What Do We Do With Mutual Fund Settlement Proceeds?

DWC | 08/7/18

QOTW - 8.7.2018

Facts

Our company sponsors a 401(k) plan, and we moved to a new recordkeeper about two years ago.  Last week we received a letter and a check from our previous recordkeeper indicating that the check represented our portion of the proceeds from a legal settlement involving one of the mutual funds that used to be part of our plan investment menu.

Question

What are we supposed to do with the check?  Does it get deposited into the plan and, if so, to whose account?

Answer

While not as frequent as they were a few years ago, these checks (often for very small amounts) for mutual fund settlement proceeds are somewhat common.  Let’s start with the easy part of the question.  The settlement proceeds are plan assets and should, therefore, be deposited into a plan account, presumably with you current recordkeeper.

Unfortunately, we don’t really have any meaningful guidance from the regulatory agencies on where to go from there.  That means it is up to plan fiduciaries to determine a course of action that is prudent and in the best interest of plan participants.

Here are some of the more common ways we have seen plan sponsors handle settlement proceeds.

Allocate to Affected Participants

In this scenario, the settlement proceeds are allocated to the specific participants who were invested in the mutual fund that generated the settlement during the applicable time frame.  This is probably the most equitable route to go, but it is also the most arduous and time-consuming.  It is more complicated still if several years have passed and, as here, you have changed providers along the way.  Factor in that some of those participants may no longer have balances in the plan or that others may have transferred in or out of the mutual fund in question, and this option may be impossible to implement.

Allocate to All Participants in the Plan at the Time

Rather than trying to identify which participants were invested in the problem fund, some sponsors elect to allocate the proceeds to all participants who remain employed and had balances in the plan during the period that was the subject of the settlement.  Although not quite as detailed an analysis, this option still requires a review of historical records to identify the determination date and the participants who will share in the allocation.

Allocate to All Current Participants

Instead of looking backwards, some plan fiduciaries choose to allocate the settlement proceeds to all participants who currently have a balance in the plan.  This option is the least “accurate” in terms of getting the proceeds to those who were directly impacted, but it is also the easiest and least time-consuming.

Place in Holding Account and Pay Fees

Since most 401(k) plans are written to permit payment of certain administrative expenses out of plan assets, another option is to simply place the proceeds in a holding account within the plan and use to offset upcoming fees.  There are couple caveats that go along with this option.  One is that the proceeds can only be used to pay fees that are otherwise permitted to be paid from plan assets.  In other words, if a fee is not able to be charged directly to participant accounts, it cannot be charged against the holding account.  Second is that the holding account should be used up on a timely basis, generally by the end of the current year.  The reason is that there is a general rule that prevents unallocated money from accumulating in the plan year after year.

So, which is the “best” option?  It really depends on the circumstances.  If the settlement check is for a large amount and the necessary historical records are available, it would be difficult to justify not going with one of the first two options.  On the other hand, if the check is for a very small amount, then the latter two options probably make more sense.  Then again, if you do not anticipate fees for the remainder of the year that would equal or exceed the amount of the settlement, then perhaps option #3 is your best bet.

At the end of the day, it is up to the plan’s fiduciaries to consider the facts and make a good-faith decision that is in the best interest of the participants.

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Topics: Question of the Week, DWC, Settlement Proceeds

The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.