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ERISA Fidelity Bond Failure—So what?

“I’m aware of a business retirement plan that has not maintained an ERISA fidelity bond for the plan for the last several years.  What penalties is the plan facing?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Texas is representative of a common question related to the Department of Labor’s (DOL’s) requirement for retirement plans to have ERISA fidelity bonds.

Highlights of Discussion

Through examinations of Forms 5500, the IRS has determined that one of the top two most common compliance issues among plans is not having adequate ERISA fidelity bond coverage. The DOL, pursuant to ERISA Sec. 412 and related regulations, generally requires every fiduciary of an employee benefit plan and every person who handles funds or other property of a plan be bonded to protect the plans from risk of loss due to fraud or dishonesty on the part of the bonded individuals. Please see the Department of Labor’s Field Assistance Bulletin 2008-04 for more details on ERISA Fidelity Bonds. The DOL also has a handy hand-out entitled Protect Your Employee Benefit Plan with An ERISA Fidelity Bond that provides an overview of the bonding requirements and how to obtain a bond.

Although the DOL imposes an ERISA fidelity bonding requirement on employee benefit plans,[1] the agency has not identified a specific penalty for failing to have an appropriate bond when one is required. In practice, plan officials who have failed to secure bonds have received a range of consequences from auditors’ admonitions to obtain the necessary bonds to court mandates for their removal as plan fiduciaries and plan termination.

There are substantial risks associated with not meeting ERISA’s bonding requirements:

  • Failing to report a sufficient bond on the Form 5500 can trigger a plan audit.
  • It is against ERISA law for plan officials to be without an ERISA bond.
  • Plan fiduciaries can be held personally liable for losses that could have been covered by a fidelity bond.

 

Consider the following court case.

In Chao v. Thomas E. Snyder and Snyder Farm Supply Inc. 401(k) Plan, Civil Action No. 1:00CV 889, a federal district court judge in Grand Rapids, MI, ordered the defendant (the owner of a company) to purchase and maintain a fidelity bond for the company’s 401(k) plan until the plan was terminated. The defendant also was ordered to direct the plan’s custodian to distribute or roll over the accounts of plan participants. Under the consent judgment and order obtained by the DOL, Snyder, who was a fiduciary of the 401(k) plan, further agreed to pay all expenses related to the distributions, rollovers, or plan termination, except for annual maintenance fees charged against each plan participant’s account.

Conclusion

Although no particular DOL penalty is prescribed for failing to have an ERISA fidelity bond when one is required, nonetheless, noncompliant plan officials must be aware they expose themselves, unnecessarily, to DOL audits, personal liability and potential lawsuits.

[1] Exceptions: The bonding requirements do not apply to employee benefit plans that are 1) completely unfunded or that are not subject to Title I of ERISA, or 2) maintained by certain banks, insurance companies and registered broker dealers.

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SEP and SIMPLE IRA Plans and ERISA Fidelity Bonds

“Do SEP and SIMPLE IRA Plans Require an ERISA Fidelity Bond?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Florida is representative of a common inquiry related to savings incentive match plans for employees (SIMPLE) IRA plans and simplified employee pension (SEP) plans.

Highlights of Discussion

Generally, yes, but this is a great question with a multi-layered answer depending on the individuals and/or entities that handle the assets of these plans. ERISA Section 412 requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan be bonded in order to protect the assets of the plan against the risk of loss due to fraud or dishonesty. For this purpose, SEP and SIMPLE IRA plans are considered employee benefit plans. The DOL further explained (albeit somewhat vaguely) its position on the matter in Field Assistance Bulletin (FAB) 2008-4, Q&A 16. With regard to having a fidelity bond, the DOL states: “There is no specific exemption … for SEP or SIMPLE IRA retirement plans. Such plans are generally structured in such a way, however, that if any person does “handle” funds or other property of such plans that person will fall under one of ERISA’s financial institution exemptions” (See DOL Reg. §§ 2580.412-27 and 28).

The logic here is that, typically, employees establish their SIMPLE IRAs and SEP IRAs at banks, trust companies or insurance providers, and such institutions are exempt from the bonding requirement provided they are subject to supervision or examination by federal or state regulators and meet certain financial requirements. The Pension Protection Act added an exemption to the ERISA bonding requirement for entities registered as broker/dealers under the Securities Exchange Act of 1934 if the broker/dealer is subject to the fidelity bond requirements of a self-regulatory organization. Consequently, the employees of qualified financial institutions that hold SEP IRA and SIMPLE IRA plan assets need not be covered by an ERISA fidelity bond.

However, there is no exemption from the ERISA bonding requirement for the fiduciaries of employers who handle SEP and SIMPLE IRA plan assets prior to the assets being held in their respective IRAs. When do SEP and SIMPLE IRA contributions become plan assets? In the case of salary reduction (SAR) SEP and SIMPLE IRA employee salary deferrals, such amounts become plan assets as of the earliest date on which they can reasonably be segregated from the employer’s general assets (DOL Reg. 2510.3-102). In contrast, employer contributions generally become plan assets only when the contributions actually have been made to the plan (FAB 2008-01 and Advisory Opinion 1993-14A).

Court cases provide evidence that this is indeed how the DOL enforces the bonding requirement for SAR-SEP and SIMPLE IRA plans. In Chao v. Smith, Civil Action No. 1:06CV0051, the employer failed to remit employee contributions to a SIMPLE IRA plan. In addition to restoring the salary deferrals to the plan, as part of the settlement the employer was required to secure a fidelity bond and keep it active throughout the life of the plan “as required by the Employee Retirement Income Security Act.”  Similarly, in Chao v. Harman, Civil Action Number 4:07cv11772,  the DOL sued business executives and trustees of a firm’s SIMPLE IRA plan in Jackson, Michigan, for failing to forward employee contributions to workers’ accounts and obtain a fidelity bond. Finally, the DOL sued an employer with a SAR-SEP plan for mishandling of employee deferrals and lack of a fidelity bond (Chao v. Gary Raykhinshteyn, Civil Action No. 01-60056).

In each case, the DOL made a point to state employers with similar problems who are not yet the subject of an investigation may be eligible to participate in the DOL’s Voluntary Fiduciary Correction Program (VFCP) to correct the errors and avoid enforcement actions and civil penalties as well as any applicable excise taxes.

Since some form of employer contribution is required with a SIMPLE IRA plan, employers who fail to make these contributions have an IRS operational failure and may have the ability to correct the error by following the applicable provisions of the Employee Plans Compliance Resolution System in Revenue Procedure 2016-51.

Conclusion

While the DOL offers exemptions from the ERISA fidelity bonding requirement to qualified financial institutions that hold SEP and SIMPLE IRA assets, the agency requires employers who sponsor SEP or SIMPLE IRA plans and other plan fiduciaries who handle plan assets to be covered by an ERISA fidelity bond to prevent against loss as a result of fraud and/or dishonesty.

 

© Copyright 2021 Retirement Learning Center, all rights reserved