Broker makes distribution without authorization...?

[chris]

Employee terminates employment 12/31/04. Anniversary date of PSP is 6/30. Plan says terminated participant's account balance will be distributed as soon as administratively feasible after anniversary date coinciding with or next following date of termination of employment. Broker was notified in writing that no distributions were to be made without authorization from Plan trustees. Terminated participant talks to broker and broker distributes 10K out of terminated participant's account in March 2005 without communicating with trustees. From the dollar perspective there won't be a problem b/c participant's account balance is sizeable enough that the early distribution of the 10K won't create an issue of trying to get money back from the participant. However, it seems there is an operational defect as well as a reporting problem that has to be dealt with. Not only has the distribution been made prior to the distribution date in the PSP, but now distributions will be in two different Plan years. Also, the Plan only allows for one lump sum payment. I understand from the accountant that the coding on the distribution will be an issue. It won't work out the immediate issues but would an indemnification/hold harmless type agreement from the broker and possibly the participant as well suffice as to the consequences of the operational issues? Need some suggestions.... Thanks.

[maverick]

Lump sum is defined as payment in a single taxable year, of 100% of the recipient's "balance to the credit" (whatever that means) under the plan [402(d)(4)]. So, I don't think you have a problem if 2 payments are made in 2005.

This type of problem (broker making an unauthorized distribution) occurs frequently, and, other than rapping him across the knuckles with a ruler, what can you do? I guess you could change brokers.

I'll let some of the technical experts weigh in on the distribution not made in accordance with the plan document. How about amending the plan to allow just this distribution? Makes sense to me, but I've learned that when you're dealing with ERISA, common sense doesn't always prevail.

TGIF,

Maverick

[david rigby]

...what can you do?

How can this be acceptable? Seem like the Plan fiduciaries will be considered "part of the problem" if they don't take some action. Methinks a judge or jury would have no trouble reaching that conclusion.

Perhaps the plan sponsor should verify that its fidelity bond is up-to-date. Perhaps the broker's employer should do the same.

[chris]

How about demanding that the participant pay back the "unauthorized" distribution and having both broker and participant sign off on a hold harmless/indemnification agreement....?

[Guest 401der]

As a fiduciary of the plan, I would treat this unauthorized distribution from the plan's trust as I would any other unauthorized distribution from the plan's trust, regardless of who the funds were paid to. The trust must recoup the money from whoever made the distribution so the plan can pay and report the participant's distribution in the proper manner and at the proper time and not get involved in trying to find a workaround that benefits no one but the broker. I would, therefore, require the broker to reimburse the plan and go about getting his $10,000 he "gave" to the participant from the participant whatever way he can.

[E as in ERISA]

Call your local prosecutor and ask him what crimes are committed when someone who has access to an account, but not legal authority to take money without direction, takes money from the account. Based on the size of the distribution probably some type of felony.

Then try and discuss the IRC requirements (following plan terms), discrimination issues (if participant is HCE and getting preferential timing of distribution), etc. that cause qualification issues. Then discuss fiduciary issues -- he probably makes himself a fiduciary by acting as a fiduciary -- and is subject to DOL fiduciary breach for making an unauthorized distribution. If he doesn't listen to those, then tell him about the felony.

Then fire him.

[Belgarath]

WOW! I don't know securities rules, but would seem likely that this violates some sort of NASD or SEC rules? Shouldn't the broker be concerned about license revocation/penalties/whatever?

I'm not sure how this should be handled. I'm inclined to think that the the Plan Aministrator must write to the participant, explain that it was an unauthorized distribution, and request return of the funds plus interest. If the money is not returned, I can't see that most PA's would actually bring suit, because what is gained? The funds are returned, then immediately paid out again, as the participant is now actually entitled to a distribution.

Suppose the broker is sued? Suppose the broker repays the plan the $10,000.00. Is the plan still liable to pay the participant $10,000.00? Even though the original payout was improper timing, the amount wasn't incorrect, and it was in fact paid from plan assets.

So you go around and around to come back to the place you started. I'm not necessarily saying this is incorrect, but I wonder of the PA has the ability to refuse to initiate legal action if the costs outweigh the benefit? It isn't like the participant got overpaid.

Humor me for a moment - is the IRS really going to disqualify a plan for this if the money isn't recovered, to be paid right back out again? I've never seen a real life situation like this, so I truly don't know how much room there is for a common sense solution.

[mbozek]

I think some people are blowing this problem up out of proportion to the violation.

There is no issue in reporting the distribution since the employee will receive the lump sum in one calandar year which can include more than one payment during the year. The trustee can authorize the lump sum distribution to meet the plan requirements for a distribution.

I dont think that the plan will be able to recoup the funds from the broker since the amount that was paid is due the participant under the plan, and is not an excess payment. The broker will not give the plan a hold harmless agreement in the very unlikely event the plan is disqualfied and requiring/demanding the participant to sign a hold harmless in order to receive the balance of his distribution would be a violation of Section 510 of ERISA.

