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ERISA Assets: QPAM and INHAM Audit
Legal Requirements and Best Practices Structuring Provisions to Achieve Tax Benefits and Avoid Common Pitfalls
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WEDNESDAY, AUGUST 29, 2012
Presenting a live 90-minute webinar with interactive Q&A
Susan Mangiero, Managing Director, FTI Consulting, New York
Terry Orr, Contractor, FTI Consulting, Dallas
David E. Pickle, Partner, K&L Gates, Washington, D.C.
William A. Schmidt, Partner, K&L Gates, Washington, D.C.
ERISA Assets: QPAM and INHAM Audit
Legal Requirements and Best Practices August 29, 2012
Overview
• Institutional Investors Face Challenges
• QPAM and INHAM Audit Rules
• Nature of QPAM and INHAM Audits
• How to use QPAM and INHAM Audits
• Conclusion and Questions
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ERISA Clients Are Nervous
• Fiduciary breach litigation is on the rise.
• Investment complexity is a challenged for organizations with small teams and limited budgets.
• 2008/2009 losses are still a reality with investors trying to play “catch up” by taking on more risks in search of greater returns.
• Liquidity risk is getting more attention after lock up and “no redemption” surprises.
• Corporate plan sponsors are getting downgraded for “bad performing” pension plans while having to contribute billions of dollars to meet statutory funding requirements
• Regulators are taking hard looks at institutional investor commitments to alternatives.
• New disclosure rules are forcing institutional investors to get more information from their service providers.
• Investors need to be able to vet a fund’s use of leverage.
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Overview of the QPAM
Exemption—PTE 84-14
• Provides relief from a broad range of “party in interest” prohibited transactions
• Applies if transactions are entered into and plan assets are managed by a “Qualified Professional Asset Manager” and transactional conditions are satisfied
• Does not provide relief for “self dealing” prohibited transactions
• Generally intended for managers of “unaffiliated” assets
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QPAM Status Conditions
• SEC-registered investment adviser or state or federally regulated bank or state-regulated insurance company
• At least $85 million in assets under management as of the end of the most recent fiscal year
• At least $1 million in owner’s equity on most recent balance sheet prepared on a GAAP basis
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QPAM Transactional Conditions
Conditions include:
• Counterparty is not person (or affiliate) who has power to appoint QPAM or negotiate terms of agreement with QPAM
• Transaction is not covered by certain other PTEs
• QPAM independence with respect to transaction
• Counterparty is not QPAM or related to QPAM
• Plan (and related plans) are not more than 20% of assets managed by QPAM
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Plans Sponsored by a QPAM
• Does the QPAM Exemption apply to plans sponsored by the QPAM?
▫ Pre-2003: Yes (consensus view)
▫ 2003-2010: DOL suggests the answer is no, but grants transitional relief
▫ 2010: DOL issues final amendment requiring adoption of policies and procedures and audits with respect to QPAM-sponsored plans
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Special Requirements for
“QPAM Plans”—Post 2010
• QPAM must adopt policies and procedures that address compliance with “objective requirements”: ▫ QPAM status and definition
▫ Transactional conditions listed in slide 10
• Annual audit of QPAM on compliance with policies and procedures and objective requirements
• Test of representative sample of transactions
• Written audit report issued to QPAM sponsored plan
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Overview of the INHAM
Exemption—PTE 96-23
• Provides relief from a broad range of “party in interest” prohibited transactions
• Applies if transactions are entered into and plan assets are managed by a “In-House Asset Manager” and transactional conditions are satisfied
• Does not provide relief for “self dealing” prohibited transactions
• Intended for in-house managers of “affiliated” assets, e.g., assets of plan sponsored by INHAM’s parent
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INHAM Status Conditions
• Subsidiary (80% or more) of plan sponsor or parent
• SEC-registered investment adviser
• At least $85 million in assets under management as of the end of the most recent fiscal year
• “Affiliated Plans” must have at least $250 million in assets
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INHAM Transactional Conditions
Conditions include:
• INHAM independence with respect to transaction (limited veto permitted)
• Transaction is not covered by certain other PTEs
• Counterparty is not employer or certain affiliates
• Counterparty is not a fiduciary with respect to assets involved in the transaction
• Counterparty is not the INHAM or related to the INHAM
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INHAM Policies and Procedures
and Audit Requirement
• INHAM must adopt policies and procedures that address compliance with “objective requirements”: ▫ INHAM status and definition
▫ Transactional conditions listed in slide 15
• Annual audit of INHAM on compliance with policies and procedures and objective requirements
• Test of representative sample of transactions
• Written audit report issued to affiliated plans
13
QPAM and INHAM Audit Outcomes
• Clean Audit
• No Audit ▫ QPAM
▫ INHAM
• Late Audit
• Failed Audit ▫ Failure of QPAM or INHAM status
▫ Failure to comply with policies and procedures
▫ Failure to comply with transactional requirements
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Nature of QPAM and INHAM Audits
• Auditor Qualifications
• Audit Components
• Role of Counsel and other Professionals
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Auditor Qualifications
For both QPAM and INHAM:
• Independence
• “Appropriate technical training or experience and proficiency with ERISA’s fiduciary responsibility provisions”
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Auditor Qualifications
• Independence
▫ Is the Adviser’s regular accounting firm or counsel independent?
