401(k) Deferrals of Fraudulent (Stolen) Compensation

Payroll employee fraudulently paid herself additional compensation in the form of bonuses, PTO payouts, etc. She was terminated recently for cause, the police were involved and the case is currently in court.

This has apparently been going on for 4 years and employee deferrals and employer matching contributions were made to the 401(k) plan on the stolen amounts.   I have never run into this.

1) Can the plan sponsor make corrections to recoup the fraudulent contributions?  (We know they cannot get repayment of the entire stolen amount from her 401(k), but are asking only with respect to the contributions made in error based on the stolen amounts.)

2) Participant just requested a distribution of her entire 401(k). (Ha!) Can employer delay her distribution until this is straightened out? They are still looking at payroll records, etc to determine the scope of the theft. I believe the prosecutor has asked the judge to freeze her account, but I am not certain if that would be preempted by ERISA?

Any thoughts would be appreciated. I have searched the forum for "Embezzle," "Embezzlement," "Theft" etc., but there are no prior discussions on point. :-)

Thanks!

My one and only experience with a qualified plan and these kinds of issues was a bank teller stealing from the bank.  The bank had an ESOP. 

What the bank's lawyer's did was talk to the prosecutor and convinced them to make as part of any plea bargain the lady had to repay the stolen funds.  Since the only large asset she had was the ESOP balance part of the court agreement was she faced less jail time if she agreed to take an ESOP distribution and cash the check at the bank.  She then gave the money to the bank of her own "free will". 

I know of no way to force the money from her account or stop the payment on the plan's authority only.  In my opinion the company needs to try and get the prosecutor to convince the defendant it is in their best interest to at least do nothing at this point with the money in the 401(k) plan so it leaves open that is a bargaining chip they have when it comes time to see what kind of deals can be made. 

You can offset benefits payable to a participant for amounts that represent fraud against the plan - but not the employer, as you note. The trick here may be identifying the fraudulent contributions (and earnings thereon) and doing so in a timely manner. Check plan provisions to make sure such an offset is supported or not expressly forbidden.

Below is some volume submitter language from Relius. That the case is currently in court and there is not a current judgment, holding up payment now might require a court order. Although by the time the participant could bring an ERISA based suit to pay the benefit I expect the embezzlement case would be resolved.

 (c)   Exception for certain debts to Plan. Subsection (a) shall not apply to an offset to a Participant's accrued benefit against an amount that the Participant is ordered or required to pay the Plan with respect to a judgment, order, or decree issued, or a settlement entered into in accordance with Code Sections 401(a)(13)(C) and (D).

I have also seen essentially what ESOP Guy described, where the participant embezzler agrees to pay restitution via distribution from their retirement plan account.

41 minutes ago, CuseFan said:

I have also seen essentially what ESOP Guy described, where the participant embezzler agrees to pay restitution via distribution from their retirement plan account.

Yes, I have seen this as well.

1 hour ago, Belgarath said:

Yes, I have seen this as well.

Here too. 

I agree with ESOP Guy. This is exactly the situation I had. We had the former participant complete the election form requesting a cash distribution. She then reimbursed the Employer for less prison time. There were no contributions involved.

I have seen (and did) what ESOP Guy has done - but I think the issue is more of whether or not an operational error occurred in that money went into the plan on the basis of that which is not "compensation."  Money taken (even through payroll) that is fraudulently obtained is not "pay for work performed" and hence should not count for allocation purposes.  The fact that it was done means an error occurred - that should be correctable.

It would be interesting to see someone (not me) file a VCP based on not following the plan's definition of compensation.....

Keep in mind that the embezzled money may still be "taxable" to the theif - but that doesn't make it "comp" for plan purposes.

I believe that to get the restitution remedy that ESOP guy is talking about you have to have involvement of feds because it is done under a federal restitution statute. There is an earlier series of posts on this that I participated in. Where a bank is involved, embezzlement usually a federal crime.

I'm trying to be creative, but maybe you could go back and redo her comp and W-2's to show the embezzled amounts were not actually compensation eligible for 401(k)? Then under VCP you could withdraw the excess contributions and earnings.

I also think that as long as there is a question about whether her contribution amounts are correct based on comp issue, you could probably delay distribution as not "administratively feasible," but might depend to some extent on plan doc verbiage.

The SPD (and of course the plan) should have a claims procedure.  Ours had a 90 day review period with another 90 day extension possible.