Compliance February 10, 2022

Fraudulent Hardship Withdrawals Draw Grand Jury Ire

A federal court has denied a defendant’s motion to dismiss a lawsuit in which he is accused of committing wire fraud while taking allegedly fraudulent hardship withdrawals from a 401(k) plan.  

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The U.S. District Court for the Southern District of Ohio has ruled against a dismissal motion filed by the defendant in a lawsuit stemming from federal grand jury charges related to allegations of fraudulent hardship withdrawals taken from a tax-advantaged retirement plan.

As alleged in the indictment, the defendant in the case was employed by Academy Health Services Inc., a home health care provider. The company offers its employees access to a 401(k)-style retirement savings plan, in which the defendant participated, according to case documents. As is par for the course, the plan is supported by a third-party administrator, Latitude Retirement Services, and by a custodian, Mid Atlantic Trust Co.

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Case documents show that, in 2019, the defendant submitted to Latitude two hardship withdrawal applications to obtain disbursements from his 401(k) account. The first was made in June 2019 and the second in October of the same year. According to the order rejecting the defendant’s dismissal motion, the applications stated the funds would be used to purchase his primary residence and pay medical expenses. Both of these would be permissible reasons for a hardship withdrawal under the plan and the applicable tax laws and benefit plan regulations.

As recounted in the order, both applications were processed and resulted in Mid Atlantic disbursing funds to the defendant’s bank account. Based on the grand jury’s findings and recommendation, the government alleges the defendant used the funds for impermissible purposes, such as personal expenses, and therefore falsely represented the purpose of the withdrawals on the applications. Further, the government alleges the defendant forged a plan trustee’s signature on the applications.

Based on these actions, the defendant faces charges of wire fraud, making false statements and concealing facts in a legal proceeding. As noted by the court’s order, a conviction of wire fraud requires that the government show the defendant devised or willfully participated in a scheme to defraud, that he used an interstate wire communication to further the scheme and that he intended to deprive someone of money or property. The dismissal motion filed by the defendant argues he cannot, as a matter of law, be convicted of wire fraud, because did not deprive a victim of money or property.

In explaining its rationale, the court points out that Section 4.4(a) of the plan document provides that “the administrator shall establish and maintain an account in the name of each participant.” Section 4.2(c) further provides that the defendant’s “elective deferral account shall be fully vested at all times and shall not be subject to forfeiture for any reason.” Given these sections in the plan document, the defendant says he was the owner of the funds he obtained as a result of the hardship withdrawal applications and thus he did not deprive another of their property interest. In response, the government notes Section 4.2(d) of the plan document prohibits distributions from a participant’s elective deferral account “except as authorized by other provisions of this plan.”

The government also contends that, despite the defendant’s account being fully vested, the funds the defendant withdrew are plan assets, rather than assets owned by the defendant.

The order states that the Ohio District Court is aware of only one other federal court that has addressed this issue. In United States v. Barringer, the defendant was convicted by a jury of wire fraud, among other charges, for transmitting a fraudulent hardship withdrawal form to her company’s 401(k) plan provider to obtain a distribution from her account. However, the court in that case reversed course and granted the defendant’s motion for judgment of acquittal on the wire fraud conviction, finding the government in fact failed to prove that the defendant’s deceit deprived another person or entity of a property interest.

Ultimately, the plan provider’s contractual interest did not qualify as a property interest, and although it was deemed “possible” that the trustee may have held such a property interest, the court concluded the government’s witness did not adequately claim that the plan provider was the victim of a fraud nor suffered any loss due to the defendant’s misrepresentations contained in the hardship withdrawal forms.

Reflecting on this precedent, the new order states that, while the facts in Barringer are directly comparable to the facts of this case, the difference in procedural posture is significant, as the court in Barringer ruled after the evidence was submitted at trial.

“Here, the government intends to present evidence at trial regarding the plan document and the relationship between the trustee, plan administrator, asset custodian, plan and assets, as well as evidence of the misrepresentations made,” the new order states. “The government contends this evidence will demonstrate that the funds the defendant obtained were plan assets in which the trustees had a property interest.”

As sch, the order concludes, whether the government’s evidence will support the wire fraud charges is a question of fact for the jury. Accordingly, the defendant’s motion to dismiss as to the wire fraud charges is denied. Similar conclusions are reached by the court regarding the other charges, and thus the case can proceed to trial.

The full text of the order is available here.

Data and Research February 10, 2022

Corporate DB Plan Funded Status Little Changed in January

Whether plans saw a slight increase or decrease depended on their lifecycle stage and allocation to equities.

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The aggregate funded ratio for U.S. corporate defined benefit plans sponsored by S&P 500 companies increased by an estimated 0.4 percentage points month-over-month in January to end the month at 95.8%, according to Wilshire.

The monthly change in funding resulted from a 5% decrease in liability values, mostly offset by a 4.6% decrease in asset values.

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“January saw significant declines for both asset and liability values,” says Ned McGuire, managing director, Wilshire. “Equities, represented by the FT Wilshire 5000 Index, and the liability value experienced the worst monthly return since the early stages of the COVID-19 pandemic in March 2020. The liability value decreased due to the approximately 40 basis point increase in corporate bond yields used to value corporate pension liabilities. The rise in Treasury yields accounted for nearly two-thirds of the increase in yields.”