Financial independence
Relational independence
▫ Other factors relating to independence
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Auditor Qualifications
• Appropriate technical training or experience
▫ Audit-related training or experience
▫ Other training or experience
• Proficiency with ERISA’s fiduciary rules
▫ Lawyers only?
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Audit Components
• Definition of “exemption audit” ▫ Review of written policies and procedures for
consistency with “objective requirements” QPAM/INHAM status Selected transaction conditions (see prior slides)
▫ Test representative sample of plan transactions ▫ Written audit report Steps taken by auditor Auditor’s findings
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Audit Components
• Representative sample of plan transactions
• Must allow auditor to:
▫ Make findings on compliance with policies and procedures and objective requirements
▫ Render an opinion on compliance with the sections of the QPAM or INHAM Exemption that require policies and annual audit
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Audit Components
• Written audit report
▫ Describes steps taken by auditor
▫ Lists auditor’s findings
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Audit Issues
• Timing—Report required within 6 months of end of audit period
• Document Review
• Transaction sample—“Size and nature”
• Certifications from QPAM/INHAM
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Audit Issues
• Scope—Audit must cover required elements; should an audit cover other aspects of QPAM or INHAM compliance?
• Role of QPAM/INHAM Employees
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Take Advantage of the
Audit Requirement
• Information Gathering
• Risk Mitigation
• More Than Just Compliance
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Partial List of Risk Factors to
Measure and Manage
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Accounting Compliance Headline Model
Actuarial Contagion Fiduciary Political
Advisory Correlation Fraud
Portfolio
Allocation Counterparty Leverage Process
Asset-Liability Integration
Custodial Limits Regulatory
Basis Demographic Litigation Settlement
Benchmarking D&O Longevity Style Drift
Capital Access Document Adherence
M&A Systems
Client Mix Downgrade Market Tax
Collateral Enforcement Operational Valuation
Complexity Fees Plan Design Vendor
Dangers of Overlooking
Operational Risk Factors
• Human error, systems problems and poor or missing checks and balances cost asset managers and investors billions of dollars every year.
• From an asset manager’s perspective, not every investor is asking the same questions. Scope may differ based on factors such as prior relationship, location and the manager's experience.
• Operational due diligence should be coordinated with legal due diligence and investment due diligence.
• Best practices generally include:
Third-party vendors - identify, verify relationship and capabilities Controls - cash, systems, organization Compliance programs and policies Valuation policies Portfolio companies
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Audit Issues—Role of Counsel
• Inside or outside counsel may have various roles relating to the audit. Possible functions of counsel include:
▫ Vetting auditor candidates
▫ Helping maintain auditor independence
▫ Preservation of attorney-client privilege
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Using the QPAM or INHAM Audit
• Possible uses of an audit beyond maintaining the QPAM or INHAM Exemption include: Responding to DOL enforcement inquiries
Marketing
Correcting deficiencies or identifying weak areas
Mitigating litigation risks
• The audit report– public or private?
