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NEED EXPERT REPLY FOR COMPLEX SCENARIO


Guest 3.141592653
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Guest 3.141592653

Do the plan participants have a claim for recovery of benefits? Please reply with your expert opinions on this complex scenario.

INTRODUCTION

- Company XYZ has a 401(k)/Profit Sharing Plan that has been in place since January 1, 2000.

- The plan is valued annually as of December 31st.

- As of December 31, 2009 the plan had combined net assets of approximately $4.5M.

- The plan's original trustees were also the owners of XYZ (until sale of company -- see below).

- The plan's administrator is "Jenny" who is also the CFO of XYZ and a plan participant.

- The 401(k) funds are managed through a third-party administrator and investments are self-directed.

- The Profit Sharing funds are managed through a third-party securities broker who invests on behalf of participants.

- Company XYZ was sold to Company ABC on January 1, 2010.

- Company ABC appointed two new trustees on January 1, 2010.

- Company ABC appointed a new plan administrator on January 1, 2010.

- Company ABC replaced previous CFO "Jenny" with new CFO "Emma".

- Company XYZ adopted an Plan Advisory Committee on January 2, 2010.

SCENARIO

The newly-formed Plan Advisory Committee informed executives at Company ABC of possible illegal transactions perpetrated by Jenny, the former plan administrator and CFO. Upon review of plan records during years 2000 to 2008, it was discovered that in each year, Jenny took out large loans against her personal Profit Sharing account balance during years when investment losses were high, and subsequently repaid those loans in full during years when investment gains were high. Each year similar transactions occurred, and it appeared that Jenny was using her advance knowledge of investment performance (because only Jenny received the monthly Profit Sharing investment statements from the third-party securities broker) to maximize her gains and minimize her losses. It appeared Jenny was taking advantage of the plan's provisions and features in order to receive a personal gain. Further, it appeared that the benefits Jenny was receiving as a result of these questionable loan transactions were being achieved at the detriment of the other plan participants.

ADDITIONAL INFORMATION

Here I will explain the math behind the above scenario.

Year 1

In the beginning of year 2000 the aggregate account balances of the Profit Sharing pariticipants were $2.0M, of which $200,000 was Jenny's.

Jenny saw the Janary 2000 statement and the November 2000 statement and saw that there were $1.0M of losses so far during the year.

Jenny figured that the losses would not reverse during December 2000.

On December 30, 2000 Jenny took out a loan of $200,000 against her account balance, making her account balance $0 before allocation of current year losses.

The remaining participants' aggregate account balances before allocation of current year losses are now equal to $1.80M.

The $1.0M current year loss is allocated to the $1.80M beginning balance proportionately to the participants based on their individual account balance as a percentage of the total aggregate account balances, resulting in ending aggregate account balances equal to $0.80M.

Note that Jenny's account balance was allocated 0% of the current year losses.

Year 2

In the beginning of year 2001 the aggregate account balances of the Profit Sharing pariticipants were $0.80M, of which $0 was Jenny's.

Jenny saw the Janary 2001 statement and the November 2001 statement and saw that there were $1.0M of gains so far during the year.

Jenny figured that the gains would not reverse during December 2000.

On December 30, 2000 Jenny repaid in full the $200,000 loan, making her account balance $200,000 before allocation of current year gains.

The remaining participants' aggregate account balances before allocation of current year gains are now equal to $1.0M.

The $1.0M current year gain is allocated to the $1.0M beginning balance proportionately to the participants based on their individual account balance as a percentage of total aggregate account balances, resulting in ending aggregate account balances equal to $2.0M.

Note that Jenny's account balance was allocated 20% of the current year gains, or $200,000.

CONCLUSION

At a minimum, it appears Jenny was breaching her fiduciary duties by engaging in questionable transactions. Does Jenny have a liability to the participants? Do the former trustees (who were former owners) have a liability to the participants? Do the new owners of XYZ company have a laibility to the participants? Is there a specific law that was violated? Please give you opinion regarding what the plan participants can do, if anything, to obtain relief for the benefits they lost out on due to the actions of the former plan administrator.

THANK YOU FOR READING THIS AND REPLYING WITH YOUR OPINIONS.

Sincerely,

3.14159265358979323..... and so on

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One wonders about the due diligence done by ABC prior to the buy/sell.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Guest 3.141592653

Here are some concerns:

1) The previous trustees were basically negligent. They weren't paying attention and meanwhile their CFO was cooking the plan's books. The trustees weren't the ones committing fraud but they're probably liable to some extent.

2) Do the new company's owners have any liability? Assume for this example that in the sale-purchase agreement the former owners represented that the benefit plans were administered properly.

