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Why Your 401(k) Plan Needs an Objective Auditor

Sept. 18, 2015
Why Your 401(k) Plan Needs an Objective Auditor
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By Jonathan Broadbent

Learn more about Jonathan on NerdWallet’s Ask an Advisor

Some corporate accountants perform a critical function called a retirement plan audit. Once a year, they prepare a report showing how well — or how poorly — a company’s 401(k) plan is being run. This is an opportunity to uncover any problems or conflicts of interest, so it’s essential that the auditors be objective. That’s why these audits are typically done externally, meaning the accountants who perform them are not employees of the company.

If you have money in a 401(k), however, it’s important to understand that while having an outsider do the audit is a good start, it’s not enough by itself to guarantee objectivity.

The results of a retirement plan audit become public record. Anyone can delve into your 401(k) and see who’s doing what for the plan, how much they’re getting paid, what the investments are and how much money is in each one. Even small plans, which are not required to have an audit, file a “short form” version of this report, which also becomes public record.

If employees are unhappy about the plan and discover that the CEO’s country club pal is the plan advisor, or that the company’s bank also runs the 401(k), or any other questionable arrangement, they might want to look at the fees being paid by the plan. If the fees are high, employees have every right — I’d argue it’s an obligation — to question those fees.

This is where the accounting firm comes in. If the auditors do a good job, their reports and tax filings can uncover potential problems in your plan — soft-dollar (commission) revenue sharing, kickbacks to brokers, affiliated investments, high servicing fees and a variety of similar schemes that create a drag on investment performance or leave your company exposed to liability. This is why audit reports are public: so interested parties can examine them. It’s not guaranteed that the audit will uncover all flaws, but at least you have a fighting chance when the auditor is objective.

But what happens when the auditors are not objective or have a relationship with your plan advisor? When the accounting firm is affiliated with a wealth management or brokerage firm that also manages the 401(k) plan, things can get ugly quickly.

To be fair, a growing number of accounting firms are insisting on autonomy, electing not to do audit work if they also have wealth management divisions, or splitting off the business unit that represents a conflict of interests. And many small- to mid-sized accounting firms outsource certain parts of the audit to firms that can conduct more complete advisory examinations of 401(k) plans.

But when the accountant and the plan advisor work for the same firm, you essentially have auditors overseeing their own work. Imagine having to disclose improper kickbacks involving a broker who is just down the hall from you and whom you see at the annual holiday party.

Such circumstances can generate a dizzying array of potential conflicts. A broker’s primary objective is selling investments or insurance to individuals outside of 401(k) plans. This is because, on average, they stand to make a lot more money on those products and services.

Reconciling these two roles — advising the 401(k) plan and selling products to individuals — is difficult. When the same person or firm attempts to fill both roles, distinguishing between them becomes nearly impossible. Yet many wealth management and brokerage firms still oversee 401(k) plans. When the firm auditing these arrangements is also affiliated with the wealth management firm, you likely lose any real chance of accountability.

To make matters worse, retirement plan advisors are often asked to assess the reasonableness of the fees the plan pays to its service providers, including the accountants. This is called “benchmarking.” But an advisor who is affiliated with the accountant may have trouble calling attention to high accounting fees or a lack of service. Or what if the advisor’s own compensation has been misreported? Who would catch that?

In short, when you have accountants effectively auditing their own work and financial advisors examining the fees being paid to their colleagues, the system designed to protect you is dismantled.

If you have a brokerage firm handling your 401(k), you shouldn’t be surprised if you continue to experience high fees and low accountability. And if your accountant also happens to be affiliated with the firm, the checks and balances are virtually eliminated. At the very least, it creates the appearance of a conflict of interest that should be addressed.

This article also appears on Nasdaq.

Image via iStock.

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