CBIZ & MHM Executive Education Series™ Terms and Inherent Risks of

Retirement Plan Investments Presented by: Mike Loritz, Hal Hunt, Cindy Dwyer and

Al Chingren with American Century Investments

December 9, 2014

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Before We Get Started…

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This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic participation markers throughout the webinar.

External participants will receive their CPE certificate via email immediately following the webinar.

CPE Credit

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The information in this Executive Education Series course is a brief summary and may not include all

the details relevant to your situation.

Please contact your service provider to further discuss the impact on your business.

Disclaimer

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Today’s Presenters

Mike Loritz, CPA Shareholder, MHM 913.234.1226 | mloritz@cbiz.com Mike has 17 years of experience in public accounting with diversified financial companies and other service based companies, including banking, broker/dealer, investment companies, and other diversified companies ranging from audits of public entities in the Fortune 100 to small private entities. He is a member of MHM's Professional Standards Group, providing accounting knowledge leadership in the areas of derivative financial instruments, investment securities, share-based compensation, fair value, revenue recognition and others.

Al Chingren Vice President, DCIO Practice Management American Century Investments 1-800-345-6488, ext. 43155 | Al_Chingren@americancentury.com Al Chingren is part of the sales team dedicated to delivering value added sales programs. Al's area of expertise is 401(k) and retirement resources. He is responsible for developing materials in the form of presentations, brochures, and white papers on topics ranging from understanding retirement plan expenses, fiduciary responsibilities, and legislative updates, to retirement plan business development. He has delivered retirement industry updates and sales ideas at national and regional conferences and has spoken on numerous occasions at advisor sponsored meetings providing insights on the 401(k) plans, and retirement industry trends. Al has over 25 years of industry experience in a wide array of qualified plan arrangements, including 401(k), profit sharing, ESOP, defined benefit and health/welfare plans.

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Today’s Presenters Hal Hunt, CPA Shareholder, MHM 913-234-1012 | hhunt@cbiz.com Hal leads MHM’s Employee Benefit Plan (EBP) Audit Practice. With over 25 years of diverse experience with EBP accounting, auditing and compliance issues, he is also a member of the firm’s Professional Standards Group as EBP subject matter expert. As the EBP National Practice Leader, Hal is responsible for providing internal training, along with providing technical support to engagement teams, serving as engagement quality reviewer and developing resource tools for our EBP audit professionals. He served on the AICPA’s Employee Benefit Plan Audit Quality Center (EBPAQC) Executive Committee and is currently a member of the EBPAQC ESOP Task Force.

Cindy Dwyer, CPA Shareholder, MHM 913.234.1022 | cdwyer@cbiz.com Cindy is the President of MHM Retirement Plan Solutions LLC with over 30 years of experience in her field. MHM Retirement Plan Solutions is a Third Party Administration Firm for qualified retirement plans, including ESOPs. Services provided include plan design and consulting, participant recordkeeping, asset reconciliation, non discrimination testing, preparation of Form 5500 and assisting Plan Sponsors navigate the various IRS and DOL plan correction programs that are available. .

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Today’s Agenda

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Understanding retirement plan investment types

Valuing investments and FASB ASC 820 Fair Value Hierarchy Selection and monitoring of plan investments and involvement of outside investment advisors

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4 Regulatory reporting requirements and audit process

UNDERSTANDING RETIREMENT PLAN INVESTMENT TYPES

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Review of investment agreements and other pertinent investment documentation

Discussions with those at plan sponsor knowledgeable regarding investments

Discussions with service providers including trustee/custodian, investment advisor, insurance company, etc.

Review of service provider reports including trustee/custodian, investment advisor, insurance company, etc.

Importance of Understanding Nature and Terms of Investments and Arrangements

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Average asset allocation of 401(k) account balances, percentage of assets

EBRI/ICI Plan Asset Allocation Plan Year-End 2012

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Asset allocation reported by Callan Associates shows significant growth in TDF since 2012

DC Asset Allocation Second Quarter 2014

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An investment vehicle that is made up of a pool of funds for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets

Structured and maintained to match the investment objectives stated in its prospectus

Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV).

Mutual Funds

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Second Quarter 2014 Net Cash Flow Explains Industry Focus on Target Date Funds (TDF)

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An investment vehicle, designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date approaches

The 'glidepath' illustrates how an investment strategy becomes increasingly conservative over time towards the target date.

