Pension attention: increased regulatory oversight increases pension plan Consulting opportunities for CPAs.

Pension plans and fiduciary responsibility rocketed into the regulatory spotlight with Enron's collapse, and with United Airlines recent high-profile pension plan failure, the increased scrutiny won't be subsiding anytime soon.

Regulators continue to step up efforts to ensure compliance with the Employee Retirement Income Security Act and the DOL is on a second tour of its Fiduciary Education Road Show "Getting It Right," an outreach initiative aimed at fiduciaries in the small and midsize business arena.

This increased regulatory environment provides CPAs with an opportunity to advise small and midsize businesses about shoring up the fiduciary process, from advising on prudent investment practices to tax code compliance.

In fact, in 2004 there was a sizable increase in the use of pension plan advisers. In a survey of 426 U.S. plan sponsors conducted by Deloitte Consulting, 45 percent of respondents reported the use of outside investment consultants, a 10 percent increase over 2003.

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DANGER AREAS

So, what are the major issues facing plan fiduciaries under ERISA? In "Getting It Right," the DOL includes:

* Understanding the plan and one's fiduciary responsibilities;

* Selecting and monitoring service providers;

* Contributing amounts withheld from an employee's paycheck to the plan in a timely fashion;

* Avoiding prohibited transactions; and

* Timely filing annual reports with the government and timely disclosures to participants and beneficiaries.

At first blush, these requirements may not seem daunting, but they can become sizable responsibilities once a pension plan is put in motion.

"The reality is that plan sponsors are not going to be experts on federal pension law or tax law, and for that reason they need to seek and rely on outsiders to advise them," says Robert Doyle, the DOL's director of regulations and interpretations.

In fact, hiring outside experts is much more than a suggestion. ERISA states that "if the trustee or fiduciary involved in selecting the investments doesn't have the requisite level of expertise, they are required--it is their fiduciary obligation--to bring in somebody as an investment adviser to the plan," says Joel Framson, CPA, president of Los Angeles-based Silver Oak Wealth Advisors and chair of the AICPA's Personal Financial Planning Executive Committee.

The consequences of non-compliance can be sizable. The Sarbanes-Oxley Act increased the civil and criminal penalties under ERISA to a maximum fine for individual offenders from $5,000 to $100,000 and the maximum prison term from one year to 10 years. For corporate offenders, the maximum fine has been increased from $100,000 to $500,000.

WHO IS A FIDUCIARY?

Who are the fiduciaries charged with meeting these regulations? According to ERISA, the fiduciary is any person so named in a retirement plan and any person who exercises any discretionary authority or control with respect to the management or administration of the retirement plan or its assets. This includes the plan sponsors, plan administrators, investment managers and trustees--but it also extends to employees responsible for handling the plan and its assets.

"There are a lot of situations where, especially in a small company, day-to-day roles of a fiduciary may not be spelled out in one's job description," says Framson, who edited the AICPA's Personal Financial Planning Committee's Prudent Investment Practices: A Handbook for Investment Fiduciaries.

"People are asked to informally help give an opinion on investment choices, but the issue is, when have you crossed that line in giving investment advice that makes you a plan fiduciary?"

In addition to acting in the sole interest of plan participants and their beneficiaries, fiduciaries must carry out their duties prudently; follow the plan documents; diversify plan investments; and pay only reasonable plan expenses.

"Some fiduciaries are spelled out as trustees in the plan document, but you can have functional fiduciaries, who perform a fiduciary activity, like selecting investments for a 401(k) plan. If a person has the ability to name a plan trustee, for instance, they have fiduciary responsibility. It's a very wide net," says Framson.

These lines of distinction between what constitutes a fiduciary action can get murky. For example, when a business owner decides to establish a plan and begins determining the plan's features, that owner is making a business decision. But if that owner takes steps to implement the decisions, that's acting on behalf of the plan and by law is considered a fiduciary.

PLAN DOCUMENT

Theory meets reality in the plan document, which outlines the plan's specific features--such as vesting schedules and the use of investment advisers. Other issues spelled out in the plan document include who's in the plan; the type of plan; the trustees' duties; whether trustees can delegate any part of the investment decision-making to outside experts; and vesting schedules.

