The Rise Of ERISA Forfeiture Litigation And What Plan Sponsors Must Know

Since 2023 employers and plan sponsors have been plagued by almost 100 class action lawsuits alleging that sponsors of 401(k) retirement plans caused financial harm to plan participants by using forfeitures from terminated participant accounts to offset current/future employer contributions, rather than using those forfeitures to enhance employee contributions or using them to offset plan costs. A forfeiture occurs when a short-term employee terminates employment before he/she has vested in the employer’s contributions to the plan. Forfeiture cases are attractive because of the significant amount of money involved. For example, three of the initial forfeiture cases involved: (i) LifePoint Health’s plan held $4.4 million in forfeitures over just one year, (ii) Mattel’s plan held $11 million in forfeitures over a 5-year period and (iii) Siemens’ plan held between $35–$44 million in forfeitures over a five-year period.

 If the forfeiture cases gain a foothold in the courts, their impact could reach even the smallest of plans. Twenty years ago, a different theory of class action lawsuits hit plan sponsors alleging that a plan’s investment options, selected by plan sponsors, charged excessive fees to plan participants and that plan sponsors failed to select alternative investment options with lower fees. These lawsuits forced all plan sponsors to reconcile fiduciary duties owed to plan participants. The forfeiture cases are poised to create a similar reckoning. Historically, qualified 401(k) plans handled forfeiture funds in one of three methods: (i) the funds were divided among current participants and deposited into those accounts, (ii) the funds were used to offset employer contributions to the plan, or (iii) the funds were used to pay plan administrative expenses. In 2023, the IRS’ proposed regulations confirmed these three methodologies and required that the forfeitures be used within 12 months of the forfeiture. The DOL acquiesced to these proposed regulations and did not issue regulations of its own.

Most of these cases settled or were dismissed on summary judgment. When dismissing these cases, the Courts either: (1) relied on the IRS’ regulations allowing employers/sponsors to use forfeitures in any of the three ways discussed above; or (2) concluded that the forfeitures consisted only of the employer’s contributions, so plan participants had suffered no actual loss since the funds never belonged to the participants in the first place. 

Over time, the fiduciary duty owed by plan sponsors to plan participants has expanded so that today, plan sponsors owe three principal fiduciary duties:

• A duty of loyalty to plan participants. Employers/sponsors breach their duty of loyalty by using forfeitures to offset their future contributions or to pay for plan administrative expenses, both of which benefit the employers/sponsors to the detriment of plan participants.
• A duty of prudence. Employers/sponsors use of forfeitures to pay the employer’s contributions or plan expenses negatively affects plan participant accounts since the accounts never have the benefit of the investment growth they would have seen had the forfeitures been deposited in the participant accounts.
• An anti-inurement requirement, which prohibits plan sponsors from utilizing plan assets for their own benefit. Such inurement would give rise to a prohibited transaction between the plan and the fiduciaries involved in the transaction. 

In June of this year, a Minnesota district court permitted claims against UnitedHealthcare to move forward in Re: UnitedHealth ERISA 401(k) Litig. The court recognized that while the plan documents bestowed on the employer/sponsor discretion over allocation of forfeitures, the employer/sponsor may have nonetheless violated the duties of loyalty and prudence by consistently using forfeitures to fund its own employer contributions rather than lowering administrative expenses charged to participants. In the first appellate decision concerning forfeitures, the Eighth Circuit affirmed a lower court decision that the plaintiff in Matula v. Wells Fargo & Co. did not suffer injury as the plan document specifically authorized the employer to use forfeitures and the document did not provide for the treatment argued by the plaintiff. Other recent cases have focused on plans which do not bestow discretion on employers/sponsors to allocate forfeitures.

Going forward, for plans not yet swept up in this rush, plan sponsors should evaluate: (i) the express terms of their plans concerning the discretionary use of forfeitures; (ii) the plan’s historical use of forfeited funds; and (iii) whether the forfeiture account has grown to an amount far exceeding what could be needed to fund either the accounts of returning participants or a reasonable expectation of employer contributions in the immediate future. Plans without language requiring participants to pay plan expenses and plans which have always used forfeitures to offset employer contributions could be at risk. Granted, to date, the class action lawsuits have been centered on mega-large plans (those with 5,000 to 10,000 or more participants) and the vast majority of U.S. plans are sponsored by much smaller employers. However, since smaller plans tend to utilize pre-approved standard documents from plan vendors and investment houses which contain boilerplate language giving the employer discretion, smaller plans are also at risk. Since language matters, and until the courts or IRS/DOL provide additional guidance, it is best to confirm the provisions regarding allocation of forfeitures, and if problematic language or administrative history exists, consult with qualified plan counsel or vendors to amend the plan going forward.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.