Most frequently chosen option as Qualified Default Investment Alternative (QDIA)

Rules on disclosures for target-date funds were published by the SEC in 2010.

Target Date Funds

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An investment vehicle, in the form of a trust, sponsored and maintained by a bank or trust company subject to state or federal banking law

Permits collective investment, on an undivided, unitized basis, of assets of employee benefit plans sponsored by unrelated employers

Units of participation represent an undivided interest in underlying assets of the Trust

Purchase or redemption price is set by the trustee based on value of underlying assets

Common/Collective Trusts

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A limited partnership is typically a form of partnership that offers the protection of limited liability to some of its partners (limited partners).

The rights and obligations of limited partners are usually different from those of general partners who take part in management.

Typically valued based on plan’s interest in net asset value, as the practical expedient. Often times valued quarterly.

Limited Partnership Investments

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A commingled fund that typically uses more aggressive strategies than a mutual fund or collective trust

Typically not registered (can be registered) Typically valued monthly (some are quarterly) Limited redemptions (typically quarterly or monthly) Investor balances may be unitized (NAV per share) or may

be expressed in terms of a capital account (total market value).

Common terms associated with HF: gates, lock-ups, performance or incentive fee or allocation, clawback and sidepockets

Auditing and reporting issues similar to limited partnerships

Hedge Funds

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Investment vehicle named after DOL regulation (§2520.103-12). 103-12 is not a legal entity form.

103-12 investment entities are designed to invest plan assets of two or more plans that belong to more than one unrelated employers.

103-12 investment entities often do business in the form of a trust, limited liability company or limited partnership. Read trust agreement (fund documents).

103-12 Investment Entities

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A private equity fund typically invests in start-up companies (i.e. venture) or other private companies called portfolio companies.

Assets are illiquid.

The fund typically invests in 20 or fewer portfolio companies – therefore less diversity.

No redemption provisions; may be subject to capital calls.

Common terms associated with PEF: commitments, preferred return, carried interest, hypothetical liquidation.

Private Equity Funds

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Separately Managed Accounts (SMA)

An account set up on behalf of one plan for which an investment advisor serves as manager

Assets are often held by a bank. Often mistaken for a commingled

fund Allows for customization of the

portfolio by the investment manager Investment structure key difference

– a mutual fund investor owns shares of a company that in turn owns other investments, whereas an SMA investor owns the invested assets directly in its own name.

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Fixed income securities structured products refer to a broad class of investments designed to facilitate highly customized risk-return objectives to meet an investor’s financial needs. Examples: Mortgage Backed Security (MBS), Collateralized

Mortgage Obligations (CMO), Collateralized Loan Obligations (CLO), Structured Investment Vehicles (SIV)

Common characteristics are: Includes securitized products – investments that are collateralized

by other assets, typically financial assets, such as mortgages, consumer loans, corporate loans and debt, and even more exotic assets like life insurance contracts.

Cash flows on the underlying assets provide for repayment to the investors.

Fixed Income Securities – Structured Products

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One type of structured product is a Mortgage Backed Security (MBS). An MBS is a debt instrument with a pool of underlying real estate loans as the underlying collateral.

Some MBS are known as pass-through securities. MBS are created when mortgages are pooled together and

sold. Payments of principal and interest on the underlying

mortgages are passed through monthly to investors (less certain fees).

Monthly payments for principal and interest are calculated using factors.

The factor represents the percentages of each pool’s original face value still outstanding.

Fixed Income Securities – Structured Products

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XYZ Company is the primary servicer. The principal and interest earned on the mortgages provide cash flows passed on to investors.

Mortgage Backed Securities Structure

Third Party Investors

Senior Tranche

$80

Mezzanine Tranche

$15

$100 pooled

mortgage loans sold

$95 Cash

Equity – residual in XYZ securities (ABC

Company)

Trust Transferor (XYZ

Company)

Residual

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Target date funds – Investments based on the participant’s age, target retirement date or life expectancy Change their asset allocation over time with the objective of

becoming more conservative with increasing age

Balanced or risk based funds Consistent with a target level of risk appropriate for

participants or of the plan as a whole

Managed Accounts An investment management service that allocates assets

based on the participant’s age, target retirement date, or life expectancy

Qualified Default Investment Options

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VALUING INVESTMENTS AND FASB ASC 820 FAIR VALUE

HIERARCHY

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Financial Instruments & Fair Value

ASC 820 does not provide guidance with respect to the recognition or classification of financial instruments!

Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures provides guidance with respect to:

• Defines fair value • Sets out a framework for measuring fair value, which refers

to certain valuation concepts and practices • Requires certain disclosures about fair value measurements

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Financial Instruments & Fair Value

Fair Value Hierarchy

• Level 1 inputs are quoted prices (unadjusted) in active

markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

• Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

• Level 3 inputs are unobservable inputs for the asset or liability.

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Financial Instruments & Fair Value

Valuation techniques: When fair value is directly observable (exchange traded), the quoted market price must be used for measuring fair value, generally without any adjustments. ASC 820-10-35-24A describes three commonly accepted valuation techniques:

•Market approach •Income approach •Cost approach

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Market Approach • Level 1 securities • The fair value of a

private equity security may be estimated based on observable EBITDA multiples, market caps, etc. for similar companies

Income Approach • Interest rate swap

discounted cash flows

• Investment contracts • Private company

equities - DCF

Cost Approach Generally not applicable to

financial instruments (start-up phase

company equities possibly)

Financial Instruments & Fair Value

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Unit of Account

Investment Type Unit of Account

Limited partnership Interest in LP

CCT (Common/collective trust fund) CCT unit

Hedge Fund Interest in Fund or Hedge Fund unit

Managed fund (aka “separate account”) Underlying investments

Synthetic GIC Underlying investments

Fixed income security Individual security

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You may enter your text here. Keep it short and simple

You may enter your text here. Keep it short and simple

Fair Value – Basics

EQUITY - Publically traded equity securities and publically traded debt are level 1 securities and should use the closing price on the applicable exchange.

DEBT - Most debt securities (including most US Treasuries) are valued using a pricing model and are level 2 securities. • Proprietary models used by pricing

services • Use inputs such as credit risk and

interest rates • To be level 1, the bond must be

traded and have a market observable price.

Investment Securities

(as defined)

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You may enter your text here. Keep it short and simple Investment

Securities (as defined)

MUTUAL FUND – a mutual fund is not an exchange-traded instrument. • Classification may depend on

the level of activity. Most open-end funds sell shares to the public every business day which are priced at net asset value (NAV).

• Closed-end funds and some open-ended funds that are infrequently traded may be level 2 measurements (or considered a NAV practical expedient).

Fair Value – Basics

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Alternative Investments May report the investment in these funds at the net asset value (NAV) in certain instances. • Entities that apply the investment guide and

meet certain criteria (ASC 946-10-15-2) • Entities that report a NAV or it equivalent (real

estate fund)

Definitions

You may enter your text here. You may enter your text here.

Fair Value – Financial Instruments

Investments in private investment funds; including investments in hedge funds, private equity funds, venture capital funds, commodity funds, real estate funds, offshore fund vehicle, and fund-of-funds, as well as bank common/collective trust funds.

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Typically valued at NAV using practical expedient

Often included as a “level 2” for ASC 820 disclosures However, these are often level 3 as well

Also, need ASC 820-10-50-6A (ASU 2009-12 disclosures) Strategies

Unfunded commitments

Redemption frequency, restrictions, notice period

Alternative Investments

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NAV & Fair Value Restrictions on redemption impact the fair value

measurement within the hierarchy, but not the reported fair value (NAV)

Adjustments are recorded only if it is probable the plan will dispose of at an amount less than NAV

Underlying characteristics of assets held by the investment company does not impact the measurement (leveling disclosure)

Alternative Investments

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Your Title Text Here

Liquidation restrictions, including estimated period of time

Unfunded commitments

Redemption rights and other limits on redemption

Potential sale at amount other than NAV

Alternative Investments Required disclosures if the NAV is used include all disclosures required by ASC 820 plus several specific disclosures regarding each major investment category reported at the NAV.

Alternative Investments

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As defined by the ASC, investment contracts include: Traditional guaranteed investment contract (GIC)

Separate account GIC

Bank investment contract (BIC)

Synthetic GIC

A contract with similar characteristics

Plans may hold stable value investments through direct contracts with issuers or through a specifically plan-managed account.

Plans may also hold stable value investments through ownership of bank collective trust funds or pooled separate accounts (which own investment contracts).

Investment Contracts

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Guaranteed Investment Contracts Present value of future cash flows (straightforward calculation)

Model needs to consider terms of the contracts; no one size fits all method.

