Many (if not most) defined contribution plan documents provide that the plan administrator may use forfeitures to reduce contributions, pay plan expenses, or allocate to participants as additional benefits.
In fact, the Treasury and IRS recently suggested that plans be drafted this way to avoid the impermissible accumulation of forfeitures (see our article from April 2023). A recent complaint filed in a federal circuit court, however, raises fiduciary concerns when plan fiduciaries make decisions permitted by the provision.
The complaint, filed by participants in a 401(k) plan, alleges that the employer and plan administrator breached their fiduciary duties and engaged in a prohibited transaction by electing to use forfeitures to reduce employer contributions rather than to pay plan expenses. Dimou v. Thermo Fisher Scientific, Inc., S.D. Cal. No. 3:23-cv-01732 (9/19/2023). The case is in its infancy but warrants monitoring because of the impact it could have on plan design and/or operations. 
The facts of the case are straightforward. Thermo Fisher Scientific, Inc. (Thermo) maintains a 401(k) plan that gives the plan the ability to use forfeitures to pay reasonable plan expenses (to the extent not paid by the employer) or to reduce any of the company’s contributions under the plan. Over the six-year period covered by the complaint, the company elected to use forfeitures to reduce employer contributions rather than pay plan expenses.
Approximately $23,431,000 of forfeitures were used to reduce employer contributions. During this same period, plan expenses ranged from approximately $340,000 to $1,373,000 per year and were paid from plan assets. Thus, participant accounts were reduced to pay plan expenses and the amount the employer was required to contribute to the plan was reduced by plan forfeitures.
Breach of Duty of Loyalty and Anti-Inurement
Two of the claims against the fiduciaries relate to the duty of loyalty. ERISA prohibits plan benefits from inuring to the benefit of the employer and it requires that plan assets be held for the exclusive purpose of providing benefits to the participants (as well as defraying reasonable administrative expenses). [1]
The plaintiffs claim that by electing to use forfeitures to reduce employer contributions, the plan fiduciaries were acting for the exclusive benefit of the employer rather than plan participants. Participants were harmed because their accounts were charged with plan expenses that could have been paid using forfeitures. The plaintiffs claim that the reduction in the required employer contributions was also a prohibited inurement in favor of the employer.
Breach of Duty of Prudence
The complaint alleges the fiduciaries also breached the ERISA duty of prudence by failing to follow a reasoned and impartial decision-making process in deciding how to use the plan forfeitures. The complaint does not include any details on what—if any—decision-making process was used by the plan fiduciaries. Rather, the allegation appears to be that the decision to reduce employer contributions is, on its face, evidence that there was a failure to have, or to follow, a prudent decision-making process.
Engaging in a Prohibited Transaction
The last allegation in the complaint is that using forfeitures to offset the employer’s contributions resulted in a prohibited transaction. The argument is that there was an indirect sale or exchange of assets because plan assets were used to reduce an employer obligation. While not stated in the facts, it’s likely that the plan used forfeitures to reduce fixed contributions under the plan, such as matching contributions), rather than discretionary contributions.
Conclusion
The plaintiffs in this case have attempted to throw the “ERISA book” at the plan fiduciaries. While anyone can file a complaint, it remains to be seen whether the case progresses past this point. Regardless, the case may have an impact even before we know the outcome. For example, if an employer wants to use forfeitures to reduce employer contributions, some advisors may want to play it safe by specifically providing for this in the plan document rather than leaving the decision to the plan administrator.
Footnote
[1] ERISA Section 1104 provides, in relevant part: a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and (A) for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan.
Robert M. Richter, J.D., LL.M., APM, is Retirement Education Counsel for the American Retirement Association.
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