Posted By: Maria T. Hurd, CPA
Transactions with Related Parties and Parties In Interest: What are the GAAP disclosure requirements?
ERISA’s definition of a party in interest is broader than a related party as that term is defined by GAAP. Parties in interest include all entities and individuals that provide services to the plan; however, these entities may not necessarily be related parties. Party in interest transactions are prohibited under ERISA Section 406(a) unless specifically exempted from the prohibited transaction rules. Material transactions with Related Parties must be disclosed. Transactions with Parties in Interest must be disclosed unless they are listed as a Statutory or Administrative Exemption.
Party in Interest vs. Related Party: Definition
ERISA Section 3(14) defines a Party-in-Interest more broadly than FASB Accounting Standards Codification (ASC) 850 defines Related Parties.
Related Parties include parties who can control or significantly influence management or the operating policies of transacting parties, such as the principal owners of the entities and affiliated entities and their immediate families, management of the entities and their immediate families, and the pension and profit-sharing trusts. Applying that control-or-influence concept in the context of an ERISA-governed employee-benefit plan, a plan’s decision-making fiduciary likely is a FASB-described related party, but a plan’s non-fiduciary service provider might not be such a related party (even if it is an ERISA party-in-interest).
Parties-in-Interest includes the employees of the plan, fiduciaries of the plan, the employer or employee organization whose employees are covered by the plan, owners of 50% or more of the employer or employee organization, relatives of the owners, and service providers to the plan, including the TPA, custodian, the plan’s counsel, trustee, investment managers, and the plan auditor.
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, the following (with certain restrictions and limitations): (a) Loans to plan participants or beneficiaries; (b) The provision of services necessary for the operation of a plan for no more than reasonable compensation; (c) Loans to employee stock ownership plans; (d) Deposits in certain financial institutions; (e) Contracts for life insurance, health insurance, or annuities with one or more insurers; (f) Providing of any ancillary service by a bank or similar financial institution; x exercise of a privilege to convert securities; (g) 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; (h) Distribution of the assets of the plan in accordance with the terms of the plan; (i) Transfer made before January 1, 2014, of excess pension assets from a defined benefit plan to a retiree health account in a qualified transfer; and (j) 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.
DOL Administrative Exemptions
The DOL may grant administrative exemptions to an individual or a class of individuals allowing them to engage in a variety of transactions involving employee benefit plans. DOL administrative exemptions are referred to as Prohibited Transaction Exemptions (PTEs).
For example, DOL class exemptions permit: (a) Parties in interest to make unsecured interest-free loans to plans for plan operating expenses; (b) Various transactions involving employee benefit plans whose assets are managed by in-house managers; (c) Lending of securities by plans to banks and broker-dealers who are parties in interest to such plans; (d) Certain transactions between multiemployer plans and parties in interest involving delinquent employer contributions, construction loans, leasing of office space, provision of services and the sales of goods by the multiemployer plan; (e) Transfer of individual life insurance policies by plans to participants, relatives of participants, plan sponsors or another plan; (f) Insurance company pooled separate accounts, in which plans invest in, to engage in certain transactions with parties in interest and to hold employer securities or employer real property; (g) Purchases and sales of open-end mutual fund shares by a plan when a plan fiduciary is also the investment adviser for the investment company marketing the mutual fund.
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.
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 act on both sides of a transaction involving a plan.
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 SchedulesWhen 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 StatementsIf 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.
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.
Penalties and Corrections
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.
The DOL established the Voluntary Fiduciary Correction (VFC) Program to aid plan administrators in self-correcting violations of ERISA, including prohibited transactions. The VFC Program 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.
The IRS also provides a correction program called EPCRS: Employee Plan Compliance Resolution System.
Confessing Is Not Enough, You Must do the Penance
Although proper disclosure results in an audit opinion indicating the financial statements are complete and accurate in all material respects, correction of prohibited transactions is important. 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. The EPCRS only provides deminimis exceptions to corrections when excess contributions to a participant’s accounts are $75 or less and when excess distributions are $100 or less. As such, disclosure does not constitute forgiveness or permission, prohibited transactions must be corrected. Once there is a confession, the employer must also see it through and make it right.