MUST CONSIDER RESTRICTIONS ON REDEMPTION AND THE ABILITY TO TRANSACT AT FAIR VALUE!

Synthetic GICs For synthetic GICs, the calculation of fair value is determined separately

for the portfolio of underlying investments and the wrapper (sum of the two values equals for fair value of the synthetic GIC).

Investment Contracts

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Private Company

Equity Securities

If quoted prices in active markets or arm’s length transactions have occurred for the entity’s equity securities, use that information.

If not, then management should select the valuation method(s) that are appropriate for their industry, life cycle, etc. • A single valuation method may be

appropriate • Or, it may be more appropriate to

use multiple valuation methodologies (typically market and income approach)

Fair Value – Financial Instruments

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Private Company Securities Market Approach

Market value of equity (MVE) to net income or book value Enterprise value to EBIT Enterprise value to EBITDA Enterprise value to revenue Enterprise value to debt free cash flows Enterprise value to book value of assets

Income Approach Discounted cash flows Probability weighted cash flows

Typically, a combination of these methods is appropriate.

Private Company Securities – ESOPs

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Fair Value – Financial Instruments

Valuation should consider the relative applicability of the valuation techniques used given:

• Nature of the industry • Current market conditions • Quality, reliability and verifiability of the data used in each model • Comparability of public entity or transaction data used • Additional considerations unique to the entity

Consideration should be given to significant differences in valuation methodologies (why are they different?)

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Fair Value – Financial Instruments

Discount rate: 20.00%Growth rate: 10.00%Time - midyear convention 0.5 1.5 2.5 3.5

YEAR 12/31/2010 12/31/2011 12/31/2012 12/31/2013 ResidualEBITDA $11,435,726 $12,579,299 $13,837,228 $15,220,951 $15,220,951

$152,209,513Discount Factor 91.29% 76.07% 63.39% 52.83% 52.83%PV - cash flow $10,439,342 $9,569,397 $8,771,947 $8,040,951 $80,409,514

PV - cash flows $36,821,637PV - cash flows + residual value $117,231,150

Marketability Discount 35%

Estimated Fair Value $76,200,248

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Fair Value – Financial Instruments

DCF $76,200,248 0.75 $57,150,186Market Approach $94,000,000 0.25 $23,500,000

Blended value $80,650,186

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Fair Value – Interest Rate Swaps

Interest rate swaps are not traded on an exchange, thus the income approach is typically used to measure fair value.

Settlement Value (received from the counterparty) vs Fair Value:

• Settlement value does not consider counterparty (CVA) or company specific creditworthiness (DVA), thus does not represent fair value.

• Many times the amount reported by the counterparty includes accrued interest receivable/payable.

Interest Rate Swaps

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Fair Value – Financial Instruments

Some typical classifications within the hierarchy: Investment Level Traded equities Level 1

US T-Bills Level 1/2

US Treasuries Level 2

Municipal securities Level 2

US Agency securities Level 2

Private (hedge) funds Level 2/3

Private company equities Level 3

Private company debt Level 3

Funds - Net Asset Value (NAV) Level 2/3

Certificates of deposit Level 2

Mutual Funds Level 1/2

SELECTION AND MONITORING OF PLAN INVESTMENTS AND

INVOLVEMENT OF OUTSIDE INVESTMENT ADVISORS

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ERISA Fiduciaries

Plan Participant

Plan Assets

Plan Administrator Section 3(16)

Investment Manager

Section 3(38)

Excluded Fiduciary

Investment Fiduciary Section

3(21)

These fiduciaries exercise control

Mutual funds excluded

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A plan administrator named in the plan document is responsible for regulatory filings, making disclosures to participants, selection and monitoring of all service providers and any other activities called for in the plan documents.

Plan administrators may use other service providers to carry out any or all of these duties.

The plan administrator has responsibility for all aspects of the plan, except where specific relief is granted by regulation or transferred to another fiduciary.

Section 3(16) Plan Administrator

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Selected by the plan fiduciary as an expert to advise the plan fiduciary concerning investment decisions. The advising fiduciary does not have discretionary authority.

Generally limited-scope: responsibilities include recommending investments to the plan sponsor.

Monitoring those investments and suggesting replacements as appropriate.

Providing participant education (can include one-on-one advice).

Advising the plan sponsor in following a fiduciary process, including the Investment Policy Statement.

Investment Fiduciary under Section 3(21)

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Investment manager selected to manage some or all of plan assets and have discretionary authority to select investments.

