5500s and Tattling: A Tale of Two Audits

Many assume the Form 5500 is a tax form, but the development of the entire 5500 series was a joint effort by the Department of Labor (DOL), Internal Revenue Service (IRS), and Pension Benefit Guarantee Corporation (PBGC) to “satisfy annual reporting requirements under ERISA and the Internal Revenue Code.” In other words, all three agencies have a keen interest in the data contained in the 5500, which must be filed with the DOL by July 31^st for most plans.

That keen interest may potentially result in a time-consuming audit triggered by something as simple as an IRS inquiry about a required question on the 5500 not answered or inconsistent data reported. The IRS inquiry could lead to an audit and then to a possible referral to the DOL (more on what happens when one agency “tattles” to another later).

If a 5500 has hot button issues – such as a significant drop in plan participants, reporting of late deposits and deferral contributions, or an adverse auditor’s opinion – then the possibility of an audit greatly increases.

Accurate 5500s are Your Fiduciary Responsibility
As a plan sponsor, you may hire a tax preparer or third party administrator to prepare your 5500, but that doesn’t relieve you of your fiduciary responsibility. As fiduciary to the plan, you have responsibility for every consultant you hire, including the preparer of your 5500. Ultimately, you must sign the 5500, and by doing so, you essentially attest in a fiduciary capacity that all the information contained in it is true and valid. Therefore, you must thoroughly review your 5500, understand all of the information it contains, and be able to track it back to all underlying, supporting data in order to ensure its accuracy. If you can’t do all of those things, don’t sign it until you can.

IRS Referrals to the DOL
Although the IRS looks at the 5500 data for its own purposes, once it identifies a problem and looks deeper, it may discover issues it knows will be of interest to the DOL. Want proof? Look no further than the official IRS referral form, IRS Examination Referral Checksheet B (Form 6212-B). This form, used by IRS employees when referring plans to the DOL, requires the IRS agent to answer specific questions, such as (directly quoted):

• Do the investments of the trust appear to be prudent and permitted by the plan document, and is the performance of the investment portfolio monitored? (ERISA sec. 404)
• Does the plan appear to have diversified its investments by not holding more than 20% of its portfolio in any SINGLE investments, except as permitted by the plan document? (ERISA sec. 404(a)(1)(C))
• With respect to any person rendering services to the plan, and receiving directly or indirectly more than $5,000 in compensation from the plan (excluding employees of the plan earning less than $1,000 each month), does the compensation appear reasonable for services rendered? (ERISA sec. 404(a)(1)(A))

A “No” answer to any of these three questions, or certain answers to the other questions on this form, may mean the DOL will investigate the plan further, which in turn, could lead to a full-blown DOL audit.

And, by the way, if you’ve been following the news, you surely recognize the issues these questions address. These are the same issues (imprudent funds selection, overpaying for funds or services) that have given rise to numerous class-action lawsuits brought by plan participants against plan fiduciaries.

Audits Are a Fact of Life
Let’s be clear on one thing: even if the 5500 if filled out properly, the plan could still be audited by the DOL. Other audit triggers include random selection and complaints received directly from plan participants.

If your plan is audited, your best defense is demonstrating that you have in place a strong process of prudence that covers all the specific elements the DOL and ERISA consider mandatory for plan success, including:

1. Documenting the plan’s goals and objectives
2. Developing an Investment Policy Statement
3. Monitoring investments on a continuous basis
4. Documenting fiduciary standards of care
5. Selecting and monitoring service providers
6. Understanding plan expenses
7. Understanding what the DOL, ERISA and FINRA expect of communications to employees
8. Staying current with any regulatory changes that may affect the plan

If your employee retirement plan doesn’t have the above elements in place, then you’re not meeting your fiduciary responsibility, and you and your plan are at risk.