normal deposit fails to arrive. The employer should have controls in place over confirming the deposit was made successfully.
- Are controls in place to segregate and separately address the correction of any errors? Even in the best-run systems, errors still happen. We frequently find situations where the entire deposit for a pay period has been delayed while a minor error is tracked down and corrected. The regulations apply a reasonableness standard to the concept of timely. It is reasonable to take some time to track down and correct an error, which may justify an additional day or more to make the deposit related to that error. However, the funds not associated with that error should not be delayed.