Investment managers take responsibility for the duties called for in their specific agreement with each plan.

Must be (a) a bank, (b) an insurance company, or (c) a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940 to qualify to be a 3(38) investment manager.

Investment manager must acknowledge in writing that they are acting as a fiduciary with respect to the plan.

Investment Manager Under Section 3(38)

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Proposed definition is a two-part test: First part (defines services included in the definition) Provide advice or appraisal or fairness opinion concerning

the value of securities or other property

Recommends as to the advisability of investing in, purchasing, holding, or selling securities or other property

Provides advice or recommendations as to the management of securities or other property

Proposed Investment Fiduciary

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Proposed Investment Fiduciary

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*Employee Retirement Income Security Act of 1974 (ERISA), enacted September 2, 1974) establishes minimum standards for pension plans in private industry and provides for extensive rules on federal income tax effects of transactions associated with employee benefit plans. ERISA was enacted to protect the interests of employee benefit plan participants.

Second part (one of four alternative conditions) Acknowledged ERISA fiduciary

Exercises discretion with respect to the management of plan assets or administration of the plan

Investment advisor (Investment Advisors Act of 1940)

Multi-factor – provides advice or recommendation pursuant to an agreement, arrangement, or understanding

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Individuals responsible for purely administrative functions, such as:

Accountants, attorneys, actuaries and consultants, and service providers generally not considered fiduciaries.

Applying rules to determine eligibility for participation

Preparing employee communication materials

Collecting contributions and applying them as provided by the plan

Preparing government agency reporting

Maintaining participant records

Who is not a fiduciary

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Conduct a plan audit / fiduciary checklist. Create an investment policy statement and follow it. Not required but encouraged. “An investment policy statement

…. is consistent with fiduciary obligations set forth in ERISA §404(a)(1)(A) and (B) 1”

Create an administrative policy, include periodic reviews. Annual (minimum) investment reviews Other reviews if circumstances warrant them Regular meetings with fiduciaries and service providers

Maintain a fiduciary due diligence file to document all decisions and meeting minutes.

Documenting a Prudent Process

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1 Interpretive Bulletin 2509.94-2

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Construction of an investment menu

Participant demographics are included in investment decisions

Select choices that are not highly correlated;

Available options should cover the spectrum of risk and reward;

Investment menu should not inadvertently tilt toward a particular asset class by offering multiple funds in one or two asset classes.

Investment Menu Selection

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Qualitative – Stability of the organization: There should be no perceived organizational or

significant legal problems. The same portfolio management team should be in place for at least three years. Continuous.

Quantitative – Asset Allocation: An appropriate allocation is one that, looked at in its entirety,

has asset classes with low correlation to each other. Asset classes are chosen that tend not to move in tandem with each other. Additionally, underlying securities should be reviewed for overlap. Annually.

– Correlation to style or peer group: The product should be highly correlated to the asset class of the investment option. Important because much of the remaining due diligence involves comparisons of the manager to the appropriate peer group. Quarterly.

Investment Analytics

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Quantitative – Performance relative to a peer group and appropriate benchmark: The

product's performance should be evaluated against the appropriate benchmark and peer group's median manager return, for 1-, 3- and 5-year cumulative periods. Quarterly.

– Performance relative to assumed risk: The product's risk-adjusted performance (standard deviation and Sharpe Ratio) should be evaluated against the peer group's median manager's risk-adjusted performance. Quarterly.

– Minimum track record: The product's inception date should be greater than an established minimum number of years, and the managers should have a similar minimum managing the proposed asset class with a verifiable track record. Quarterly.

– Expense ratios/fees: The fund's expense ratio or manager's fees should be compared to the median of its peer group consideration may be given for funds or managers that consistently provide superior performance. Quarterly.

Investment Analytics

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Consider Alternatives. The investment strategy, historic returns, and expenses tend to vary greatly for TDFs, even if they target the same retirement year.

Periodic Review. The EBSA notice warns as follows: “At a minimum, the [fiduciary] review process should include examining whether there have been any significant changes in the information fiduciaries considered when the option was selected or last reviewed.”

Volatility. The underlying investments for TDFs depend on assumptions about the “glide path” by which plan participants cash-out their accounts. This affects the investment risks for the TDFs, and causes a surprising level of investment volatility that warrants informed analysis by ERISA fiduciaries.