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Using the Audit—Responding to the DOL
• The DOL has increased investigations of investment advisers
• DOL is likely to look at policies and procedures and audit reports
• Proper and consistent policies and practices can help close DOL investigations
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Using the Audit - Marketing
• According to David Chavern, Chief Operating Officer for the U.S. Chamber of
Commerce, “the World’s Most Ethical Companies are also among the most successful.”
• According to the CFA Institute website, some firms claim compliance with the Asset Manager Code of Professional Conduct.
• NYSE CEO Duncan Niederauer recently testified before a Congressional panel that market malfunctions have made investors less interested in putting their money at risk. Fewer dollars invested means lower revenue for private fund owners.
• A few bad players make it harder for the remaining parties to transact with investors.
• Litigation against asset managers is on the rise.
• Third party litigation funding is becoming a big business.
• “An ounce of prevention is worth a pound of cure.”
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Using the Audit—Correction
The audit presents an opportunity to:
• Correct non-complying policies and procedures
• Identify areas where compliance can be improved
• Identify transactions that may not be covered by QPAM or INHAM and determine whether other exemptions apply
• Correct non-exempt prohibited transactions, if necessary
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Using the Audit—Mitigation
• Audit may support defense that adviser complied with QPAM or INHAM exemption
• Policies and procedures may demonstrate compliance mindset
• Policies and audit may help demonstrate that the adviser uses prudent investment process
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Conclusion and Questions
• Compliance Versus Governance
• Counsel and Auditor Complement Each Other
• ERISA Fiduciaries Want Assurances More Than Ever Before
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Susan Mangiero, PhD, AIFA®, CFA, FRM
− 34 −
Dr. Susan Mangiero is a managing director in the FTI Consulting Forensic and Litigation Consulting practice and is based in
New York. Dr. Mangiero is a CFA charterholder, certified Financial Risk Manager and Accredited Investment Fiduciary
AnalystTM. She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of
Pension Supervisors as well as offering expert testimony and behind-the-scenes forensic analysis, calculation of damages
and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence,
risk and valuation matters. She has over twenty years of experience in capital markets, global treasury, asset-liability
management, portfolio management, economic and investment analysis, derivatives, financial risk control and valuation.
This includes work on trading desks for several global banks, in the areas of fixed income, foreign exchange, interest rate
and currency swaps, futures and options.
Some of her recent engagements include: (a) analysis of DB plan funding status for a private equity buyer of a closely-held
company (b) analysis of an investment manager’s actions by a group of union plans (c) review of annuity terms for DB and
DC plans (d) review of investment policy statement language in the aftermath of bank downgrades (e) assessment of
damages by an asset manager that did not properly hedge positions (f) review of benefit distributions by a plan sponsor that
is being investigated and (g) analysis of fees paid by a large trust. Dr. Mangiero has provided insights about asset allocation,
fiduciary duties, risk management, modeling, hedge effectiveness, hedge funds, private equity funds, ERISA, valuation and
industry best practices for consulting clients and employers that include the General Electric Company, Prudential
Retirement, PricewaterhouseCoopers, Mesirow Financial, Bankers Trust, Bank of America, Chilean pension regulator,
World Bank, Pension Benefit Guaranty Corporation, RiskMetrics, U.S. Department of Labor, Northern Trust Company and
the U.S. Securities and Exchange Commission. Dr. Mangiero is the author of Risk Management for Pensions, Endowments
and Foundations (John Wiley & Sons, 2005), a primer on risk and valuation issues, with an emphasis on fiduciary
responsibility and best practices. Dr. Mangiero has written chapters for several books, including the Litigation Services
Handbook and The Handbook of Interest Rate Risk Management.
She is a frequently invited speaker and has keynoted or led workshops for organizations such as the Stable Value
Investment Association, Harvard Law School, Florida Public Pension Trustees Association, New York State Department of
Insurance, Association of Public Pension Auditors, AICPA - Employee Benefits Section, National Association of Corporate
Directors and Financial Executives International. She is a member of the 401(k) vendor RFP best practices committee for
the Association of Financial Professionals. Susan can be reached at [email protected].
Terry L. Orr, CPA
Forensic and Litigation Consulting
FTI Consulting
2001 Ross Avenue
Suite 400
Dallas, TX 75201
Tel: 214 397 1689
Fax: 214 397 1784
Education
B.S. in Accounting and
Business Administration.