Atempting to recoup the funds from the participant or broker will require the plan to incur substantial legal fees to recover money that the participant is legally entitled to receive from the plan and will be ultimately be paid back to the participant.

There needs to be criminal intent by the participant to steal money, not merely a mistake in paying someone before authorization is received. It is difficult to infer criminal intent to steal money that one is legally entitled to receive from the plan.

[SoCalActuary]

The action taken by the broker showed a disregard for legal responsibility and accountability. Unless the participant was a trustee, the broker took funds out of the trust without authorization. This should be reported to the broker's broker-dealer with request for disciplinary sanction. Discipline does serve to train people to do the right thing, sometimes by making a bad example out of people doing the wring thing.

Naturally, this is playing hardball, and some TPAs are reluctant to do so, since it would sour the possibility of future business. However, the Plan Administrator and trustees only have to worry about their plan, not future business.

[chris]

mbozek -- I was suggesting having the particpiant execute the hold harmless with respect to her request/receipt of the 10K unauthorized distribution not as a condition to receiving the balance of her account.

The "..two payments in one taxable year..." aspect sort of/kind of gets me to a lump sum payment, however, what about the 20% mandatory withholding? Can the plan administrator withhold on the second distribution the 2000 that should've been withheld on the unathorized 10K distribution as well as the 20% on the remaining account balance? Also, what if participant says she wants to rollover all of the remaining balance? I guess plan administrator can withhold 2000 (20% of 10K unauthorized distribution) and then treat the rest as a direct rollover.....??? Thanks for all the suggestions thus far.....

[mbozek]

Plan admin has to collect the 2k from the remaining account balance regardless of whether the participant wants to do a direct rollover in order to comply with law. If you can get the participant to sign a hh agreement for the 10k then get it.

[WDIK]

Not to be a nitpicker, but the withholding amount on the $10,000 net distribution would be $2,500.

(10000 / 0.80 = 12500)

[Demosthenes]

Why is the Trustee participating in this fiasco at all? This is unauthorized activity in a brokerage account, (unless the broker holds Power of Attorney) something the SEC and NASD do not take lightly.

Have the trustee contact the Broker-Dealer, tell them there's 10 k withdrawn that the I, the Trustee, didn't authorize. Instruct them to replace it immediately and make the distribution to the participant.

Compounding the broker's error with hh or "odd" withholding doesn't do the Trustee any favors. The plan and Trustees did nothing wrong here, try to keep it that way.

Should the SEC or NASD disciplinary arms get involved, the Trustee wants to be as far away from this situation as possible.

[Guest 401der]

Amen, Demosthenes. My sentiments exactly, just no so well expressed.

[chris]

Regarding having the broker replace the 10K distributed, how do you prevent the participant from getting a windfall as the plan will eventually distribute out the participant's account balance which would then include the 10K from the broker to make the plan whole? I assume the broker would be stuck with getting the 10K back from the participant.....? and it's up to borker to deal with the windfall issue....????? Also, wouldn't you still have the 1099 issue w/r/t the 10K unauthorized distribution?

[mbozek]

Distributing 10k in excess of the participant's account balance is a breach of fiduciary duty as well as a disqualfication issue.

[Guest Pensions in Paradise]

The original post indicated that the broker was notified in writing to not process any distributions. Despite this, the broker still processed a distribution. It would seem to me that the fiduciaries of the plan would be in breach of their duties if they did not report the broker to the proper authorities and/or fire the broker.

They got lucky this time because it's relatively easy to correct the problem. But what happens next time when the broker pays out too much?

[chris]

Seems there are roughly two options -- 1) withhold all amounts from the back end distribution and attempt to get a hold harmless from the participant and deal with broker; 2) contact broker and let broker resolve it all as well as address the unauthorization issue....???

[david rigby]

Perhaps option (3)?

- As stated earlier, just plain lucky that the entire balance can be distributed in 2005. If that is correct, and it happens, move on, do the 1099-R showing full amount of distribution.

- Then fire the broker.

[chris]

Update.... turns out broker is terminated participant's personal broker and will "be leaving" once terminated participant's assets leave the plan. Thinking is to send terminated participant's atty. a letter notifying him of unauthorized distribution as well as fact that plan will withhold the required fed. and state withholdings (that were not able to be withheld first time around) on the remaining balance that will be distributed once 6/30 valuation date passes. Also, will demand a hold harmless/indemnification from the terminated participant as well.

[david rigby]

...will demand a hold harmless/indemnification from the terminated participant as well.

Don't hold your breath.

BTW, why notify attorney? Has the (now terminated) participant told you to send all correspondence to attorney?

Why is anyone tolerating this broker's behavior? Why is not the broker already gone? Is anyone planning to inform the "powers that be" of the inappropriate behavior of the broker? Broker has a license, doesn't he?

[chris]

Notification to atty b/c terminated participant has sued former employer (our client ) over a wage issue. Client may or may not pursue broker issue....