Dueling Decisions Spur Employer Confusion on 401(k) Forfeitures

Employers tasked with reallocating 401(k) assets forfeited by former employees are encountering a wave of litigation alleging the misuse of plan funds, as well as emerging disagreement between judges on these suits’ viability.

The appetite for litigation has risen over plan sponsors’ use of forfeited funds to pay their own contributions rather than offset workers’ costs, despite existing and proposed US Treasury Department regulations that appear to allow this type of usage.

HP Inc., which used unvested 401(k) cash to fund its other required plan contributions, successfully defeated class action claims June 17, when a US District Court for the Northern District of California judge ruled that the practice falls within the bounds of the Employee Retirement Income Security Act.

In May, however, a judge in the Southern District of California ordered Qualcomm Inc. to defend its use of forfeited 401(k) assets, ruling that plaintiffs plausibly alleged the employer put its own financial interests ahead of its workers’ by using that money to pay its plan contributions.

The schism between the two decisions underscores broader uncertainty that has prompted similar suits against large employers like Wells Fargo & Co., Tetra Tech Inc., and Honeywell International Inc. in recent months over their use of forfeited plan assets.

“This has been a small wave, or at least small so far, that we have seen developing in the past six to 12 months or so,” said Caroline Wong, a senior managing associate at Sidley Austin LLP. “All these cases have been surprising to us and other practitioners in the space because they’re essentially challenging conduct that a federal regulation says plan sponsors aren’t only allowed to undertake, but are required to undertake.”

401(k) contributions from the employee salaries fully vest immediately, but employer contributions can remain unvested or only partially vested for a period of time and can be forfeited in whole or part when the worker leaves the company.

It is not uncommon for 401(k) plan documents to specify that these funds can or should be used to pay for administrative expenses or put toward employer contributions.

Treasury Regulations

Judge Beth Labson Freeman’s decision dismissing the suit against HP said that the allegations against the employer improperly extended ERISA beyond its bounds and contradicted Congress and the Treasury Department’s understanding of defined contribution plans.

HP’s practice also wasn’t a prohibited transaction under ERISA, nor did it violate the statute’s anti-inurement provision, which prevents plan funds from being used to an employer’s benefit, she said.

Existing and proposed Treasury standards authorize plan sponsors to use money forfeited by ex-employees to offset their usual contributions without breaching their fiduciary duties, Qualcomm argued in a motion to dismiss that case in January. The suit filed by Qualcomm plan participants doesn’t mention or challenge the Treasury regulations in question, the plan sponsor pointed out when seeking dismissal.

Qualcomm could have used $1.2 million of forfeited contributions from 2021 to pay plan administrative expenses, which would have benefited all participants by eliminating those charges from their accounts, but those participants instead had to pay expenses while Qualcomm used the assets to reduce its own contributions, Judge Roger T. Benitez said in the order denying dismissal of the case.

A 1963 Treasury regulation says that retirement plan providers must use forfeited assets as soon as possible to “reduce the employer’s contributions under the plan.” Another rule proposed by the IRS in February 2023 seeks to clarify that plan sponsors can use the forfeited assets to pay administrative expenses, reduce employer contributions, or increase benefits in other participants’ accounts in accordance with the plan’s terms.

“If that rule becomes final, that would be an additional reason that defendants could point to for why these cases should be dismissed from the outset,” Wong said. “If plan documents dictate one particular use of forfeiture amounts, as opposed to leaving it to the plan sponsor’s discretion how to use those amounts, then litigation risk should be minimal.”

Many complaints targeting employers’ alleged misuse of asset forfeitures have highlighted language in plan documents that leave it to the plan sponsor’s discretion how the money will be used, instead of clearly stating one purpose reallocated assets will serve under Treasury regulations.

The suits against both Qualcomm and HP indicate that relevant plan documents give the employers discretion over whether to put forfeitures toward expenses or contributions.

Open Door for DOL

Establishing and enforcing fiduciary standards under ERISA typically falls within the Labor Department’s purview, but the agency has been largely quiet on the matter of asset forfeitures from a rulemaking perspective, aside from a series of advisory opinions.

“It could be that it’s truly not a priority quite yet,” said Anna Mikhaylina, associate at Verrill Dana LLP. “The DOL could have signaled more interest, but at the same time, maybe it’s such a new topic that the court is a better place for these type of controversies to be resolved.”

DOL filed its own lawsuit against Sypris Solutions Inc. in 2017, alleging that the employer didn’t follow the asset forfeiture provisions of its own plan document by using the money to reduce its required contributions. The US District Court for the Western District of Kentucky judge in that case issued a consent order and judgment in September 2023, ordering Sypris Solutions to pay $575,000 to participants harmed by the plan sponsor’s use of their funds and $57,000 in penalties to the DOL.

The courts’ differing interpretations of ERISA leave open questions that could undermine the foundations of the statute’s fiduciary standards, but each plan’s own documentation and how closely the employer complies with it should be the first question when assessing whether a fiduciary breach has occurred, according to Christine Cushman, of counsel at Bricker Graydon LLP.

“To the extent the plan document provides that forfeitures can be used to pay plan expenses or reduce employer contributions, I do not think there is merit to say a fiduciary breached their duty by following the plan provision,” she said. “If you begin down the path of arguing ERISA fiduciary duties require such behavior, the ERISA fiduciary structure will eventually collapse upon itself.”

The cases are Hutchins v. HP Inc., N.D. Cal., No. 23-cv-05875-BLF, 6/17/24 and Perez-Cruet v. Qualcomm Inc., S.D. Cal., No. 3:23-cv-01890, 5/24/24.