Compliance November 19, 2007

Misdirected Participant Investments – A Case Study

Here's an interesting case study from our friends at Reish Luftman Reicher & Cohen: "Recently, a 401(k) plan trustee requested our advice regarding a failure of the plan service provider to allocate participant accounts in the manner described in participant enrollment forms."
Reported by

“The service provider invested participant accounts in the plan’s default fund, rather than in the various funds selected by the participants. This “misdirection” of funds had been going on for a number of months. Did this case involve a failure to operate the plan in accordance with its written terms?  

Generally speaking, the first step in any correction analysis is to determine the type of problem. Does the error impact the planfs qualified status? Is it a prohibited transaction? Is it a fiduciary breach? This is important because the IRS remedial program known as the Employee Plans Compliance Resolution System or “EPCRS” (see  IRS Revises Correction Program with New Corrections ) can only be used to fix certain types of defects.

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For 401(k) plans, EPCRS is available to correct only defects amounting to “qualification failures”. that is, defects that jeopardize the tax-qualified status of the plan. Qualification failures fall into three categories:

  • “plan document failures”, failures to keep the plan document up-to-date with the law and the current requirements of Internal Revenue Code qualified plan rules;
  • “demographic failures”, failures to satisfy the non-discrimination, participation and coverage rules; and
  • “operational failures”, failures to operate the plan in accordance with its written terms.

In addition, depending on the type of defect(s) at issue, EPCRS may prescribe a specific correction methodology. Finally, not all types of defects are eligible for correction under each of EPCRS component programs.

So what did we have here? In our case, plan document and demographic failures were clearly not at issue. But did this case involve a failure to operate the plan in accordance with its written terms? It could be logically argued that the answer is no. This is because the defect involved the failure to follow the terms of participant enrollment forms, which are arguably documents separate and distinct from the plan document. Thus, the failure to follow the forms could not result in an operational failure, which only occurs if there is a failure to follow the plan document.”

The rest of the case study is online  HERE

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