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Trickle down: how Sarbanes-Oxley reaches pension plans of private companies.

Nearly three years have passed since the passage of the Sarbanes-Oxley Act, requiring public companies to make their operations more transparent to outsiders. As public companies have struggled to comply, private companies--in particular, those with qualified plans, also have found themselves within SOX's reach. Here are three ways SOX impacts private companies:

1) Some legal analysts say Sec. 402, which makes it illegal for companies to make personal loans to directors and officers, may prohibit pension plans from making loans to any plan participants.

2) Sec. 904 significantly stiffens penalties for ERISA violations. Individuals can face fines of up to $100,000 and prison terms of up to 10 years, while companies can be fined up to $500,000.

3) Sec. 306 requires that administrators of plans with individual accounts--for example, 401(k) plans--give participants 30 days' notice of any blackout periods during which they may not direct plan investments, take out loans or obtain distributions. The same section prohibits insider trading of company securities by directors and senior executives during blackout periods.

These provisions make it imperative that public and private companies with qualified plans understand their duties as plan fiduciaries and review the procedures by which they carry out those duties.

CPAs can help in this effort, with caution. Laws governing pension plans are complex, and plan sponsors will need expert advice from competent counsel to make sure they are in compliance.

Pension laws also generalize regarding the fiduciary duties of plan sponsors, offering few specific guidelines about how to carry out these duties, and CPAs should not dictate what clients do in overseeing their plans.

The trust between CPAs and their clients, however, gives CPAs an opportunity to help plan sponsors understand the goals of pension laws so that their clients can find ways to shape their business practices to meet those goals.


Let's start with the uncertainty over loans from qualified plans.

Sec. 402 amends the Securities and Exchange Act of 1934 to make it illegal for public companies to "extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that [company]."

Pension experts note that this wording does not specifically outlaw loans from qualified plans, whether made to insiders or anyone else.

And three other factors give rise to further confusion:

* SOX doesn't define what it means by "credit" or "personal loan;"

* Although Sec. 402 allows several exceptions, none mention loans to participants in qualified plans; and

* This section made its way into SOX late in the legislative process, so there is no committee testimony or conference report outlining what Congress had in mind.

The confusion puts plan sponsors in a pickle: Are plan loans to officers and directors outlawed by SOX? If so, can plans allow other participants to take out loans without running afoul of ERISA, which requires that qualified plans make loans available to all participants on a reasonably equivalent basis?


The SEC, which has power to interpret the Securities and Exchange Act, has not provided plan sponsors with any guidance. And the Department of Labor has taken the position that public company qualified plans may deny loans to officers and directors, notwithstanding SOX and ERISA.

But the department took this position in a Field Assistance Bulletin, FAB No. 2003-1, issued April 15, 2003, for the guidance of department field representatives. In other words, it was a departmental memo not legally binding.


At some point the government will clear up this confusion. In the meantime, given the stiffened penalties facing those who run afoul of ERISA, the wise course for plan sponsors is to review the procedures by which they carry out their fiduciary duties, asking at every step whether the procedures are reasonable and likely to bring about the desired end.

Start with the generalities of pension law, which holds plan sponsors accountable for, among others, the following:

* Developing an investment policy statement that outlines the goals and objectives of the plan;

* Offering investment options in accordance with those goals and objectives;

* Identifying and training company officials who, in overseeing a qualified plan, take on fiduciary responsibility;

* Preventing prohibited transactions, including self-dealing and top-heavy contributions;

* Maintaining a surety bond equaling the lesser of $500,000 or 10 percent of plan assets to recover plan losses resulting from dishonest acts by fiduciaries; and

* Complying with the annual audit requirements for plans with 100 or more eligible participants.

Lacking in-house resources to meet these goals, most small and mid-market companies farm out their pensions to professional administrators or stock brokerages, banks or insurers. Few employers, however, understand that they remain accountable for everything having to do with their pensions.

So if things go wrong, it's not just the CEO who may shoulder the blame, but any company official who manages property for the benefit of another, exercises discretionary control over that property or acts in a professional capacity of trust.

Although plan sponsors must demonstrate accountability, it is the individual enterprise that must devise detailed, documented processes and procedures to get the work done in-house or make sure it gets done by outsiders (DOL Regulation 2550).

It is here that CPAs can lend a hand.


CPAs should advise clients that the investment policy statement, for example, must spell out which kinds of investments the plan will offer.

Small and mid-market companies typically offer five or six investment options on the theory that fewer options don't give plan participants a broad enough range to meet their objectives, and more options may make it hard to choose intelligently.

