When a downturn in the economy occurs, the incentive to commit fraud increases. Because of the characteristics of fraud, the auditor’s exercise of professional skepticism is important when considering the risk of material misstatement due to fraud.
There are two types of fraud associated with employee benefit plans: fraudulent financial reporting and misappropriation of assets. Specific areas of concern might be the improper valuation of investments, defalcations, inappropriate vesting of participants, ineligible participants included in the plan, and inappropriate benefit disbursements.
Plan administrators must also be aware of the possibility of a partial termination when a downturn in the economy causes layoffs at the plan sponsor. When a partial termination occurs, the Internal Revenue Code requires that all affected participants become fully vested. A partial termination is a technical term that does not have a clear definition but has generally been interpreted to apply when 20 percent or more of the workers have lost their jobs due to an event such as a plant closing or general layoffs. Because many 401(k) plans use forfeitures to reduce employer contributions or to pay expenses, it is important for the plan administrator to properly identify when a partial termination has occurred.
The trend of participants withdrawing money from their 401(k) accounts due to hardship is expected to continue as the economy continues to struggle. If the hardship distributions are significant to the plan, they may need special consideration during audit because hardship distributions are generally processed differently than other types of distributions.