What to do with gain from recordkeeping erorrs?

[Guest GMedley]

If we as recordkeepers make a mistake & lose money, we make it up from our profits. But when an error correction results in a gain, it's less clear what should be done with that money.

In this instance we were sent a contribution with the wrong SSN associated with it. Therefore we applied it to the wrong person. Upon discovery & correction, due to the different investment elections the participants had, we find ourselves with a gain of approximately $1700.

This plan uses daily recordkeeping. It seems fair to fix this by reversing the shares purchased by the erronious contribution, thus the gain is not kept by the person who accidently received extra contribution.

Since we'd be making this right out of our pocket if the market had gone the other direction, it does seem reasonable to put this aside to offset errors that do result in a loss. Traditionally, we've never done this, instead allocating this gain somehow to the plan, perhaps thru a reduction in fees.

Does anyone have any thoughts on the proper way to handle these situations? Any references to IRS/DOL documentation would be great.

Thanks.

[Guest MTransue]

Since you use a daily valuation, is there a way for you to reverse the entire contribution from the original trade effective date?

I'm assuming the 1,700 gain is unrealized?

If the funds were invested (as of the original trade date) to the appropriate individual, what would their gain/ loss have been to date?

Could we possibly have a "wash" effect?

[Guest GMedley]

The $1700 is the result of reversing the original transaction, selling erroniously held shares, & purchasing the shares that would have been purchased had the contribution originally been applied correctly. It is a realized gain, currently sitting in Money Market.

I'm interested in general answers to trading error gains, as well as this particular situation.

[Guest Dune]

We have found ourselves in the same situation. With the same question. Does anyone have any research or info on this topic?

[Guest IluvNewComp]

I don't think you are allowed to keep it. If r/k's were allowed to keep "profits" from incorrect transactions, it could lead to abuse.

[Jim Chad]

In my prior life, I was licensed as a stock broker and it was drilled into us that the SEC and NASD regulations required that we pay any loss and the client keep any gain. If you are regulated by either of those or any state securities regulatory body, than this is the rule you have to follow.

So here is my thoughts on what is right (FWIW)

Really, really nice thing to do...apply it as a gain to the whole plan. In a daily plan that might be difficult.

Good choice, Employer made mistake and would have had to make up any loss, so it seems reasoanable to me to offset

my fee so employer benefits

OK choice: I would not criticize a TPA that kept it to make up for some of the stupid costs caused by others, including clients, suppliers and the government.

Here are my thoughts...Anyone else?

[Peter Gulia]

GMedley, an “even-stevens” approach of allowing a recordkeeper that must pay up losses caused by errors use inadvertent gains from the same class of errors can, if correctly used, be fair and even favorable to a retirement plan.

There are serious issues concerning at least ERISA sections 403(a), 404(a), 406, 408, 410(a) and Internal Revenue Code sections 401(a)(2) and 4975. But there are legitimate ways to design an error-correction procedure so that it meets those concerns and is practical and administrable.

I’ve worked on this design from both “sides” – advising a recordkeeper or advising an employer plan fiduciary. The legal analysis and its fact sensitivity makes the topic not a good fit for a bulletin board. If you’d like a (free) talk about how to approach the issues, please call me.

[Kevin C]

The $1700 results from investment gain on plan assets. That makes it plan assets. Using plan assets to benefit the TPA or the Employer sounds like a prohibited transaction to me. The plan's assets are used to pay benefits and to pay reasonable administrative fees. What you are describing doesn't fit either category.

I think your answer is to allocate it as an investment gain. Allocating it to the entire plan sounds reasonable.

Edit: Peter posted while I was typing. Consulting with an ERISA attorney is a very good idea.