Large retirement plans that require an audit often merge-in the assets from small plans in connection with a stock acquisition or a merger of the plan-sponsor companies. When large plans merge-in assets from another plan, auditors will have to consider whether previous operational errors of the merged plan could result in potentially tainted assets that affect the financial statements under audit. Asset acquisition transactions and rollovers from target-company plans that are terminated before the merger transaction are less likely to bring tainted assets into the audited plan. Let’s explore the audit implications of plan mergers when the merged-in assets have and have not been previously audited, as well as when the target company plan is terminated prior to the M&A transaction.
Merging Potentially Tainted Assets vs. Rollovers from a Terminated Plan
If the merged company terminates its plan prior to the merger, participants are generally allowed to roll over their account balances into the successor plan or to their own IRA. Rollovers from other qualified plans lose the character they had in the previous plan. Specifically, they are no longer classified by source: deferrals, match, QNEC, profit sharing, etc. For that reason, they are not potentially tainted assets. In those cases, the successor plan auditor’s responsibility includes only verification that the rollover came from a qualified plan and that the funds are deposited in accordance with the participant’s investment elections.
Rollover contributions from a terminated plan eliminate the risk of welcoming tainted assets into the plan, which is optimal, but the corporate merger or acquisition transaction often takes place before one plan is terminated. Consequently, after a merger or stock acquisition transaction, the controlled group sponsors both plans as a matter of law, even without any plan amendments. Treas. Reg. 1.401(k)-1(d)(4) says that plan termination is not a distributable event for salary deferrals if the employer, (in this case, the controlled group), establishes or maintains an alternative defined contribution plan. Limited exceptions are beyond the scope of this discussion. In most cases, if both plans exist after the M&A transaction, merging the plans or continuing to sponsor both are the two most common alternatives. When both plans exist after the transaction, transfers from the merged plan to the successor plan would preserve their source codes, unlike rollovers, so they could potentially be tainted assets if the plan harbored qualification errors.
Merger of Previously Unaudited Participant Account Balances
Inherited qualification problems could affect the completeness and accuracy of the audited financial statements. Once a plan is disqualified, it remains disqualified until the error is corrected. Hence, it shouldn’t be a surprise when the auditor asks for backup dating back more than one year for the merged assets. The merged assets include the accumulation of activity in participant’s accounts since the merged plan’s inception, which may even include previous mergers, but in most cases the auditor won’t need information all the way back to the inception of the plan.
Similar to beginning balance procedures performed in an initial audit of a previously small plan, auditors will use their judgement to get comfortable with the opening balances.
Since the audit opinion includes the assets available for benefits, including the merged assets, the auditor will likely ask for plan data that supports the completeness and accuracy of the merged accounts, including amounts, classification by source, and vesting percentage, as applicable. To test these attributes, the auditor will likely request information subject to a six-year retention record by ERISA Section 107, such as:
- Payroll and employer contribution reports
- Discrimination Testing and Coverage Test Results
- Tax Returns of the Plan Sponsor
- Forms 5500 Are Available Online
Additionally, the auditor may request several years of benefit records that Section 209 of ERISA states the employer must maintain sufficient information to determine benefits that are due or may become due for each employee, such as:
- Census Data to Substantiate Eligibility and Vesting
- Participant Account Balance Report
- Deferral Elections
- Employer Contribution Calculations
- Payroll Data Including Pay by Payroll Code, Hours Worked, etc
- Plan Documents, Adoption Agreements, SPD, IRS letter, as applicable
The nature, timing and extent of the auditor’s procedures will vary depending on the materiality of the merged assets to the successor’s financial statements, the quality of the available records, and the complexity of the merged plan.
Merger of Previously Audited Participant Account Balances
When participant account balances from an audited plan are merged into a successor plan, the auditor of the successor plan will request the plan sponsor to authorize the predecessor auditor to:
- allow the successor’s auditor to review the predecessor’s audit documentation and
- respond fully to the auditor’s inquiries
thereby providing the auditor with enough information to properly assess the risk of material misstatement and design the audit procedures applicable to the merged balances. However, the auditor cannot refer to the work of the predecessor auditor as a basis for the auditor’s opinion and cannot revise the previously audited numbers.
It is customary for the predecessor auditor to make himself or herself available to the new auditor and to make available for review audit documentation including but not limited to:
- audit planning;
- risk assessment procedures;
- substantive audit procedures and test of controls;
- audit results;
- matters of continuing accounting and auditing significance,
- schedule of uncorrected misstatements,
- demographic testing,
- governance letters,
- work papers relating to contingencies, related parties, and significant unusual transactions.
The successor auditor will inquire about the predecessor auditor’s understanding of the reason for change in auditors and whether there were suspicions of fraud or disagreements about accounting policies or any other matters of concern. If the predecessor auditor is out of business, or does not grant access to the workpapers, or limits access, the auditor will consider the implication on client acceptance and on the extent and nature of audit procedures that must be performed on beginning balances, as if the merged balances had not undergone an audit.
The above discussion relates to M&A transactions including mergers and stock sales. Asset sales tend to be more straightforward if the buyer doesn’t adopt the target’s plan.
Asset Sales
If the buyer buys the assets of another company, the employees generally terminate employment with the target company and can choose to rollover their funds to the buyer’s plan or to an IRA. With respect to rollover balances, the assets are not tainted, auditor’s responsibility is limited to verifying that the assets are coming from a qualified plan and that the participants’ investment selections are observed. If the buyer chooses to adopt the target’s plan, then please go back to step 2 above, regarding audits of merged plans.
To Each His Own Lane
Personally, I would favor administrative simplicity and limiting the possibility of transferring tainted assets in connection with an M&A transaction, but my priorities and values are not relevant to any audit engagement. As auditors, our only job is to verify that the plan document is being followed. Auditors are the oversight entity charged with an independent verification that the plan was operated in accordance with its terms, with the ultimate goal of issuing an audit opinion regarding whether the plan’s financial statements are complete and accurate in all material respects. We are not ERISA attorneys, investment advisors, third party administrators, plan consultants, so we stay in our lane. There’s enough life in the ERISA fast lane for all of us.
