Investment errors

[Guest Sieve]

Participant directs that deferrals be used to purchase Fund A. In error, the deferrals are used to purchase Fund B. When the error is discovered, it is corrected.

If the error results in a loss to the participant, the partipant is made whole. So far, so good. But, if the error results in a gain, the gain is taken from the plan and used to offset the amounts that have been used to make other participants whole in prior error situations.

If the gain is not directed from the plan to a fiduciary, I guess there's not a problem--although it just doesn't seem right to me. I think the $$ should stay in the plan and be allocated to participants on some kind of proportional basis.

Is the procedure described (gains taken from the plan) appropriate? Would it make a difference if the funds were directed to a plan fiduciary?

[J Simmons]

In an individual direction plan as you describe, I think the individual participant gets the benefit of the error (all of the gain from Fund B), but the fiduciaries would have to make up any loss. The individual gets the best of both worlds.

I do not think that the Fund B gain can be used to relieve the fiduciaries of their liability to make other employees whole for losses due to other error situations.

[jpod]

Why all the gymnastics? Why wouldn't you just go to the participant and explain what happened and get him to "sign off" on and acccept Fund B in place of Fund A? If he doesn't like Fund B, and this is daily val, he can switch into Fund A having made out like a bandit. If he's a dope and says no I won't accept Fund B then you give him the same number of shares of Fund A which he would have had if no mistake had been made and take the extra money and use it to pay plan expenses or for some other legitimate plan purpose.

[Guest Sieve]

No gymnastics being performed, jpod. Your approach works well on a prospective basis, but I happen to be dealing with a done deal.

In the fact pattern I've been presented, the employee terminated employment, and an inadvertent subsequent deferral was credited to his account by the employer (out of severance payments). When the deferral was reversed, and the mistake of fact corrected and returned to the employer (or held by the plan to offset future contributions), a gain remained in the employee's account.

The TPA, who placed the purchase and the subsequent sale, wants to keep the gain for itself by taking the $$ out of the plan. The question is whether such an approach is permitted under these facts and whether or not the TPA can treat all gains resulting from trading errors the same in the future. Your solution is one I would recommend, but it does not contemplate taking gains back out of the plan, which is what the TPA apparently wants to continue doing if permissible.

Perhaps it comes down to this: to the extent that a TPA placed a trade, and made an error in placing that trade, wouldn't it be a fiduciary and therefore not be able to keep any gain resulting from that transaction?

[jpod]

Isn't the liability issue rendered moot by the exclusive purpose/exclusive benefit issues? In other words, how do you legally get those plan assets out of the plan and deliver it to the TPA? Doesn't the mistake of fact exception only permit you to get contributions out of the plan? Does the TPA's contract say that it is liable to the plan for losses due to trading errors, but gains from trading errors increase its "fees?" If so, maybe you can justify it on that basis, but I'm not sure.

[Guest Sieve]

The mistake of fact exception (ERISA Section 403©(2)(A)) only applies to employer contributions (which applies in my specific scenario), but does not deal with investment errors (which is my broader question). I think perhaps we are in ERISA Section 406(a)(1)(D) -- prohibited transaction based on "use . . . for the benefit of, a party in interest, of any assets of the plan . . ."

Does anyone know how others handle gains resulting from investment errors?

[J Simmons]

The mistake of fact exception (ERISA Section 403©(2)(A)) only applies to employer contributions (which applies in my specific scenario), but does not deal with investment errors (which is my broader question). I think perhaps we are in ERISA Section 406(a)(1)(D) -- prohibited transaction based on "use . . . for the benefit of, a party in interest, of any assets of the plan . . ."

Does anyone know how others handle gains resulting from investment errors?

The only way I've seen them handled is to credit them to the benefit of the employee off of whose account the gains were generated from the investment error.

[K2retire]

I can see some room for discussion as to whether the gain stays with the participant or is used as a forfeiture. But to allow the TPA who was resposible for the error to benefit from it is clearly unethical.

[Kevin C]

What does the plan document say about allocation of investment gains/losses? With a self directed investments, I would not expect there to be anything that would allow you to take part of the gain from one participant and allocate it to others.

I agree that using the extra gain to reduce a correction amount for a future error by the TPA would be a PT. It would be using plan assets to benefit a disqualified person.

We've always taken the approach that the participant keeps the gain if the mistake works to their benefit. If the mistake makes them worse off, the responsible party pays the difference.

[Guest Sieve]

I appreciate the input. You've confirmed that my gut feeling was on track . . . Thanks.