Whatever the number, employers should offer seminars or written material to help plan participants match their risk tolerance with the plan's investment opportunities.

The investment policy statement should require that the employer report to participants on a quarterly basis comparing performance of plan assets against peer-group investments and, if appropriate, a benchmark index such as the S&P 500. The investment policy statement also should detail how the qualified plan will go about hiring and firing money managers--and why.

CPAs should understand that monitoring participant loans often troubles small and middle-market companies. Regulations (DOL 2550.408b-1) require qualified plans to service loans to participants much as banks monitor their loans. Here again, however, regulations merely outline the goal--keep track of loans made to plan participants--and leave it up to the company to develop procedures to ensure this happens.

CPAs should advise plan sponsors that, at the least, they must record the details of all loans to participants--the identity of the borrower, the loan amount, interest, term, repayment schedule, etc.--and track the dates and amounts of payments. They also should institute procedures to trigger reports to the plan administrator and employer when loan payments fall past due.

Hardship withdrawals also are trouble-some, usually because of the often overlooked requirement that an employee who takes a withdrawal to pay medical bills or purchase a principal residence, for example, must cease deferring income through the plan for six months.

As with participant loans, regulations [IRC Reg. 1.401(k)-1(d)(2)(iii)] require plan sponsors to develop and follow procedures designed to monitor hardship withdrawals. For such withdrawals, individuals may withdraw only their own deferred income, not any earnings generated by investing the income, and they must pay ordinary income taxes on the withdrawal [IRC Sec. 402(a)].

Payroll software tracks loans and hardship withdrawals automatically, as does most pension software, but the employer can't assume that someone somewhere is keeping an eye on things. Nor is it enough for the employer simply to tell the accounting department to flag loans and hardship withdrawals.

Instead, employers should issue a board resolution outlining the goal and follow up with a written directive instructing the accounting department to develop specific procedures designed to do the job, to pass these procedures by legal counsel for review, and send them up the corporate ladder for approval.

Another matter that may trip up the plan sponsor is the census that must be prepared at the end of each plan year. The data must cover the date of birth, date of hire, age, marital status, hours worked and wages or compensation paid to each participant in a qualified plan--crucial information for the actuary who must calculate the contribution for each participant in a defined benefit plan.

Clerical errors can make it necessary to re-do the actuarial work at additional cost. They also can trigger another unhappy turn of events: If the actual deferral percentage for 401(k) plans exceeds legal limits, the employer may have to remit the excess contribution to the employee, who may have to recognize the money as ordinary income subject to tax [IRC 401(k)(8) and IRC 4979].

The best way to prevent such errors is to reconcile census data with payroll data item by item, and CPAs should advise the plan sponsor to make sure that the individual who undertakes this duty gets proper training.

The plan sponsor also must make sure that the work is done in a timely fashion. Assuming that the plan year coincides with the calendar year, the employer must take corrective action by March 15 or face excise tax on excess contributions paid subsequent to March 15 [IRC 4979].

Employers must exercise particular care when hiring new employees who want to roll over pension plan assets from their previous companies.

Since this involves checking whether the assets in question originate from a qualified plan, the employer should develop paperwork to:

* Require new employees to provide information about the previous plan, and

* Request certification from the previous employer as to the type and qualified status of the plan.

In addition, where the employer does not use ready-made qualified plan documents, but instead commissions documents unique to the employer, the employer must seek competent legal help to make sure that any amendments to the plan comply with IRS and DOL regulations.

In this and other matters having to do with qualified plans, employers take on heavy responsibility, so it is good practice for the employer to continually monitor the plan and review everything from the plan documents to the investment policy statement to the methods by which the company identifies those employees holding fiduciary responsibility, and trains them in carrying them out.

This can seem to be costly and burdensome, but the alternative is worse.


For a discussion of the legal aspects of the impact of SOX on public and private companies with pension plans, see:


Robert Cohen, CPA is a partner with and Anthony Apodaca, CPA is a manager at Encino-based accounting firm Frankel, Lodgen, Lacher, Golditch, Sardi & Howard. They can be reached at and Pat Severo, CIMA is senior vice president of RBC Dain Rauscher in Beverly Hills. You can reach him at
COPYRIGHT 2005 California Society of Certified Public Accountants
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Title Annotation:PENSION PLANS
Author:Severo, Pat
Publication:California CPA
Geographic Code:1USA
Date:Jun 1, 2005
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