Fees. Do you understand the fees and expenses, including any sales loads, for plan investments In recent years, the most common and costly source of ERISA litigation has come from plans that pay excessive fees.

EBSA "Tips" that ERISA Fiduciaries Should Consider

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Customized Products? While it is common to use a “fund family” from one vendor in order to cover some alternatives, customized alternatives are possible, with EBSA steering plan fiduciaries to engage in a cost-benefit assessment.

Employee Communications. The 2008 financial downturn shocked many plan participants who thought their TDF investments were secure from losses. The DOL has proposed regulations, and is regularly issuing guidance, that require plan fiduciaries to make more extensive disclosures to plan participants.

Be Informed. The EBSA mentions an increasing number of commercially-available sources for additional information, and suggests attention to them as a supplement for fiduciary assistance.

Document Diligence. The EBSA tips close by simply noting that “fiduciaries should document the selection and review process, including how they reached decisions about individual investment options.” An ability to demonstrate procedural prudence is simply critical for defusing ERISA litigation. Smoking guns may occur in committee minutes that note issues, but leave questions about resolution and action. ERISA meetings warrant detail, coupled with thoughtful review for completeness.

EBSA "Tips" that ERISA Fiduciaries Should Consider

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REGULATORY REPORTING REQUIREMENTS AND AUDIT

PROCESS

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The DOL has recently completed its review of a sample of 400 audits performed during the 2011 filing year.

Based on the population it is expected that almost half of the audits selected have been performed by audit firms that do less than five plan audits per year. Prior DOL inspections have indicated that these firms have a higher

risk of deficient audits.

The final results are expected to be released soon. Preliminary reports are that the DOL is very concerned about the

inspection findings and will likely push for increased regulation.

DOL’s Current Focus: Audit Quality

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DOL expects (and auditing standards require) plan auditors to test: Year-end values of plan investments

A sample of purchases and sales transactions – review for proper authorization, pricing, gain/loss

Investment income (e.g. unrealized gains/losses)

Limited-scope audits – obtain proper certification

Participant loans – properly authorized and re-payments being made

DOL’s Current Focus: Investments

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Service Provider Fee Disclosures Employers and workers received in 2012, for the first time, a

new, standardized set of disclosures on all investment options in their plans.

These new disclosures highlight any plan-level fees and ensure greater uniformity of disclosures from investment type to investment type.

Places additional requirements on service providers and plan sponsors.

DOL will continue to push for increased transparency in this area.

DOL’s Current Focus: Investments

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Service Provider Fee Disclosure

Disclosures are required to avoid prohibited transaction.

Review disclosures to determine if all required disclosures have been received.

Review disclosures for compliance. Description of the services to be

provided Status as a fiduciary Direct and indirect compensation

Determine if there are conflicts of interest.

Determine if fees are reasonable.

FOR INSTITUTIONAL USE ONLY / NOT FOR PUBLIC USE

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Required annual discloser – who will be distributing annual disclosure(s)?

Review expenses required to be disclosed on quarterly participant statements.

Review website responsibilities. Review investment options to determine which will be

“designated investment alternatives”(“DIAs”). Managed accounts

Models

Brokerage windows

Create participant communication to establish expectations.

Participant Fee Disclosure

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DOL’s examples of valuation best practices: Established, comprehensive, and documented valuation

policies and procedures are established.

Policies should identify the methodologies for valuing each type of financial investment.

Consistency of valuing financial investments using established procedures.

Policies and procedures are reviewed regularly.

Plan management ensures high level of independence in application of valuation policies and procedures.

DOL’s Current Focus: Hard-to-Value Investments

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On September 30, 2013, the DOL’s Office of Inspector General (OIG) issued a report: “EBSA Needs To Provide Additional Guidance and Oversight to ERISA Plans Holding Hard-To-Value Alternative Investments” OIG’s Findings:

Significant plan assets are invested in hard to value assets Critical of EBSA for not requiring fiduciaries to have an established

process to determine the fair market value of alternative investments, and to maintain written documentation.

EBSA’s response suggests that specialized guidance for valuing alternative investments will not be forthcoming.

The EBSA has established alternative investment investigation projects in several regional offices

EBSA’s response also indicates that its attention to valuation issues will continue on a case-by-case basis.

DOL’s Current Focus: Hard-to-Value Investments

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OIG’s Findings, continued: The “limited scope audit exemption” was another factor that

raises the risk of losses from hard-to-value investments: ERISA allows plans to elect a “limited scope audit” in which plan

auditors perform no auditing procedures to test for existence or valuation of plan assets held and “certified” by a qualifying financial institution.

