Legal contests continue, as long accepted 401k practices related to the handling of plan forfeitures come under courtroom scrutiny. Yet another in the wave of ERISA “forfeiture lawsuits” against retirement plans, which began popping up in 2023, has been filed. At the heart of the lawsuits is a test of the fiduciary duties of loyalty and prudence. Read on to learn what’s in question, and how to protect yourself.
Avoid Self-Dealing—-And Even Its Appearance
When an employer sponsors a retirement plan and commits to a match against employee savings, a timeframe is set for when the employee becomes eligible for these funds (aka “fully vested.”) If an employee leaves the business before becoming eligible, the funds from the employer match are essentially forfeited. At the guts of the wave of “forfeiture lawsuits” is the allegation that utilization of forfeited funds to lessen employer contributions, rather than to directly benefit participants through reduced expenses, runs counter to the exceptionally high fiduciary standards of ERISA. Building on similar claims winding their way through courts, the latest, filed in the U.S. District Court for the Northern District of Illinois, alleges that retirement plan fiduciaries violated their duties of loyalty and prudence by using forfeited funds to reduce employer contributions, and thus provide a benefit to themselves, rather than to participants: “Defendants should have allocated this forfeiture money to pay Plan expenses, as required and permitted by the Plan, and then Plan participants would have been better off….” At Plan Sponsor Council of America, ERISA expert, Nevin E. Adams provides a snapshot of this latest forfeiture case:
The suit (Gardner-Keegan et al. v. W.W. Grainger Inc. et al., case number 1:25-cv-05233…) further alleges that the defendants “(a) improperly utilized forfeited Plan assets to disloyally reduce future employer contributions for their own selfish interests; (b) did not engage in a prudent process when deciding to use Plan forfeitures for the employer’s own benefit rather than to reduce Plan expenses; (c) failed to follow the Plan document by prioritizing paying Plan administrative expenses; (d) failed to monitor those responsible on the Plan Committee for allocation of Plan forfeitures; (e) engaged in party-in-interest fiduciary prohibited transactions by enriching themselves through Plan forfeitures; and (f) engaged in fiduciary prohibited transactions by favoring their own accounts with Plan forfeitures.”
Although the case against the WWG Plan represents big dollars and is likely to generate big headlines until resolved, retirement plan sponsors from even smaller businesses are wise to take note: “The suit references language from the Form 5500 filings of the plan for multiple years that detail the forfeiture balances and how they were utilized to offset Company profit sharing contributions to eligible participants.” Indeed, Form 5500 filings are public, and make it relatively easy for creative and hungry plaintiff attorneys to seek out copy cat cases, especially as the capabilities of AI advance. At 401k Specialist Magazine, national risk management expert, and Chief Insurance Officer for Colonial Surety Company, Richard Clarke, has pointed out that although ERISA regulations do not provide protocols for the use of plan forfeitures, 401k forfeiture lawsuits are on the rise, “with plan sponsors accused of misusing forfeited funds instead of reinvesting them for participants.” To avoid getting caught up in the courtroom battles playing out around forfeiture, it’s imperative for plan sponsors to follow these three risk management pointers:
- Plan sponsors should consider whether to remove from the plan language any discretion regarding the use of forfeitures…. Plan sponsors may also consider whether to amend their plan to specify that forfeitures must first be used to reduce employer contributions and then, if any forfeitures remain, those must be used to pay administrative expenses….
- Transparent communication with participants on the use of forfeitures — including clearly communicating the forfeiture process and how forfeitures are to be used — through the plan document, summary plan description and other plan communications.
- Plan sponsors should consider conducting regular audits to ensure that the forfeitures are being used in accordance with the plan document and applicable law.
Remember, when you sponsor a retirement plan you are automatically a fiduciary under the high standards of ERISA, and, as the U.S. Department of Labor explains: “Fiduciaries who do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.” You can never fully eliminate the risk of being held personally accountable to the plan, participants and beneficiaries. Outsourcing plan services does not free you from your risks: as a sponsor, you choose the service providers and remain ultimately responsible for their success on behalf of plan participants and beneficiaries. As a fiduciary, you can even be held accountable for failing to adequately mitigate cybersecurity threats to the plan, or to curtail the damage from a breach. You can also be held responsible for failure to monitor your chosen service providers for their adherence to cybersecurity protocols.
If you face claims that you have failed in your responsibilities as a retirement plan sponsor, the only type of protection that shields you personally is Fiduciary Liability Insurance—-with it, you’ll be armed with coverage for defense and penalties. Without Fiduciary Liability Insurance, your personal assets are exposed. Colonial Surety Company offers an efficient and affordable Fiduciary+ Cyber Liability Insurance bundle specifically to protect retirement plan sponsors. For a few dollars a day, you’ll be armed with:
- $1,000,000 for Defense and Penalties if you are faced with alleged or actual breaches of fiduciary duty.
- Cybersecurity Coverage for the business and plan, which addresses Department of Labor recommendations, and includes expert response services to curtail damage after an incident.
To make protection even easier for plan sponsors, Colonial Surety Company helps you add the Fiduciary+ Cyber Liability Insurance to your ERISA Bond.
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