401(k) Specialist Issue 1 - 2024 - 31

401(k) FIDUCIARY
Forfeiture Litigation Raises New Issues
for Plan Fiduciaries
By George M. Sepsakos
AS IF ERISA FEE LITIGATION isn't enough
to keep plan fiduciaries up at night, plaintiffs
have concocted new claims brought against
fiduciaries in a spate of recent lawsuits. Specifically,
five recent suits all brought in Northern
California have alleged claims against plan
fiduciaries related to the use of plan forfeitures.
We discuss the background of the cases, the
allegations and potential implications below.
Background
As a refresher, a plan forfeiture occurs when
a participant's plan balance is forfeited due
to events spelled out in the plan document.
Most commonly, plan forfeitures occur where
participants separate from employment before
becoming fully vested in employer contributions.
Plan forfeitures may also occur on
employer matching contributions where the
employee doesn't contribute or meet other
conditions to receiving the match as described
in the plan document.
In the cases brought by the plaintiffs, the
plan documents permit the use of forfeitures
for both the paying administrative expenses
and reducing future employer matching
contributions. The plan documents generally
provide that the fiduciary has the authority to
use plan forfeitures to either pay reasonable
expenses of the plan or to reduce discretionary
contributions, special contributions, and/or
matching contributions.
These types of provisions are customary
in that they allow plan forfeitures be used in
accordance with the Internal Revenue Code.
In this regard, the legislative history for the Tax
Reform Act of 1986 provided that forfeitures
arising in any defined contribution plan " can
be either (1) reallocated to the accounts of
other participants in a nondiscriminatory
fashion, or (2) used to reduce future employer
contributions or administrative costs. " Moreover,
IRS/Treasury recently issued proposed
rules that would further codify the existing
practice. There, IRS/Treasury proposed that
did not serve the plans with an eye single to
providing benefits but instead used forfeiture
amounts to reduce contributions that
the employer would have otherwise owed
to the plan. As a result, the plaintiffs allege
that the fiduciaries breached their fiduciary
duties to the plan under ERISA section 404
when using plan forfeitures to offset employer
contributions rather than pay plan expenses.
The lawsuits also alleged violations of ERISA's
anti-inurement provision under ERISA section
403, and self-dealing prohibitions under ERISA
section 406.
The claims have surprised the retirement
" The claims
have surprised
the retirement
community given that
the use of forfeitures
to offset employer
contributions is so
well established and
widespread. "
plan forfeitures could be used to 1) to pay
plan administrative expenses; (2) to reduce
employer contributions under the plan; or
(3) to increase benefits in other participants'
accounts in accordance with plan terms. Use
of Forfeitures in Qualified Retirement Plans, 88
Fed. Reg. 12282 (proposed February 27, 2023)
Allegations
In essence, the lawsuits claim that despite
the fact that fiduciaries are authorized to
use forfeitures to pay down plan expenses
within the plan document that the fiduciaries
consistently use forfeiture amounts to reduce
employer contributions.
Thus, plaintiffs argue, the plan fiduciaries
community given that the use of forfeitures to
offset employer contributions is so well established
and widespread. As noted above, the
longstanding practice is explicitly described
in legislative history and new proposed regulations.
We expect defendants to lean on this
legal backdrop and argue that the practice of
using forfeitures to offset employer contributions
is explicitly permitted by the Internal
Revenue Code when seeking to dismiss the
claims from court.
Potential Implications
These cases raise interesting issues for plan
fiduciaries and sponsors and plan sponsors
and fiduciaries will be reviewing these cases
closely. If the cases are successful and proceed
beyond a motion to dismiss, plan sponsors
could be left to reevaluate whether plan
document language that provides flexibility
on the use of forfeiture amounts remains
appropriate. The answers to those questions
won't be easy and may involve an analysis of
regular and ongoing plan operations. Hopefully
decisions in these cases can shed some
additional light on these issues. Until then, we
will all need to wait.
George Sepsakos is a principal at Groom Law Group,
Chartered, where he represents clients on a broad
range of ERISA, federal tax, and securities law matters.
ISSUE 1 2024 | 401kSpecialist.com
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401(k) Specialist Issue 1 - 2024

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