Brigham Young University
Certifications
Certified Public Accountant
Professional Affiliations
American Institute of Certified
Public Accountants
Texas Society of Certified
Public Accountants
Terry L. Orr is contractor with FTI Consulting Forensic and Litigation Consulting practice and is based in
Dallas. Mr. Orr has over 30 years of experience in accounting and auditing, dispute advisory services,
financial advisory services, financial reporting, expert witness testimony and case consultancies. He
has provided professional services to clients in a wide variety of industries including E&P,
manufacturing/distribution, high tech, hospitality, healthcare, real estate and gaming.
Mr. Orr has been designated as an expert in Federal and State courts as well as domestic arbitrations
on matters involving claims requiring the analysis of: lost profits, financial misrepresentations, post-
acquisition disputes, negligence and accounting irregularities. Additionally, he has been retained by
audit committees, companies and outside counsel to assist in investigating allegations of accounting and
financial improprieties, including SEC and DOJ investigations and potential restatements. Mr. Orr has
also served as a monitor on compliance with deferred prosecution agreements after being selected by
the companies with agreement from the US Attorney’s office.
Mr. Orr’s investigation experience includes investigating alleged accounting irregularities related to
revenue recognition, earnings management, claim processing, management kick backs, option back
dating, whistle blower accusations, irregularities in internal controls and alleged fraudulent activities.
These engagements have involved analyzing company documents, including electronic evidence,
interviews of personnel, and discussions with auditors, management, boards and regulators. In addition
to services in investigations and litigation, his work has been used by companies and lending institutions
in their assessment of value and operational performances.
Prior to entering consulting, Mr. Orr was an audit partner with BDO Seidman, the 5th largest accounting
firm in the world. He also has previously worked for a Big Four accounting firm and was a partner in a
locally owned accounting practice. He holds a B.S. in accounting and business administration from
Brigham Young University and has developed and conducted training regarding accounting for and
financial presentation of option grants and establishment and monitorship of appropriate internal
controls. Mr. Orr is a Certified Public Accountant licensed in the state of Texas and is a member of the
American Institute of Certified Public Accounts and the Texas Society of Certified Public Accountants.
35
36
David Pickle, Partner
Washington, D.C.
T 202.778.9887
F 202.778.9100
Overview
Mr. Pickle concentrates on representing clients in matters dealing with ERISA’s prohibited
transactions and exemptions and ERISA’s fiduciary rules. He represents investment
managers, financial institutions and plan sponsors in a wide variety of matters including
investments and other transactions with ERISA plans and in litigation and government
enforcement actions. He also assists clients in obtaining U.S. Department of Labor ERISA
advisory opinions and prohibited transaction exemptions.
Mr. Pickle’s experience includes: defending clients in litigation and government enforcement
actions; negotiating investment management and related agreements; counseling asset
managers regarding fiduciary obligations and compliance with prohibited transaction
exemptions.
Professional Background
Mr. Pickle was formerly a Trial Attorney at the U.S. Department of Labor’s office for ERISA
enforcement, the Office of the Solicitor’s Plan Benefits Security Division. In that capacity he
was responsible for ERISA investigation, enforcement and litigation of a wide variety of
matters involving ERISA’s fiduciary rules and prohibited transactions. Mr. Pickle serves as
an Adjunct Professor of Law at Georgetown University Law Center.
37
William Schmidt, Partner
Washington, D.C.
T 202.778.9373
F 202.778.9100
Overview
Mr. Schmidt works in the areas of institutional investing and employee benefits, with
particular emphasis on fiduciary responsibility matters under the Employee Retirement
Income Security Act of 1974 (“ERISA”). Mr. Schmidt advises major financial institutions,
including banks, insurance companies, registered investment advisers and large
employee benefit plans about ERISA restrictions relating to plan investments and to fee
arrangements for investment management and plan administrative services.
Professional Background
Mr. Schmidt was formerly Counsel for Regulation in the Plan Benefits Security Division of
the Office of the Solicitor of the U.S. Department of Labor, where he was responsible for
providing legal advice with respect to the Department's regulatory, interpretive and
legislative activities under ERISA. Mr. Schmidt serves as an Adjunct Professor of Law at
Georgetown University Law Center.