3) There isn't any evidence that outright proves the former CFO said "hey, look at the bank statements, there are losses, I'll take my money out as a loan" but it's pretty obvious that's what happened.

4) Some of these transactions occurred 10 years ago and I'm not sure what, if any, is the applicable statute of limitations.

5) The former CFO reached normal retirement age and has since cashed out of the plan.

Again, thanks for your input...

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Guest 3.141592653
One wonders about the due diligence done by ABC prior to the buy/sell.

The due diligence was broad in scope and we didn't get transactional in our analysis of anything that was older than 3 years, but we did learn all about the plan, its provisions, the trustees, plan administrators/advisors, etc. But in this case due diligence isn't the concern because the former owners had to represent in the buy/sell agreement that the plans were administered in accordance with ERISA at all times.

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3.14159265358979323..... and so on, consider that you might not get much expert opinion on this public website. Although some practitioners who read and write in BenefitsLink might be capable of giving advice about the situation you've described, practitioners are governed by professional, ethical, and practical rules. In my experience, a lawyer or an expert witness is unlikely to say much beyond generalizations until he or she has had some conversation with the inquirer and has ruled out conflicts of interests.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Guest 3.141592653
3.14159265358979323..... and so on, consider that you might not get much expert opinion on this public website. Although some practitioners who read and write in BenefitsLink might be capable of giving advice about the situation you've described, practitioners are governed by professional, ethical, and practical rules. In my experience, a lawyer or an expert witness is unlikely to say much beyond generalizations until he or she has had some conversation with the inquirer and has ruled out conflicts of interests.

Understood. Generalized guidance works for me in this case since I'm really just looking to see if it's worth approaching a lawyer. I have a question maybe you can answer - if we did hire an ERISA lawyer, I assume the fees would be paid by the plan? Or, would those individuals bringing a case against the plan/employer/fiduciaries need to pay the legal fees?

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The only objective analysis that can be made about this scenario is that the maximum amount of loans permitted to a participant secured by plan assets is $50,000 and the loans are sublect to plan rules. Any loan in excess of the 50k max would result in the loan being immediately taxable to the CFO and could result in disqualification of the plan. The plan sponsor/fiduciaries need to retain ERISA counsel to determine what rules have been violated and how the violations need to be corrected. This will be expensive and the plan sponsor will have to pay the costs to clean up this mess. I dont know if you will be able to find a lawyer who would take this case based on a contingency that the legal fee will be determined by a federal judge after a sucessful recovery. Q are the plan fiduciaries covered by an insurance policy? A determination that the prior trustees were negligent in administration of this plan doesnt mean much for recovery purposes if they declare bankruptcy because they do not have sufficient assets to pay the judgment. You may be better off going the US Department of Labor and have the plan loans and operation reviewed for violations of ERISA by the Employee Benefits Secuirty Administration (EBSA) which can take action against the plan and trustees. You can google the EBSA website to get further information.

As for as the reps/warranties of the prior owners, you need to see when they expire. Many buy-sell agreements have a limited time period for recovery of monetary damages based on a violation of the reps such as providing notice of violation within 1 year of sale or have limitations on the amount that can be recovered. In some cases a small portion of the sales proceeds would be held in escrow for a limited period after the sales closes.

mjb

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You haven't said what your role is, or I missed it - are you with ABC?

So many questions - you say Jenny was the plan administrator, but was she the Plan Administrator or was XYZ? Who was actually allocating the gains and losses? Who was preparing the 5500s? Why no thoughts about the prohibited transactions that occurred as a result of these loans?

I wouldn't assume that the plan would pay the fees. If I were a participant and knew what was going on, I would just try to blow everybody up by going to the DOL. If I were with ABC or XYZ I would go to an attorney right away and not mess around with this board.

Ed Snyder

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Guest 3.141592653
The only objective analysis that can be made about this scenario is that the maximum amount of loans permitted to a participant secured by plan assets is $50,000 and the loans are sublect to plan rules. Any loan in excess of the 50k max would result in the loan being immediately taxable to the CFO and could result in disqualification of the plan. The plan sponsor/fiduciaries need to retain ERISA counsel to determine what rules have been violated and how the violations need to be corrected. This will be expensive and the plan sponsor will have to pay the costs to clean up this mess. I dont know if you will be able to find a lawyer who would take this case based on a contingency that the legal fee will be determined by a federal judge after a sucessful recovery. Q are the plan fiduciaries covered by an insurance policy? A determination that the prior trustees were negligent in administration of this plan doesnt mean much for recovery purposes if they declare bankruptcy because they do not have sufficient assets to pay the judgment. You may be better off going the US Department of Labor and have the plan loans and operation reviewed for violations of ERISA by the Employee Benefits Secuirty Administration (EBSA) which can take action against the plan and trustees. You can google the EBSA website to get further information.

