Party-in-Interest Versus Related Party

ERISA Section 3(14) defines a Party-in-Interest more broadly than FASB Accounting Standards Codification (ASC) 850 defines Related Parties.

Specifically,

29 CFR 1002(14) defines the term “party-in-interest” as follows:

1. Any fiduciary (including, but not limited to, any administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;
2. A person providing services to such plan;
3. An employer any of whose employees are covered by such plan;
4. An employee organization any of whose members are covered by such plan;
5. An owner, direct or indirect, of 50 percent or more of—
   1. the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation.
   2. the capital interest or the profits interest of a partnership, or (iii) the beneficial interest of a trust or unincorporated enterprise, which is an employer or an employee organization described in subparagraph (C) or (D);
6. A relative (as defined in paragraph (15)) of any individual described in subparagraph (A), (B), (C), or (E);
7. A corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—
   1. the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
   2. the capital interest or profits interest of such partnership, or
   3. the beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
8. An employee, officer, director (or an individual having powers or responsibilities similar to those of officers or directors), or a 10 percent or more shareholder directly or indirectly, of a person described in subparagraph (B), (C), (D), (E), or (G), or of the employee benefit plan; or
   1. A 10 percent or more (directly or indirectly in capital or profits) partner or joint venturer of a person described in subparagraph (B), (C), (D), (E), or (G). The Secretary, after consultation and coordination with the Secretary of the Treasury, may by regulation prescribe a percentage lower than 50 percent for subparagraph (E) and (G) and lower than 10 percent for subparagraph (H) or (I).

The FASB ASC glossary defines “related parties” as follows:

1. Affiliates of the entity;
2. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the “Fair Value Option” subsection of FASB ASC 825-10-15, to be accounted for by the equity method by the investing entity;
3. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management;
4. Principal owners of the entity and members of their immediate families;
5. Management of the entity and members of their immediate families;
6. Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests; or
7. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

Statutory Exemptions in ERISA

ERISA section 408(a) contains specific exemptions whereby plans may engage in certain transactions with parties-in-interest otherwise prohibited by law. For example, the statutory exemptions include, among other exemptions:

1. Loans to plan participants or beneficiaries;
2. The provision of services necessary for the operation of a plan for no more than reasonable compensation;
3. Loans to employee stock ownership plans;
4. Deposits in certain financial institutions;
5. Contracts for life insurance, health insurance, or annuities with one or more insurers;
6. Providing of any ancillary service by a bank or similar financial institution and exercise of a privilege to convert securities;
7. Transaction between a plan and a common or collective trust fund or pooled investment fund, or transaction between a plan and a pooled investment fund of an insurance company;
8. Distribution of the assets of the plan in accordance with the terms of the plan;
9. Providing certain investment advice to a participant or beneficiary of an individual account plan that permits such participant or beneficiary to direct the investment of assets in their individual account.

Form 5500 Disclosure Requirements

ERISA and DOL regulations require transactions with parties-in-interest (excluding any transactions exempted from prohibited transaction rules) to be reported on schedules to the Form 5500 Annual Return/Report of Employee Benefit Plan. The failure to timely remit participant contributions must be reported on Form 5500, Schedule H and the Supplemental Schedule of Delinquent Participant Contributions. Other prohibited transactions must be disclosed on Form 5500; Schedule G. Additional disclosures may also be required in accordance with the Form 5500 instructions. Under ERISA section 502(c)(2), the DOL may assess a daily penalty against a plan administrator who fails or refuses to comply with the annual reporting requirements.

Financial Statement Disclosures: Related Parties and Parties-in-Interest

Related Party transactions that are material to the financial statements must be disclosed, including the name of the related party, the nature of the relationship, a description of the transactions, the dollar amount of the transaction, the effect of the transaction, and the amounts due to or from related parties as of the date of the financial statements. See FASB ASC 850-10-50-1. Any representations that the terms of a related party transaction are equivalent to an arm’s length transaction must be able to be substantiated.

Party-in-interest transactions must be disclosed, including agreements and transactions between the plan and all parties-in-interest. See FASB ASC 960-205-50-1g and DOL Reg. 2520.103-1(b)(3).

What is the Effect on the Financial Statement Audit Opinion?

In general, proper disclosure of financial transactions with related parties or parties-in-interest in the notes or the supplementary schedules, if required, will result in an audit opinion that indicates the financial statements appear to be complete and accurate in all material respects. Conversely, not reporting it results in a modified opinion on the financial statements or the supplementary schedules as follows:

• Modification of Opinion on Supplementary Schedules – When a nonexempt prohibited transaction is identified, management or those charged with governance, as applicable, must report it on the supplemental schedules required by ERISA. If a prohibited transaction with a party-in-interest is not properly reported, the auditor will modify the auditor’s opinion on the ERISA-required supplemental schedule if the effect of the transaction is material to the plan’s financial statements. Conversely, if the effect of the prohibited transaction is not material to the financial statements, the auditor will include an additional discussion describing the prohibited transaction in an “Other Matters” paragraph in the auditor’s report on the ERISA-required supplemental schedules.
• Modification of Opinion on the Financial Statements – If a material prohibited party-in-interest transaction that is not disclosed in the ERISA-required supplemental schedule is also considered a related-party transaction and that transaction is not properly disclosed in the notes to the financial statements, the auditor will also modify the audit opinion on the financial statements.

Disclosure Is Not Enough: Confess, then Correct

Under ERISA section 502(c)(2), the DOL may assess a daily penalty against a plan administrator who fails or refuses to comply with the annual reporting requirements, but disclosure is not enough. The DOL expects the plan to be operated solely in the best interest of the plan participants, and for the plan not to inure to the benefit of the Employer. ERISA section 406(b) also prohibits certain transactions between the plan and the plan fiduciary. A plan fiduciary is prohibited from using the plan’s assets in their own interest or acting on both sides of a transaction involving a plan.

The DOL established the Voluntary Fiduciary Correction Program (VFCP) to aid plan administrators in self-correcting violations of ERISA, including prohibited transactions. The VFCP is a voluntary enforcement program that allows plan officials to identify and fully correct certain transactions such as prohibited purchases, sales and exchanges; improper loans; delinquent participant contributions; and improper plan expenses. The program includes specific transactions and their acceptable means of correction, eligibility requirements, and application procedures. Additionally, the IRS provides a correction program called EPCRS: Employee Plan Compliance Resolution System.

Disclosure of material related party and party-in-interest transactions is an important first step, but then corrective action must be taken to make any affected participants whole, pay any applicable penalties, and update the plan’s internal controls to prevent repeat confessions. Confession must be followed by Penance through Penalty Payments as applicable, Corrective Actions, Repentance, and a New Plan Year Resolution. Confess, Correct, Repent, Resolve.