The document's "legalese" can be off-putting to those unversed in such language and "a lot of small-business owners very seldom pull out the plan document to make sure that they've met all of its requirements," says Framson. "The plan document is the genesis of their fiduciary obligation."

This is an area for pension plan advisers to exert influence on the plan sponsor and suggest periodic reviews of the plan document--especially as the company gets bigger and starts having more people and dollars in the plan--to ensure full understanding of the sponsor's fiduciary obligations.

DOCUMENTATION

All pension plans must meet certain ERISA documentation requirements, including:

* Summary Plan Description--Given to employees once they join the plan and to beneficiaries after they first receive benefits, this explains when and how employees become eligible to participate; the source of contributions and contribution levels; the vesting period; how to file a benefits claim; and a participant's basic rights and responsibilities under ERISA. Companies must provide the document annually and upon request.

* Summary of Material Modification--This outlines changes to the plan or to the info in the Summary Plan Description. It must be distributed to all plan participants within 210 days after the end of the plan year in which the change was adopted.

* Individual Benefit Statement--This provides participants with their account balance and vested benefits information. For single-employer plans, the statement must be provided upon written request, but no more than once in a 12-month period, and automatically to participants who have terminated employment.

* Summary Annual Report--Furnished annually to participants, this outlines the financial info in the plan's Annual Report.

* Blackout Period Notice--Companies must provide this at least 30 days and not more than 60 days before a plan is closed to participant transactions. Blackout periods typically occur when plans change record keepers or investment options, or when plans add participants due to a corporate merger or acquisition.

OPERATIONAL FAILURES

A lack of familiarity with the plan document often can lead to trouble for companies. From a tax qualification perspective, many plan sponsors run into trouble with operational failures--simply failing to operate the plan in accordance with its terms, says Nicholas White, a partner of the Los Angeles-based law firm Reish, Luftman, Reicher & Cohen and a former lawyer in the IRS Employee Plans and Exempt Organizations Division.

Specifically, a plan can lose its tax-exempt status through compensation calculations that are inconsistent with the plan document's terms. "An operational failure is not an issue of whether you violated the tax code, it's failing to operate the plan in accordance with its own terms," says White. "The No. 1 mistake for an operational failure is, in our experience, using incorrect compensation. That's one of the easiest mistakes to make."

For example, a plan document may state that employee contributions to the plan will be tied only to their W-2 compensation and exclude bonuses. But in operating the plan, the plan sponsor includes bonuses. "There are so many ways of describing compensation, not everybody understands exactly what each type of compensation is," says White.

This mistake can easily be avoided. A disconnect between the plan sponsor and the third-party service provider charged with drafting the document is often at the heart of an operational failure, defined in IRS Rev. Proc. 2003-44.

According to White, "the adviser needs to say to the sponsor, 'Before we sign it, before you go off and operate the plan, does it reflect your understanding and what you want?'"

The plan document is truncated into a plan summary description that describes compensation and all the other essential terms of the plan. "But often not only plan participants but plan sponsors may read only the summary plan description," says Framson.

As a best practice, the adviser drafting these documents should perform a stringent review of the plan's terms with the sponsor.

INVESTMENT POLICY STATEMENT

This is another best practice area that CPAs advising pension plan clients need to be aware of. An investment policy statement defines the goals of a pension plan's investments and how it should manage retirement assets. It can help a company minimize pitfalls by providing clear guidance.

The IPS specifies the implementation of investment choices, determining issues such as asset allocation, the kinds of asset classes that will be used and other specific issues, such as socially responsible investing that may limit broad investment choices.

The IPS should outline the criteria for selecting investment choices, as well as the criteria for determining when the use of an investment manager or mutual fund is no longer appropriate, such as identifying conflicts of interest or regulatory action.

The statement also should identify cash-flow needs to match assets and liabilities, Framson says.

The IPS creates a means for measuring compliance and establishes clear expectations of the plan's investment philosophy. Should regulatory action or a lawsuit emerge, the IPS provides fiduciaries with "an auditable trail to prove why, how and when certain investments were chosen," Framson says.

CPAs involved in selecting a plan's investments should know ERISA Sec. 404(a), which outlines procedural prudence requirements. The DOL's Interpretive Bulletin 94-1 also explains the department's views on the investment responsibilities of fiduciaries. And the AICPA's Prudent Investment Practices Handbook codifies these sources, as well as relevant court cases and the Uniform Prudent Investor Act.

