Income Withheld on sale of assets within 401(k) Plan

[rblum50]

I acquired an individually directed 401(k) plan that transferred its assets from one brokerage firm to another. The date of transfer was around the beginning of April, 2012. Given that the client wants to terminate this plan, I requested all available monthly statements from the new firm so that i could balance them. I noticed that about a week after receiving the assets (20 mutual funds) about 5 were sold. Upon the sale of each investment, 28% was withheld and sent to the IRS. This is a small group with 1 lawyer, 1 secretary and 1 prior participant. The attorney had over $65,000 removed from his account on April 14th due to this error. It appears to me that the brokerage firm did not code the account as a qualified retirement plan. Whatever the reason was, monies left the trust that shouldn't have. I contacted the broker who was handling the account on Wednesday, 7/24 at about 3:00 for an explanation. He indicated that he would get right back to me. Not hearing from him, I contacted him again today, Thursday at about 9:30. He sounded almost surprised to hear back from me and indicated that he had given the problem to his "assistant" to look into and would, again, get back to me shortly with an answer. About 2 hours later, he calls back and says that he has good news. All of the monies were deposited back into the account. When I asked when this happened, he tells me the $65,000 was deposited back into the account just yesterday (coincidence?). All of this aside, I now have some questions:

1. This plan should not only be reimbursed for the monies incorrectly removed from it, but, for the lost earnings as well. Assuming a reasonable calculation of these earnings is performed, where should these lost earnings come from? I have been told that the local brokerage can't just write a check for the lost earnings as they are covered by FINRA and it could cause a problem. I also don't think that the Employer should be on the hook for these amounts either. Any suggestions?

2. Since these monies were removed contrary to the provisions of both the plan and trust documents, could we have a qualification issue here? I was going to terminate this plan informally, but, now I am thinking about a formal termination with the IRS being apprised of the problem and our solution and hope for their blessing by them approving the termination.

Maybe I am going a little overboard, but, I don't like my clients plans being put at risk to any degree without them knowing about it. It will obviously come down to the clients' decision on how to proceed.

Suggestions on how I should proceed and what I should recommend to the client?

Thanks,

Rick

[SFSD]

Any loss is usually made up by the party causing it. It's up to the party who caused the loss (if indeed there was one) to figure out how to do it. The calculation is not all that difficult to do and definitely should be done. Hopefully, there was no loss so restitution is not needed.

Will leave your other questions for the legal experts to answer.

[Guest GeerTom]

The withdrawal was not made by sponsor or participant, so it doesn't really relate to qualification of the plan. I would not change the decision to submit or not based on this.

However, there is a fiduciary breach out there somewhere. The general fiduciary (i.e., trustee, plan administrator) should have noticed the withholding and gotten it fixed posthaste. That fiduciary had better now go get lost earnings from the broker or pay them out of their own funds. I would recommend using an earnings calculation under the voluntary fiduciary correction program, and would consider a filing under that program.

[rblum50]

I went to the DOL site and looked up the covered transactions under the VFCP program:

The VFCP provides descriptions of 19 categories of transactions and their methods of correction. Corrective remedies are prescribed for the following fiduciary violations involving employee benefit plans:

Delinquent Participant Contributions and Participant Loan Repayments to Pension Plans

Delinquent Participant Contributions to Insured Welfare Plans

Delinquent Participant Contributions to Welfare Plan Trusts

Fair Market Interest Rate Loans to Parties in Interest

Below Market Interest Rate Loans to Parties in Interest

Below Market Interest Rate Loans to Non-Parties in Interest

Below Market Interest Rate Loans Due to Delay in Perfecting Security Interest

Participant Loans Failing to Comply with Plan Provisions for Amount, Duration, or Level Amortization

Defaulted Participant Loans

Purchase of Assets by Plans from Parties in Interest

Sale of Assets by Plans to Parties in Interest

Sale and Leaseback of Property to Sponsoring Employers

Purchase of Assets from Non-Parties in Interest at More Than Fair Market Value

Sale of Assets to Non-Parties in Interest at Less Than Fair Market Value

Holding of an Illiquid Asset Previously Purchased by Plan

Benefit Payments Based on Improper Valuation of Plan Assets

Payment of Duplicate, Excessive, or Unnecessary Compensation

Improper Payment of Expenses by Plan

Payment of Dual Compensation to Plan Fiduciaries

I don't see where my situation specifically falls under any of the categories expect possibly "Improper Payment of Expenses by Plan". Do you think that category would be the one to file under?

[00hskrgrl]

1. This plan should not only be reimbursed for the monies incorrectly removed from it, but, for the lost earnings as well. Assuming a reasonable calculation of these earnings is performed, where should these lost earnings come from? I have been told that the local brokerage can't just write a check for the lost earnings as they are covered by FINRA and it could cause a problem. I also don't think that the Employer should be on the hook for these amounts either. Any suggestions?

The broker should have E&O insurance (errors & omissions). Ask him how to go about filing a claim with his E&O insurance for the lost earnings, as well as your fees to cover any services you're performinig for this correction. Technically, the plan administrator (e.g., the lawyer) may have to make the formal claim, but it might be helpful for you to understand the process as well, so you can advise your client appropriately.

[QDROphile]

I have never seen an E&O insurance policy that allowed third parties to make a claim on the policy. I think what you mean is that a claim has to be made against the broker. The broker then goes to the insurer to claim coverage (which may include defense) so that any award against the broker is paid by the insurer rather than the broker. Asking the broker how to go about filing a claim with the broker's insurance carrier does not make sense.

[ESOP Guy]

Has anyone even come up with an estimate of the lost earnings? I mean the mutual funds were sold if I read it right. Was the money put into a money market account? If so, even on that much money and interest rates so low the amount could be immaterial.

I mean there is legal and it needs to be thought of, but there is the practical also. Has anyone even figured out if there is enough money at stake to make possibly starting a fight with the broker is worth it or not?

[Guest GeerTom]

I'd go with Improper Payment of Expenses by Plan if I submitted t all. However, in lieu of that, just correct fpr lost earnings under some permissible method and move on.

[Bird]

Has anyone even come up with an estimate of the lost earnings? I mean the mutual funds were sold if I read it right. Was the money put into a money market account? If so, even on that much money and interest rates so low the amount could be immaterial.

I mean there is legal and it needs to be thought of, but there is the practical also. Has anyone even figured out if there is enough money at stake to make possibly starting a fight with the broker is worth it or not?

My thoughts exactly. Sounds like the money would have been in the MM account, earning 0% or next to it.

[rblum50]

The monies did not go into the money market account. I did review the monthly investment results for the end of April, May and June and the plan showed losses. Therefore, there will not be any income adjustment required.

I am still concerned about the money leaving the plan in the first place. Suddenly, there is a slight risk, due to a fiduciary breach, that didn't exist before. I suggested to the client that to remedy the situation, a possible course of action would be a VCP submission. Have the IRS come back and say that everything we did was appropriate and reasonable and that there will be no problems if ever the plan faces an audit. I also explained to the client the the chances of anything happening were very slight. He has opted for the VCP submission. He feels that the brokerage firm should pay any expenses regarding the resolution of this problem. I couldn't agree more.