Distribution from plan to employer first then participant???

I've run into something that I need to run by others and confirm whether I'm missing something... 

An employee terminated employment and requested a rollover from the 401(k) plan in a letter to the employer and the employer forwarded the request to Fidelity. The request was for a direct rollover to an IRA. Apparently a check was issued to the employer, who deposited it into a company account and will be issuing a check to the IRA custodian.  Is there a scenario where this is ok? Shouldn't the distribution go from the trust directly to the IRA custodian?  But I feel like I must be missing something if Fidelity issued the check to the employer?  TIA!

What role does Fidelity play - custodian, trustee? For what services are they contracted and does that include distribution processing?

I have seen where the employer is the distribution processor and the custodian forwards funds. The employer then cuts check, withholds and remits taxes if necessary, and does the 1099R reporting. I'm not saying it's a best practice or even recommended, but I have seen it done in the past, and can work if employer really knows what they're doing or has a good accountant to assist.

Thank you CuseFan, that's helpful. I'm not sure of the details re: Fidelity's role yet.  In the scenario you described, I assume the funds would need to flow through an account in the name of the plan? The employer can't deposit the funds into a general account and then cut the check from there, right? This seems very wonky to me. I'm trying to make sure this process won't mess up the direct rollover (and doesn't violate ERISA, of course).  

The IRS has said in conferences that they believe letting having the employer receive funds from the plan and then writing the check for a distribution is unacceptable.

That being said, some employers have done it although the rationalization on its acceptability is a bit murky.

There was a temporary regulation that implied this was permissible.  See Q&A 16 in https://www.ecfr.gov/current/title-26/section-35.3405-1T (which was "reserved" when the regulation became final).

Some practitioners felt this Q&A made it acceptable for the employer to be involved with making both the distribution, while others felt that this Q&A made it acceptable only for the employer to submit the tax withholding.

Some practitioners took the stance on the question of whether there was a prohibited transaction is it would not be if and only if the employer did not benefit from having had the funds pass through an employer's account.  Those who took that stance cautioned employers to hold the cash for the least amount time it took to issue the distribution, and to not put the funds in an account that earned interest.

Treasury 31.3495(c)-1 Withholding on eligible rollover distributions; questions and answers Q&A 5  answers:

Q-5: May the plan administrator shift the withholding responsibility to the payor and, if so, how?

A-5: Yes. The plan administrator may shift the withholding responsibility to the payor by following the procedures set forth in § 35.3405-1, Q&A E-2 through E-5 of this chapter (relating to elective withholding on pensions, annuities and certain other deferred income) with appropriate adjustments, including the plan administrator's identification of amounts that constitute required minimum distributions.

Prudence says do not involve the employer in writing distribution checks.  Should circumstances result in the employer receiving and depositing a check in an employer's account, then the employer should as quickly as possible write the check to the participant or to the trustee/custodian who routinely issues distribution checks, and the employer should document all of the circumstances, the actions taken to have the distribution issued, and if needed, any steps taken to give up any interest earned on the amount while in the funds were in the employer's account.

And consider that the Secretary of the Treasury has no authority to interpret ERISA §§ 401-414.

22 hours ago, kmhaab said:

An employee terminated employment and requested a rollover from the 401(k) plan in a letter to the employer and the employer forwarded the request to Fidelity. The request was for a direct rollover to an IRA.

"Direct rollover" caught my eye -- doesn't that mean the employee wanted the funds to go straight from the plan to an IRA account?

Did the letter include information about the employee's recipient IRA? or did the employee at least ask for a rollover account to be established at Fidelity?  If any of that language was included, how did Fidelity issue payment to the employer in the first place?