INVESTMENT OVERSIGHT COMMITTEE

Another best practice for fiduciaries is to form an investment oversight committee, which periodically reviews the plan's investment choices--often administered by a third-party service provider--to ensure market performance.

Since managing investments is often not a small-business owner's forte, it is their fiduciary responsibility to delegate that action to a third-party service provider "who can do the research and advise the sponsor on all the sectors of the market in determining what would be an appropriate asset allocation, and which managers should be selected," says Framson.

For CPAs advising fiduciaries, "part of their oversight could be an analysis of who the other fiduciaries are, what role they play and whether the fees that they're getting paid are reasonable," Framson says.

An important aspect of this duty is ensuring against conflicts of interest, such as self-dealing, where the plan fiduciary benefits from a specific decision, or where a friend or relative of the fiduciary is chosen to provide a service to the plan. "The CPA should ask, who's benefiting from this decision? If the answer is anyone but the beneficiaries, that should raise a red flag," says Framson.

For the small-business owner, an investment oversight committee often consists of third-party service providers like CPAs, pension plan consultants and investment advisers. The investment results typically are reviewed annually when the annual plan summary is written. For larger companies, which often staff their investment oversight committees with their corporate officers, quarterly meetings are a good rule of thumb, Framson says.

Reish, Luftman's White is a member of his firm's investment oversight committee, which has retained a registered investment adviser to prepare a quarterly report on the plan's investment options. "If certain investments are underperforming, we put them on a 'watch list' and review at the next meeting," he says.

At the end of each meeting, White and the other committee members sign off on the meeting minutes, creating a paper trail. "If we all died tomorrow, you could go to the files and see exactly what we've been doing and why we've been doing it," he says.

ENROLLMENT/EDUCATION

Investment oversight committees can help the plan in other ways. "If we see that our work force is under-utilizing a certain type of fund, we might say, 'Maybe we're not providing enough education, maybe the participants don't understand the value.' So we ask our RIA to make a presentation to the work force."

Under a defined contribution plan like a 401(k), participants must be given sufficient information to make informed decisions. But beyond that, some companies may educate their employees on investments in general, though it's not required.

There is a fear that providing such advice increases an employer's liability, but "we've taken the position that they're not responsible for the advice given by investment advisers, provided that they prudently selected the institution or company providing the advice," says the DOL's Doyle.

SEC.404(C)

For small and midsize businesses, the overwhelming favorite retirement plan is the defined contribution plan, often a 401(k) plan. "From an employer's perspective, the 401(k) is the most hassle-free type of retirement plan," says Framson. "The employee makes the investment decisions, and it doesn't lock the employer into annual contributions like a defined benefit plan would."

By allowing participants greater control over their investment choices, a 401(k) plan also can help reduce fiduciary liability. Sec. 404(c) of ERISA describes "20 things an employer has to do to absolve them of responsibility for losses that can occur in a participant-directed account," says White. "Greater understanding of what 404(c) is may lead more plan sponsors to concentrate more on investment education."

Under DOL regulations, employees must have at least three different investment options so they can diversify investments within an investment category and among the investment alternatives offered. Participants also must be allowed to give investment instructions at least once a quarter.

FRAUD WATCH

Any pension plan with 100 participants has to have an annual audit, according to ERISA. But those with smaller plans may want to do the same to ensure compliance and protect against fraud.

According to Kelly Harper, an audit director for San Francisco-based Hemming Morse, Inc. who specializes in multi-employer pension plans, fraud wasn't a consideration when she began her career. "Ten years ago, we never heard of fraud in our field, every audit was clean," says Harper, who has conducted pension plan audits for 15 years. "But in recent years, we have seen fraud.

"For plans not required to have an audit, it may be in their best interests to have an auditor look at their plan every year, and ensure the money is going where it's supposed to go," she says.

OPPORTUNITIES ABOUND

Given the complexity of ERISA and tax code statutes governing pension plans, CPAs have an opportunity to advise plan sponsors of their fiduciary obligations. Whether it's forming the plan document, advising on investment options or ensuring tax code compliance, many facets of the profession look to benefit from the increased regulatory oversight of pension plans.

Jerry Ascierto is CalCPA's managing editor. You can reach him at [e-mail].