What is the Effect of Prohibited Transactions on the EBP Audit Opinion?

Posted by Maria T. Hurd, CPA, RPA

The Truth Will Set You Free, but First, It Will Make You Miserable


When it comes to reporting prohibited transactions (PT) with parties-in-interest, it’s better to come clean, confess, and report on the supplementary schedules to the audited financial statements than to deny any wrongdoing. Withholding information results in inaccurate supplementary schedules, which compels a modified opinion on the schedules. Reporting the transaction makes the supplementary schedules accurate, which means the auditor can issue an unmodified opinion on the supplementary statements. Counterintuitive as it may seem to some clients, a “guilty plea” yields a clean opinion, a better result than withholding incriminating information would yield.

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.

Party in Interest vs. Related Party

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.

The Truth Will Set You Free

In a nutshell, when it comes to getting a clean opinion for accurate disclosures and supplementary statements, the truth will set you free. The right answer is to disclose, disclose, disclose prohibited transactions. Because prohibited transactions often lead to excise taxes or costly corrections, some clients argue that there’s a flip side is reminiscent of James A. Garfield’s wise statement: The truth will set you free, but first it will make you miserable. Perhaps that’s true.

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