He adds: “Due to larger decrease in liability value, January’s funded ratio is at its highest level since year-end 2007, estimated at 107.8%, before the great financial crisis.”

LGIM America estimates that pension funding ratios were relatively stable throughout January, increasing from 92.6% to 92.8%. The fall in liability values from rising discount rates outpaced the poor equity performance on the asset side, resulting in the 0.2% rise in the average plan’s funded status, according to its Pension Solutions Monitor.

But not all organizations that track DB plan funded status reported gains, with many pointing out that the lifecycle stage and concentration of equity investments determined how pensions fared in January.

According to Northern Trust Asset Management, the average funded ratio for pensions sponsored by S&P 500 companies was largely flat in January ending at 96.1% from 95.9%. The negative equity returns were offset by lower liabilities due to higher discount rates.

Global equity market returns were down approximately 4.9% during the month, according to NTAM. The average discount rate increased from 2.51% to 2.86% during the month, leading to lower liabilities.

“The Federal Reserve noted it will soon be appropriate to raise the fed funds rate,” notes Jessica Hart, head of the outsourced chief investment officer retirement practice at NTAM. “Investors perceived Chair [Jerome] Powell’s comments as rather hawkish. Following the press conference, Treasury yields quickly rose and equities declined. While projected earnings of S&P 500 companies are expected to end the quarter up 24% year-over-year, the reports have fallen short of fully reversing the negative market sentiment.”

In January, the aggregate funded ratio for U.S. pension plans in the S&P 500 decreased from 93.4% to 92.3%, according to the Aon Pension Risk Tracker. The funded status deficit increased by $17 billion, which was driven by asset decreases of $97 billion, offset with liability decreases of $80 billion year-to-date.

Pension asset returns were negative throughout January, ending the month by losing 4.2%, Aon says. The month-end 10-year Treasury rate increased 27 bps relative to the December month-end rate, and credit spreads widened by 4 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 2.56% to 2.87%.

“Given a majority of the plans in the U.S. are still exposed to interest rate risk, the decrease in pension liability caused by increasing interest rates partially offset the negative effect of asset returns on the funded status of the plan,” Aon says.

While the rise in discount rates resulted in a decline in liabilities for the month, plans with equity exposure may have seen a decline in funded status, River and Mercantile says in its “US pension briefing – January 2022.”

“There are lots of negative signals that are resulting in volatility in the markets that we expect to continue to see in the coming months,” says Michael Clark, managing director in River and Mercantile’s Denver office. “For example, the Fed’s announcement in December that we may see more fed funds rate hikes and earlier than expected in 2022, sustained high inflation numbers, weaker than expected quarterly earnings reports and dampened forecasts, but a bright spot in a stronger than expected jobs report in January. So far in February, rates continue to increase and equities continue to be volatile.”

Both model plans October Three tracks were close to even on the month, with Plan A improving less than 1% while the more conservative Plan B lost a similar amount. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation and a greater emphasis on corporate and long-duration bonds.

Total-return plans with higher duration liabilities and lower fixed-income allocations may have experienced an increase in funded status as opposed to liability-driven investing-focused peers holding more long-dated bonds, NEPC says. Based on NEPC’s hypothetical open- and frozen-pension plans, the funded status of the total-return plan increased by 1.5% as losses from equities were offset by declining liability values. However, the funded status of the LDI-focused plan dropped 0.9%, with asset losses stemming from both equities and long-duration bonds. The hypothetical LDI-focused plan is 77% hedged as of January 31.

Income Research + Management’s analysis of pensions’ funded status changes finds that, despite higher discount rates, negative returns on growth assets in January resulted in varied changes across the funded statuses of its sample plans. Its average plan funded status decreased slightly by 0.1% in January, ending the month at 106%. The average plan is soft-frozen with a target liability duration of 12 to 14 years, and a target asset allocation of 50% growth assets and 50% fixed-income assets.

IR+M says its end stage plan funded status increased by 0.2% and ended January at 114.9%. The plan, which is the most hedged of the firm’s sample plans, was insulated from the drawdown in equity markets. The end stage plan is hard frozen with a target liability duration of eight to 10 years, and a target asset allocation of 15% growth assets and 85% fixed-income assets.

The young plan funded status was 98%, up by 0.6% from the prior month. The plan, with a longer liability duration, benefited from the increase in discount rates. The young plan is open and accruing benefits, with a target liability duration of 15 to 17 years and a target asset allocation of 70% growth assets and 30% fixed-income assets.

“At IR+M, we anticipate a first-quarter pick-up in de-risking activity to protect the significant funded status gains from 2021 and to mitigate the heightened market volatility expected in the upcoming year,” says Theresa Roy, pension and LDI specialist at IR+M.

Sweta Vaidya, North American head of solution design at Insight Investment, urges DB plan sponsors to re-evaluate their appetite for downside funded status risk.

“Our model shows that funded status declined by 0.7%, from 95.6% in December to 94.9% in January,” she says. “The decline was driven by weak returns by equities and other growth assets but partially offset by increases in discount rates during the month. While this is a small decline relative to the approximate 7% improvement seen during 2021, it highlights that gains can be easily lost.”

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