Financial institutions holding these plan assets need not certify that they are reporting them at fair market value, but only that their records are “complete and accurate.”

DOL’s Current Focus: Hard-to-Value Investments

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5500 Reporting: Schedule H of the Form 5500 captures financial details about the

plan’s assets, liabilities and investments. Question 4g on Schedule H asks if the plan holds:

Any assets where the fair market value was not readily determinable on an established market and if so, the dollar amount involved.

DOL inspection findings indicate the answers to this question are often incorrect.

DOL plans to revise Form 5500—expect to see more questions related to hard-to-value investments.

The DOL reviews Form 5500 filings including the audited financial statements of large plans (full-scope and limited-scope) for hard-to-value investments. The DOL has been requesting documentation or other support on hard-

to-value investments.

DOL’s Current Focus: Hard-to-Value Investments

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Handouts: MHM Whitepaper, Plan Sponsors Guide to Retirement Plan

Investments

AICPA Plan Advisory, The Importance of Internal Controls in Financial Reporting and Safeguarding Plan Assets

AICPA Plan Advisory, Valuing and Reporting Plan Investments

Internal Controls: Investments

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Objective Investment transactions

are recorded at the appropriate amounts and in the appropriate periods on a timely basis.

Examples of Selected Controls Reports submitted by trustees/asset

custodians or investment managers are reviewed.

Detailed subsidiary records are reconciled to trust reports on a regular basis.

Control totals from participant’s records are compared to control totals from trust reports on a regular basis. Report of trustee’s/asset custodian’s independent auditor is reviewed.

Purchases and Sales (as a result of contributions, distributions, etc.) of mutual funds are reviewed to determine that the net asset value agrees to published quotations.

Purchases and Sales are reviewed to determine that the appropriate fair value was utilized.

Internal Controls: Investments

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Objective Investment income and

expenses are recorded at the appropriate amount and in the appropriate period on a timely basis.

Examples of Selected Controls Commissions and management fees are

reviewed for appropriateness and adherence to the contract.

Interest, dividends and other sources of income, including securities lending fees, are reviewed for receipt and for accuracy by reference to reliable sources.

If income is allocated to more than one plan or participant accounts, allocation methods and calculations are reviewed.

Internal Controls: Investments

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Objective Investments (other than

insurance contracts with insurance companies) are measured at fair value.

Examples of Selected Controls Quotation sources and appraisal reports are

compared with recorded values. Pooled separate accounts and common

collective trusts are compared to net asset values calculated by the issuer.

Financial statements of pooled separate accounts and common collective trusts are obtained and unit information contained in the financial statements is compared for reasonableness to the unit values reported to the plan.

Valuation methods are documented in the trust agreement or plan committee minutes.

Basis for “good faith” estimates including independent appraisals, if any, is documented.

“Good faith” estimates are approved by plan committee.

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Objective Investment criteria and

objectives are authorized and executed in accordance with formal authorizations.

Examples of Selected Controls Investment criteria or objectives are

documented in the plan instrument or plan committee minutes.

Authority to execute transactions is specified in the plan instrument or plan committee minutes.

Investment transactions are reviewed by a plan committee for adherence to investment guidelines.

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Objective Investment assets are

protected from loss or misappropriation.

Examples of Selected Controls Responsibility for investment decisions and

transactions is segregated from custodian’s functions.

Financial stability of financial institutions holding investments is reviewed.

Securities that are physically held (e.g., by a custodian or depository) are periodically counted or otherwise verified.

Written-off investments are reviewed for possible appreciation.

(Continued on next slide)

Internal Controls: Investments

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Objective Investment assets are

protected from loss or misappropriation.

Examples of Selected Controls Documents are controlled in a limited-

access, fireproof area. Securities held by independent custodians

are confirmed. Access to computerized investment

records is limited to those with a logical need for such access.

The custodial function is separate from the responsibility for investment decisions, transactions and recordkeeping.

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ESTABLISH, DOCUMENT AND COMMUNICATE YOUR INTERNAL CONTROLS

In Summary

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Questions?

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Join us for this course: 12/11 & 12/16: Fourth Quarter Accounting and Financial Reporting

Issues Update

2015 courses in development now!

Read this related publication: MHM Whitepaper, Plan Sponsors Guide to Retirement Plan

Investments

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