Understanding the Importance of Fidelity Bonds for ESOPs
Fidelity bond coverage is essential to help protect your employee stock ownership plan (ESOP) from loss due to fraud or dishonesty. Fidelity bond coverage must be reported on IRS Form 5500 each year, so it’s important to know the ERISA (Employee Retirement Income Security Act of 1974) bonding requirements to confirm you are in compliance. To do this, you must first understand what a fidelity bond is and the coverage requirements.
What Is a Fidelity Bond?
A fidelity bond is a type of insurance required under Section 412 of ERISA to protect the ESOP from losses resulting from fraud or dishonesty. According to 29 CFR 2580.412, “fraud or dishonesty” includes “all risks of loss that might arise through dishonest or fraudulent acts in handling plan funds or other property.” This can include a range of actions, such as theft, embezzlement, and misappropriation.
ERISA requires every person who “handles funds or other property” to be covered under the fidelity bond. Bond coverage is required for a fiduciary or individual who has:
- Physical contact with cash, checks, or similar property, unless risk of loss is negligible because of close supervision and control;
- Power to exercise physical contact or control, whether or not it actually occurs or is authorized, such as access to cash or power to withdraw funds from a bank;
- Power to transfer to oneself or a third party or to negotiate property for value;
- Power to disburse funds or other property, such as the power to sign checks or other negotiable instruments;
- Supervisory or decision-making responsibility over any individual described above.
The ERISA bonding requirement is not covered by fiduciary liability insurance, which typically insures the ESOP against losses caused by violations of fiduciary responsibilities.
An ESOP’s fidelity bond coverage is based on the funds held by the plan at the beginning of each year. The ERISA requirement is 10% of these funds, with a minimum requirement of $1,000. No bond is required for an amount greater than $500,000 ($1 million for plans that hold employer securities such as an ESOP). Most bonds can be set up with an “inflation guard” provision that automatically increases the coverage to the required amount under ERISA, up to the $1 million limit.
For example, assume an ESOP holds $3 million in funds as of December 31, 2022. The required fidelity bond for 2023 would be at least $300,000. If that same ESOP held $30 million in funds as of December 31, 2022, the required coverage for 2023 would be $1 million.
The ESOP must be specifically named in the bond (or through attachment of a rider) to help ensure proper coverage. In addition, the bond should have no “deductible” feature that applies to ERISA plan claims as §412 requires that the bond insure the plan from the first dollar of loss. Bonds also must be placed with a surety or reinsurer that is named on the U.S. Department of Treasury’s Listing of Approved Sureties. Multiple plans can be insured on the same bond as long as the bond insures the required minimum coverage for each plan that is included.
The ESOP plan sponsors and others who handle funds must make sure that proper bond coverage is in place to guarantee compliance with ERISA requirements. Since the bond is required to be reported on the Form 5500 each year, it’s essential to understand your responsibility and make sure you are fully protected.
If you have any questions or need assistance, please reach out to a professional at FORVIS or use the Contact Us form below.