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Regulation

DOL audits might catch money managers by surprise

Managers overseeing firm's internal retirement funds largely unaware of new regulation

Money managers that invest their own retirement fund assets might not be paying close enough attention to a Department of Labor audit requirement, ERISA experts warn.

Money management firms investing assets for their own pension plans have long relied on exemptions from dealings — such as principal transactions with related parties — that are prohibited under the Employee Retirement Income Security Act.

Department of Labor officials estimate 4,400 financial institutions have designated qualified professional asset manager exemptions for their own defined benefit and defined contribution plans. The QPAM designation gives them more flexibility in investment decisions without having to worry about prohibited transactions.

Despite that sizable universe, “we're not sure all QPAMs are aware of this audit requirement,” said Laura Rosenberg, vice president for finance at Fiduciary Counselors Inc., Washington.

Jennifer Eller, a principal in the fiduciary practice at Groom Law Group in Washington, also fielded fewer calls this year than in 2011, the first effective year of the audit rule. “There is less QPAM audit activity than one might have expected. People need to remember that it's an annual requirement,” said Ms. Eller.

The audit requirement, which was added in 2010, stems from concern that there was no oversight of financial institutions managing their own pension plans. “We realized that we couldn't require them to have an independent fiduciary,” said Ivan Strasfeld, who served as director of the Employee Benefits Security Administration's Office of Exemption Determinations until February 2012 and wrote the initial QPAM exemption in 1984. “The other choice was not to get the exemption, and that would have been wildly unpopular.

“We concluded that an audit was a reasonable substitute,” said Mr. Strasfeld, now an ERISA consultant and senior adviser to Fiduciary Counselors.

Institutions relying on their QPAM exemption must have the audits completed within six months of the end of their plan years. The audits must be done by an independent fiduciary auditor, which DOL officials estimated during rulemaking would cost an average of $10,000.

The audit involves reviewing QPAM written policies and procedures and testing a representative sample of transactions to confirm compliance with those procedures. Any discrepancies identified by auditors require a remedial plan. Failure to conduct an accurate and timely audit jeopardizes the QPAM exemption for any prohibited transaction, each of which is subject to 15% excise tax. If non-compliance is a simple case of excessive fees, those can be returned, but more complicated non-compliant transactions would require a reset of the plan as if the transaction had never occurred. “Failure to get one can cost quite a lot of money,” said Ms. Rosenberg.

Frank Mitchell, an associate in the tax and employee benefits group at New York law firm Seward & Kissel LLP, said while the audit rule is not a big issue for many of the firm's hedge fund clients, some are considering other exemption options. “If you are a long/short publicly traded equity fund, you probably have a service provider exemption you can use,” said Mr. Mitchell, who added another option for participant-directed defined contribution plans of hedge fund firms is to create a generic hedge fund option.

“There is no perfect solution,” agreed Ms. Eller of Groom Law Group. The QPAM exemption “is a widely used and very helpful exemption, but it's not the only game in town. (The audit) can be a pretty significant undertaking.”

So far, she has seen three general responses among her firm's clients: those that have instituted their audit process; others considering other exemption strategies, such as relying on blind or exchanged-traded transactions, or possibly outsourcing some investment functions; and those that haven't focused on the audit requirement yet.

“I would think they would keep the QPAM exemption if they could,” said Ms. Rosenberg. “It provides broad relief for transactions between parties in interest and the plan that would otherwise be prohibited.”

“The audits are beneficial for everyone,” said a financial services firm official who asked not to be identified. “Review of certain transactions by an independent third party provides us with reassurance in the strength of our existing compliance policies, procedures, and controls.”

Officials at the DOL's Employee Benefits Security Administration declined to comment on their enforcement strategy for the audit rule, which is expected to become part of the regional offices' ERISA compliance checklist.

For now, attorneys said, it is more a matter of doing the audit and having it available to show if asked. Checking up on QPAM exemption holders “would be a no-brainer,” said Mr. Strasfeld. “You get a list in each city, and ask, 'Do you manage your own plan?' If you get a clean audit, you're good. If you get a bad audit, there's an expectation that you will take action. You need to fix it,” said Mr. Strasfeld. “People that pay attention to ERISA are ready; the others are not. That's not to say everybody does what they're supposed to do.”

Howard Pianko, a partner in the ERISA law firm Seyfarth Shaw LLP in New York, which combined forces with a financial consulting firm to conduct QPAM audits, sees people getting more organized this year. “The next wave” of QPAM audits, he said, “is really going to be about how to make it cost efficient.”

No one expects the audit requirement would cause a wholesale shift by financial institutions away from managing their own benefit plans, in part because of the marketing advantage it offers or the questions not doing so would raise. “It's often perceived as important that they manage their own (plan) assets,” said Ms. Eller, who expects that fiduciaries of other pension plans eventually will ask to see their asset managers' audits. “I can certainly see it evolving over the years. People who hire QPAMs are asking more questions, and it's a savvy request.” 