Former Employees with no Distributable Event Permitted to Rollover Accounts to IRA

[Guest rocnrols2]

Y is a subsidiary of X. Both X and Y maintain 401(k) plans. Y's operations were shut down and all of its employees were eventually terminated from employment. The Y 401(k) plan is being terminated. A small number of Y employees have been hired by X. X will not accept plan-to-plan transfers of the Y plan account balances of former Y employees until the IRS issues a favorable determination letter on the plan's termination. Some of these employees requested distributions from the Y plan to rollover to an IRA maintained by mutual fund company M (which also provided the investments for the Y 401(k) plan.) Since the Y employees who became X employees did not have a "severance from employment," they could not take distributions, and thus could not effect rollovers into an IRA. In one case, an employee who initially elected a rollover told M to stop and leave it in Y's plan. However, M proceeded with the rollover.

How should this be corrected? (1) Should Y go to affected former employees, tell them that they could not make rollovers and ask them to pay back their balances plus earnings to the Y plan? (2) Should Y go after M for effectuating rollovers they were instructed to stop? Or should some combination of the above be done?