As for as the reps/warranties of the prior owners, you need to see when they expire. Many buy-sell agreements have a limited time period for recovery of monetary damages based on a violation of the reps such as providing notice of violation within 1 year of sale or have limitations on the amount that can be recovered. In some cases a small portion of the sales proceeds would be held in escrow for a limited period after the sales closes.

Thank you for your post, this was very helpful. The bottom line here is that it looks like we have a mess on our hands. Fortunately the buy-sell agreement language was very strong in our (buyer's) favor, so from a liability perspective we're covered. However, we still have the burden of fixing this whole thing, so in that regard I'd rather be in a situation where things were all fine and dandy.

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Guest 3.141592653
You haven't said what your role is, or I missed it - are you with ABC?

So many questions - you say Jenny was the plan administrator, but was she the Plan Administrator or was XYZ? Who was actually allocating the gains and losses? Who was preparing the 5500s? Why no thoughts about the prohibited transactions that occurred as a result of these loans?

I wouldn't assume that the plan would pay the fees. If I were a participant and knew what was going on, I would just try to blow everybody up by going to the DOL. If I were with ABC or XYZ I would go to an attorney right away and not mess around with this board.

XYZ was plan sponsor/plan administrator and Jenny was authorized person to act on behalf of XYZ. Trustees were former shareholders of XYZ. Local third-party administration company prepared annual statements and valuation all based on a census report provided by Jenny. No verification of census data was occurring.

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"- The 401(k) funds are managed through a third-party administrator and investments are self-directed.

- The Profit Sharing funds are managed through a third-party securities broker who invests on behalf of participants."

Generally speaking, gains and losses are allocated on a pro rata basis as follows: beginning balance plus (or minus) some portion of contributions made during the year. Loans do not bring a participant's account balance to zero. A loan remains an asset of the participant's account. So ... there may be some "liability(?)" to the third-party administrator.

Certainly I would engage the services of an appropriate ERISA practitioner to go forth on these issues.

Jim Geld

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Guest 3.141592653
"- The 401(k) funds are managed through a third-party administrator and investments are self-directed.

- The Profit Sharing funds are managed through a third-party securities broker who invests on behalf of participants."

Generally speaking, gains and losses are allocated on a pro rata basis as follows: beginning balance plus (or minus) some portion of contributions made during the year. Loans do not bring a participant's account balance to zero. A loan remains an asset of the participant's account. So ... there may be some "liability(?)" to the third-party administrator.

Certainly I would engage the services of an appropriate ERISA practitioner to go forth on these issues.

For whatever reason a review of the statements shows gains/losses were allocated to participants accounts based on the account balance after loans/distributions, so the account balance subject to gains or losses was always beginning balance - loans taken out. Also the plan summary at that time said that the Valuation Date was at the discretion of the Plan Administrator.

In any case, the plan looks to be all screwed up, so we're going to retain counsel. If I can remember I'll post updates on the status to this link, just for everyone's learning enjoyment.

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If Jenny still has a balance in the plan then I'd suggest discussing w/ your newly retained counsel whether or not to place a hold on Jenny's account to prevent her removing any ill gotten gains.

And just thinking out loud... this would be an excellent case study for a fiduciary ethics course... it certainly had my attention riveted thru all the posts above.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest 3.141592653
If Jenny still has a balance in the plan then I'd suggest discussing w/ your newly retained counsel whether or not to place a hold on Jenny's account to prevent her removing any ill gotten gains.

And just thinking out loud... this would be an excellent case study for a fiduciary ethics course... it certainly had my attention riveted thru all the posts above.

I'm glad to hear that this post was interesting to you (and hopefully others). For the past four years my company has been on an acquisition binge so I have all sorts of stories like this, although this particular case was among the worst.

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Naive question (not a defined contribution practitioner) - are there really dc plans out there that are valued only once a year? Is that allowed? Sure looks as though, besides providing poor responsiveness, it has a very high potential for shady dealings.

Always check with your actuary first!

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are there really dc plans out there that are valued only once a year? Is that allowed?

There most certainly are, and yes it is. The shadiness of any plan is more a result of the shadiness of the plan sponsor as opposed to the type of plan.

...but then again, What Do I Know?

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  • 2 months later...

How was her account $0? When she took a loan, the $200k note should have been an asset of the plan/her account? She didn't take a $200k distribution, but rather invested her $200k in an interest bearning loan (to herself).

Oh, not to mention you can only take a $50k loan from a plan.

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