Only one case has been finally decided. In that case, the Department of Labor (DOL) sued a plan sponsor and its fiduciaries because they had used forfeitures to reduce contributions, when the plan document said that the forfeitures should have been used to pay plan administrative expenses. The case was resolved in favor of the DOL and the plan sponsor had to pay $575,000 to the plan for the participants and a $57,000 penalty to the government.

However, the other complaints were filed by participants who are represented by plaintiffs’ attorneys. None of them have been finally decided.

While the facts vary from case to case, a hypothetical fact pattern would be that the plan document said that forfeitures could be used to: (1) reduce plan contributions, (2) pay administrative expenses of the plan, or (3) be allocated to the participants. In these cases, the forfeitures were used to reduce the plan sponsor’s need to make plan contributions.

Before going further with the facts, some legal context would be helpful. In setting up a retirement plan, a company is a “settlor.” Disregard the technical terminology; it’s a historical reference. More importantly, it means that an employer can act in its own self-interest in setting up a plan, making decisions about the plan’s provisions, and deciding how much to contribute. It’s not a fiduciary in making those decisions and doesn’t have a duty to act in the best interest of its employees.

However, once the plan is adopted, fiduciaries have a duty to follow its terms, unless it would be imprudent to do so. That was the basis of the DOL’s lawsuit discussed earlier in this article—the fiduciaries failed to use the forfeitures to pay plan expenses, as required by the terms of the plan.

The fact situation in my hypothetical is more complex. In that case, the fiduciaries were authorized to do three different things with the forfeitures, but the plan was silent as to whether there was a priority or how the decision was to be made.  As a result, the plaintiffs argued that the fiduciaries had a duty to act prudently and with a duty of loyalty to the participants. That argument is at the heart of the lawsuits.

Obviously, the plaintiffs claim that it would have been in the interest of the participants to use the forfeitures (which, in some of these cases, are seven figure amounts) to pay administrative expenses or to be allocated to the participants. 

And, just as obviously, the attorneys for the plan sponsors and fiduciaries argue that the intent (and interpretations by the IRS) support the opposite conclusion—that it was appropriate to use the forfeitures to reduce employer contributions.

To further complicate matters, forfeitures would be allocated to participants differently depending on how they are treated. For example, if forfeitures are treated as part of an employer “profit sharing” contribution, they would be allocated in proportion to compensation. If they were treated as part of matching contributions, they would be allocated based on deferrals. And, if they are used to pay plan expenses, they would, in effect, be allocated based on account balances.

The outcome is uncertain. (As a disclosure, my firm is defending one of these cases.) While the equities favor employers, since in most cases they can determine whether to contribute or not and, if so, how much, there will be risk until final court decisions are made. Plan sponsors and their financial professionals should be aware of the issue and consider whether steps should be taken to reduce risk.

While the past cannot be altered, it may be possible to reduce future risk.

Concluding Thoughts

Since these cases are still pending, and we may not know the final outcomes for years, plan sponsors and their financial professionals should consider whether it makes sense to modify their plan documents or take other protective steps at this time.

For example, one possible step is to amend the plan document to specify how forfeitures should be used. Another might be to specify in Board resolutions that the contribution is calculated by taking into account the allocation of forfeitures. Yet another is to develop a policy about the allocation of forfeitures. None of these have been tested in the courts. As a result, there’s some risk with any solutions. But amending the documents seems like the safest course of action. Plan sponsors should get legal advice about these and other options and their ability to mitigate or eliminate risk for this issue.

While the past cannot be altered, it may be possible to reduce future risk.