Agent’s fraudulent adoption of 401(k) plan

[JungRet]

Wondering if anyone encountered this before or has insight on it. If a 401(k) is adopted by an agent (i.e. business manager) who wasn’t authorized to do so, but employees become enrolled and make deferrals etc. and eventually the employer discovers the issue — what is the status of the plan and what must happen to the “plan assets”? Would any of ERISA’s provisions apply or not? Could the employer delay returning the contributions to let litigation run its course or would this implicate anti-alienation restrictions? Thanks for any thoughts. What if certain participants were not eligible under the terms of the plan…how would that be navigated in light of the fact that the entire plan was improperly adopted?

[Gina Alsdorf]

I have seen this before. I have a lot of questions but very few answers here. I think this is a very legal question you are asking and would require actual legal advice and it will be very dependent on facts and circumstances. There are a lot of questions someone would want to ask. What authority did the business manager have? Did they do any work on other benefits? If a sponsor never authorized the adoption how was it put into place?  Who paid the bills for the plan? Was a separate EIN filed for this "trust"? Was a 5500 ever filed? How long did this continue before it was caught? How did deferrals happen if no one approved it? How were employees enrolled? Were deferrals tax reported as deferrals at any point?  No matter what, this will be a pain to sort out. I have to ask, did this employer just never look at payroll? 

[david rigby]

When will this business manager be fired?

[ERISALawyr]

I have not encountered it before. I have some reflections. The short version is that I would not suggest arguing that the plan is not an ERISA plan (or otherwise disclaiming the plan, its existence or its ERISA coverage solely on the basis that the employer didn't authorize the plan), and the employer probably has some state law claims against the business manager, but frankly should be more concerned about the lack of internal controls that allowed this to happen without the employer's awareness.

@Gina Alsdorf is right, a lot depends on the facts and circumstances. As is always the case with legal questions, "it depends.'

From my armchair, between the participants and the plan, I doubt there is a valid argument against the plan's existence or contributions being plan assets. That ship has sailed.

ERISA probably preempts state law contract and agency law principles with respect to participants' claims about the plan and its existence. The mere existence of a written plan established and maintained to provide retirement benefits under the auspices of the employer, even if it was without the employer's authorization, and to which employees contributed, would likely be enough to deem it a "plan" under ERISA. Also, employees would have estoppel arguments that the plan has been held out to exist, with reliance (contributions withheld) and operated under the auspices of the employer. The employer would be on very shaky ground trying to disclaim or undo the plan and even more shaky ground claiming it did not exist or was not established and maintained by the employer, even if the business manager did so without authority. The employer would probably be inviting ERISA claims if it did so, and should prepare to pay participants' attorney's fees if it goes down that path.

To the extent state law (or federal law--courts have held ERISA contemplates federal common law contract principles), the business manager's apparent authority is usually enough to bind the employer to the participants and service providers. Unless participants (or service providers, if the employer is concerned about having to pay them) knew that the business manager lacked authority to act in this capacity for the employer, an agent's (business manager's) apparent authority is usually enough to bind the principal (employer).

Between the employer and the business manager, the employer may have a claim against the business manager for acting outside of the scope of their authority, if there is a way of establishing the parameters of the agent's authority (burden is on the employer). The question is what the damages are. I'm guessing this is a small employer and a small 401(k) with a large TPA where the fees are minimal, so below $10K/year. That is unlikely to be worth litigating over.

I imagine this is a small employer, but the fact that the business manager could set up a plan and arrange to withhold employee contributions for any period of time without the employer's awareness raises serious questions about the employer's internal procedures, oversight and financial controls. This whole situation should force some serious self-reflection on the employer's part.

(None of this is legal advice. Just some reflections to help give your reflections some structure.)

[ERISALawyr]

Quote

 what is the status of the plan and what must happen to the “plan assets”? Would any of ERISA’s provisions apply or not? Could the employer delay returning the contributions to let litigation run its course or would this implicate anti-alienation restrictions? Thanks for any thoughts. What if certain participants were not eligible under the terms of the plan…how would that be navigated in light of the fact that the entire plan was improperly adopted?

Based on the above, the business manager's lack of authority does not affect the plan's status. If it would be an ERISA-covered plan otherwise, it likely remains so.

The plan assets are plan assets, so are treated like any other plan assets. "Returning contributions" sounds like a bad idea to me.

ERISA provisions apply regardless of the business manager's authority.

With respect to returning contributions, the employer must follow ERISA and the plan terms, and court orders, if any. There is nothing in your summary that suggests a permissible reason for refunding contributions to participants. They would likely involve in-service distributions and/or distributions before normal retirement age, which would probably violate the plan terms and definitely violate qualification requirements, so you would be triggering ERISA fiduciary violations and plan disqualification (resulting in adverse tax consequences to the employees and employer).

So much is based on the specific facts, this employer needs to find a decent benefits attorney (to address these questions in a way that the employer can rely on) and employment lawyer (to handle the business manager).

(None of this is legal advice. Just some reflections to help give your reflections some structure.)

[Gina Alsdorf]

@ERISALawyr  I think from a facts and circumstances perspective the more a bird walks like a duck, quacks like a duck, flies like a duck the more likely it is to be a duck.   *also not legal advice*