Correcting Participant Theft from Plan

[Dalai Pookah]

Dangers of individually directed plans with participants being able to select where assets invested:

Participant moves money from brokerage to credit union IRA account. (No, she shouldn't have had the power to make the withdrawal or establish a new account without the permission/guidance of the Trustee).  Participant starts withdrawing money from the Credit Union Account and essentially empties the account to the tune of $30K.

Generally, when this happens, the employer will terminate the employee and the withdrawal would be treated as a distribution.  No such luck.  The employer does not want to terminate the employee, leaving the conundrum of how to correct the plan.

Since the funds were safe-harbor and deferral and the participant was below age 59 1/2, in-service distribution doesn't help.   Rev. Proc. 2019-19 6.06 (4)(b) seems to indicate, in this case, that after reasonable attempts to collect are made, there is no requirement for someone to repay the plan if the distribution was made to a participant or beneficiary.

Any thoughts on how you would handle?  Advice to sponsor?

[formeractuary]

Not an attorney, but this feels like a much more significant issue than what the Rev. Proc. alludes to. This situation smells of fraud to me, and it makes me uneasy to rely on self-corrections in this case.

Corrections under IRS aside, have you considered whether this would be a prohibited transaction under ERISA?

[BG5150]

My question is:  if the employer has to reimburse the plan, where does the money go?  It cannot go back into the participant's account.  If not, then where?

[Luke Bailey]

Dalai Pookah, a "diversion" of plan assets is not eligible for any voluntary correction. See Section 4.11 of Rev. Proc. 2019-19. So as a threshold matter you need to determine whetherwhat occurred is a "diversion" of plan assets. If you conclude that it did, then I would probably call the non-EPCRS EPCU corrections group and discuss with them anonymously. There is no definition in Rev. Proc. 2019-19 of what a "diversion" is, and I can only speculate as to why it is not covered by EPCRS. My guess would be that in some cases the IRS would not consider it a plan defect at all, but just a crime suffered by the plan (e.g., a bookkeeper steals from all participant accounts). Perhaps in other cases where a fiduciary is involved, e.g. a business owner, the IRS just thinks that you need to go to EBSA.

If you conclude that this was not a diversion of assets, but rather just an overpayment, then to correct under Rev. Proc. 2019-19 the plan administrator must demand repayment to the plan and notify the participant that the distribution did not qualify for rollover, possibly causing her to be taxable in an earlier year than she was based on the IRA distributions. See Section 6.06(4) of Rev. Proc. 2019-19. No "make whole" contribution would be required in this case, since the overpayment was from the account of the participant who received it. However, presumably a major part of correction in this case would be a thorough review and reform of the plan's internal controls.

If you are within the 2-year SCP period, you could self-correct, even though this is probably a significant defect. If it is outside the 2-year period, or you want the comfort of getting a compliance statement from IRS, you could submit it as a VCP. There would be some risk that the IRS would reject it because they thought it was a diversion of assets, but the risk is probably manageable. Would need to know a lot more about the case to judge that. You could always do an anonymous submission.

[C. B. Zeller]

On 10/28/2019 at 10:37 AM, Dalai Pookah said:

Generally, when this happens, ...

It sounds like this is a regular occurrence, and from your description the employer knows it is a problem. It also sounds like the employer has not taken any steps to remedy the underlying problem since they are aware of it and allow it to continue happening. In order to be eligible to use SCP, a plan administrator "must have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance in form and operation" (Rev Proc 2019-19 4.04). I think they might not meet that requirement.

[Luke Bailey]

14 hours ago, C. B. Zeller said:

It sounds like this is a regular occurrence, and from your description the employer knows it is a problem. It also sounds like the employer has not taken any steps to remedy the underlying problem since they are aware of it and allow it to continue happening. In order to be eligible to use SCP, a plan administrator "must have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance in form and operation" (Rev Proc 2019-19 4.04). I think they might not meet that requirement.

You make a good point, C. B. Zeller. My guess is that when Dalai Pookah said, "Generally, when this happens," he meant when it happens to other plans, usually under circumstances where there is more evidence of error, and less of willfulness. But even if my inference is correct, It's possible that even within 2 years, not eligible for SCP because insufficient practices and procedures. Have to have full review of facts to know.