INSIGHT: The Dog Ate My Form 5500 Audit Report—Will My Penalty Be Reduced?

The Employee Benefits Security Administration (EBSA) may impose penalties on a plan administrator who does not file a timely and acceptable independent audit report along with the plan’s Form 5500 regarding its 401k retirement plan.

EBSA may reduce or waive those penalties, or they may be ultimately reduced or waived by an administrative law judge, if there are “mitigating circumstances” warranting a reduction. But what exactly are mitigating circumstances? As shown below, only one thing consistently hits the mark—the filing of a late but otherwise acceptable audit report.

Excuses Offered, Rejected

In cases litigated before the DOL’s Office of Administrative Law Judges (OALJ), plan administrators have offered a dizzying array of mitigating circumstances to excuse their failure to file timely, acceptable audit reports:

• careless third-party service providers;
• malingering or dead employees;
• inadequate resources; corrupted or missing records;
• erroneous legal advice; corporate reorganizations or mergers; and
• bankruptcies

All of these have been rejected by the OALJ as mitigating factors warranting a penalty reduction. Some of these sound perilously close to “the dog ate my homework,” but others reflect plausible, or at least real-world, challenges to preparing a timely and compliant audit report.

Nevertheless, in each instance, EBSA successfully argued, in effect, “Not my circus, not my monkeys.”

Only One Thing Moves the Needle

Just one factor has proven successful in convincing EBSA, or in a disputed proceeding, an administrative law judge, to reduce a Section 502(c)(2) penalty: the plan administrator submits a late, but otherwise compliant, audit report. A plan administrator who is facing a civil penalty for audit report deficiencies should, therefore, focus on achieving compliance rather than trying to justify its past failures. If done quickly, the reduction in the assessed penalty can be significant.

ERISA’s civil penalty scheme is intended to incentivize plan administrators to file timely and acceptable independent audit reports, which provide plan participants with current and accurate information about the plan. (Under regulations and applicable guidance, some pension benefit plans and many welfare benefit plans with fewer than 100 participants are exempt from filing an annual return/report.)

Insisting on payment of the full penalty, despite a plan administrator’s eventual correction of deficiencies, would remove any incentive for a plan governed by ERISA to file a corrected/amended report after a penalty is assessed against it. Thus, the late (but not too late) filing of an acceptable audit report is routinely considered a mitigating circumstance that warrants a penalty reduction.

Timing Matters

There are essentially four relevant milestones in the life of a civil penalty proceeding under ERISA Section 502(c)(2):

• EBSA issues a Notice of Intent to Assess a Penalty, which describes the deficiencies in the Form 5500 or the audit report.
• The plan administrator has 35 days to submit a Statement of Reasonable Cause, which must state that the plan administrator acted in compliance with ERISA or must state the mitigating circumstances and explain why the penalty should be reduced or not assessed.
• If EBSA rejects the Statement of Reasonable Cause, it will issue a Notice of Determination, in which it actually assesses the penalty and explains the basis.
• The plan administrator has 30 days to file a request for hearing and an answer, which together essentially initiate an administrative proceeding before the OALJ, a litigated matter complete with discovery procedures, status conferences, and a hearing on the merits before an administrative law judge.

The earlier in this process the administrator files an acceptable audit report, the larger the penalty reduction it might expect to receive. An analysis of judicial opinions on the OALJ website reveals a fairly reliable trend in cases that were litigated all the way to a decision on the merits:

A plan administrator can expect even better results by agreeing to settle the matter with EBSA rather than forcing a hearing. (How much better is not reported anywhere, but rather is learned only through experience.)

One caveat: if an administrator waits too long to file an acceptable report, the window for a penalty reduction might close. As one judge explained:

While participants and beneficiaries may well have an interest in obtaining even late-filed annual reports, it is difficult to imagine that by 2013 a plan participant would significantly benefit from receiving compliant 2006 report data…. At some point an annual report is so late … that the damage of noncompliance cannot effectively be undone.

Tips for Reducing Penalties

1. File an acceptable amended audit report as soon as possible, even if it is late. This is by far the most significant driver of penalty reductions.

2. Present the real-world reasons the report was not filed in a timely acceptable manner, but only to demonstrate there was no willful noncompliance.

3. Avoid, or at least minimize, disputes with EBSA over whether something is a deficiency. Time is the plan administrator’s enemy in this regard, as the value of a late, but compliant, report goes down over time.

4. Don’t expect EBSA to begin settlement discussions with you in a penalty proceeding until an acceptable report has been filed.

5. It seems that EBSA maintains an informal “naughty and nice” list of auditors who specialize in auditing employee benefit plans and do it well versus those who dabble and don’t. If you have doubts, consider asking EBSA if your auditor is on the “nice” list.

6. Remember that obtaining and filing a compliant audit report is a critical part of a plan administrator’s obligations under ERISA. An ounce of prevention is worth a pound of cure.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Brian J. Lamb is a partner and leader of Thompson Hine’s Business Litigation practice group in Cleveland. He represents companies and their directors and officers in complex business disputes, including ERISA litigation, securities and shareholder litigation, corporate governance and fiduciary disputes, and litigation arising out of mergers, acquisitions and tender offers, and complex contract disputes.