Chances are that your pension or 401k plan has never been audited. No one's checking annually to see if the money's really there. Worried yet? It should freak you out, in my opinion. According to regulators, seventy percent of the nation's pensions have never been audited.
Lest you think I'm an alarmist, the Inspector General of the U.S. Department of Labor earlier this year in his Semiannual Report to Congress wrote that plans lacking full audits "provide no substantive assurance of asset integrity to plan participants." That's a pretty dire assessment. In layman's terms it means that if your money is invested in a pension that has never been audited, no one knows for certain the money is actually there. That, I would submit, should be of concern to every investor in an unaudited retirement plan. You need to find out if your pension is unaudited and, if so, demand a true audit before it's too late.
Is this the familiar tale of an agency of the federal government being asleep at the wheel while an outrageous compromise to the integrity of the nation's pensions came to pass? A regulator who woke up far too late to abuses?
Not exactly. In fact, nothing could be farther from the truth.
Would you believe that every year since 1989, the Inspector General of the DOL has sounded the alarm about the risks to pension participants related to failures to audit? For over twenty years, the Inspector General has recommended that Congress close the loop-hole in the federal law applicable to pensions, ERISA, that allows this state of affairs to persist.
Counsel to the Inspector General recently stated to me “we have long believed that this is an important issue. A lot of pension dollars have not been properly audited.”
I am told that this year, for the first time in over two decades, the Inspector General is considering dropping the recommendation to Congress to address this issue of critical importance to retirement savers. Why? Because the recommendation has been rejected so many times. I can't blame the Inspector General's office from being discouraged but, in my opinion, it would be a collosal mistake to give up at this point in time because we are only now on the cusp of determining the harm related to unaudited plans.
What's going on here? Under ERISA, a pension sponsor may instruct the auditor to a pension not to perform any auditing procedures with respect to investment information prepared and certified by a bank or similar institution. That's right-- no auditing procedures. The bank simply certifies the accuracy and the completeness of the information submitted to the auditor and the auditor includes it in his financial report with the following gargantuan caveat: Because of the significance of the information that we did not audit, we are unable to, and do not, express an opinion on the accompanying financial statements and schedule taken as a whole (emphasis added). In the words of the Inspector General, these so-called "limited scope audits" are "no opinion audits." They're worthless. The auditor is saying to you, "because I have been instructed not to look at certain pieces, I cannot tell you what the whole is worth."
But it's not just a sliver of plan assets that the auditors are not examining -- it's often all or virtually all of the assets in plans. To make matters worse, plans are increasing their high risk bets by loading up on hard-to-value assets, such as private equity and hedge funds, in a desperate attempt to close their funding gaps. What are these hard-to-value assets worth? Who knows? Nobody's checking, or even concerned. The custodian banks have provisions in their contracts which specify that they may conclusively rely upon values that these lightly-regulated managers provide to them. Of course, since these managers are paid a fee based upon the value of the assets they manage, they have every incentive to inflate valuations. Let's hope they're committed to telling the truth-- even if it means their rich fees dwindle. The net result is that the auditors rely upon unverified statements provided by custodian banks and the banks, in turn, rely upon unverified valuations provided by hedge fund managers handling plan assets. Nobody is required under the law to check that the money is there. Sounds Madoff-ish to me.
Here's some background on this impending train wreck. In November 1989, the Office of the Inspector General for the U.S. Department of Labor issued a report titled “Changes Are Needed in the ERISA Audit Process to Increase Protections for Employee Benefit Plan Participants.” According to the Inspector General, the most critical recommendation made in that report was to amend ERISA to require full scope audits-- real audits, not bogus no opinion audits. In September 1996, the Inspector General issued a report entitled “Full Scope Audits of Employee Benefit Plans Still Needed” which stated that “the need for full scope audits of employee benefit plans is as important today as it was 7 years ago.” This review confirmed that, at that time, almost half of the plans reviewed received limited scope audits and disclaimers of opinions. The Office of the Chief Auditor “concluded that this is a disservice to plan participants in terms of protection and in terms of useful information the participants need to monitor their plans’ ability to pay benefits.”
In 1990, 1992 and 1998, the GAO recommended that the limited scope audit exemption should be repealed. According to the GAO:
“Under this limited scope audit, the auditor is required to obtain financial statements from the company holding the investments and a certification from that company that the statements are accurate and are a part of the company’s annual report. However, the auditor would not perform the normal procedures designed to provide certain basic assurances about the existence, ownership, and value of a plan’s assets held in trust. The resulting lack of audit work can result in an auditor disclaiming an opinion on the financial statements."
No normal procedures performed to establish basic facts like the assets ... exist? That's a pretty basic fact that, in my book, somebody ought to know -- with absolute certainty.
But the GAO had more to say:
"The disclaimer can cause two problems. First, it can diminish the value of an audit by leaving a significant gap in the information intended to help participants evaluate their plan. For example, plan participants would have no basis for judging whether excluded investments are vulnerable to mismanagement, fraud, or abuse. Second, the disclaimer language could confuse the participant. It says that the auditor does not express an opinion on the financial statements and supplemental schedules, but that the auditor does provide some assurance that the form and content of information included in statements and schedules comply with the Department of Labor rules and regulations. As a result of this potentially confusing wording, users of limited scope audit reports could be uncertain about what, if any, assurance these reports provide.”
For those of you participating in an unaudited plan where signifcant assets are invested in hedge funds and other hard-to-value investments, I can assure such investments, if excluded, are "vulnerable to mismanagement, fraud, or abuse," and you should be very concerned.
The GAO is right that users of limited scope audit reports should be uncertain about what, if any, assurances these reports provide. I can assure you that, when and if sued, auditors who issue such opinions will claim that the opinions plainly warned that no assurances were provided.
As mentioned earlier, this year the Inspector General in his Semiannual Report to Congress recommended repeal of ERISA’s limited-scope audit exemption. According to the Inspector General, “This provision excludes pension plan assets invested in financial institutions such as banks and savings and loans from audits of employee benefit plans. The limited audit scope prevents independent public accountants who are auditing pension plans from rendering an opinion on the plans’ financial statements in accordance with professional auditing standards. These “no opinion” audits provide no substantive assurance of asset integrity to plan participants or the Department (emphasis added).”
You should be concerned if your retirement savings are held in a retirement plan that has never been audited. Don't let anyone tell you otherwise. Call me crazy, but it does matter whether procedures designed to verify the existence, ownership, and value of a plan’s assets have been performed. I predict that we are on the verge of learning just how worthless no opinion audits of pensions really are. I am confident that in the future it will become apparent that lack of scrutiny has resulted in widespread misrepresentation of pension asset values. Take action now to protect your retirement security.
