Troubled Firms Seen Misusing Pension Funds

The pension savings and health coverage of thousands of workers are at risk because financially troubled small-business owners increasingly are diverting funds earmarked for employee benefits to other corporate purposes, federal officials say.

Ranking officials in the U.S. Department of Labor say they have discovered a growing problem involving small, ailing companies misusing worker contributions to the highly popular 401(k) pension plans as well as health insurance premiums.

While labor officials pledge to pursue all such violations, pension experts maintain that official sanctions often come too late to help workers, who may find serious shortages in their retirement savings or discover--after filing a claim--that their health insurance was canceled.

“I’m out thousands of dollars,” said one Los Angeles employee, who asked not to be identified for fear of reprisal from his former boss. “But we didn’t know there was a problem until the company filed bankruptcy. Then it turns out there’s something like $150,000 missing from our 401(k) plan and no one has the money to pay it back.”

The problem is particularly acute in economically troubled parts of the country, such as Southern California and part of the Northeast. The Department of Labor’s Boston office has filed numerous civil lawsuits that allege such pension and heath care violations, while officials at the Los Angeles office say they are investigating numerous claims as well.

Labor officials cannot discuss specific companies under investigation. However, a labor official notes that the Los Angeles office is investigating a private school that has used workers’ health premium money to buy books and pay teachers, and a manufacturer that agreed to restore “borrowed” pension funds to workers’ accounts but has yet to pay interest on the money.

“We are dealing with a handful of cases in relation to the thousands of plans operating in Los Angeles,” said David Ganz, regional director of pension and welfare benefits administration at the Department of Labor in Los Angeles. “But we are concerned. We have seen more situations recently because companies are in financial distress, and they take the 401(k) money to keep operating,” Ganz adds.

Knowingly diverting workers’ funds is a felony, but few cases are prosecuted because the financial loss in individual cases is relatively small, and it is difficult to prove criminal fraud. Instead, the Labor Department relies mainly on civil suits aimed at returning diverted funds to the employees and barring offending company officers from serving as plan trustees.

Serious violations are rare at large firms--those with more than a few hundred employees--because this type of fraud requires top officers to agree to an illegal act. The larger the company, the less likely that top officers will conspire to divert funds, government officials say.

Unlike other types of pensions, there is no government guarantee fund for so-called defined contribution plans, such as 401(k)s. Nor is there government backing for health plans gone awry. Unless the company, its managers or pension plan trustees have the money to repay funds borrowed, “diverted” or stolen from 401(k)s and health premiums, workers are simply out of luck.

“It can happen all too frequently, and when it does, it has particularly tragic consequences,” said Alan Lebowitz, deputy assistant secretary of pension and welfare benefits with the U.S. Department of Labor.

Pension and health care fraud is not new. There have been isolated incidents of labor fraud--perpetrated by both companies and labor unions--since health and pension benefits were first instituted. But industry observers say this kind of fraud has become far more common in the past few years.

The problem appears to be the result of three factors working in concert--a sluggish economy, a credit crunch that has made it hard for smaller companies to borrow and the rising popularity of benefit plans, such as the ubiquitous 401(k).

The latest recession was unusually tough on small businesses because it lasted longer than usual, hit hardest at service industries dominated by small business and came as bank lending standards were tightened, said William J. Dennis Jr., senior research fellow with the National Federation of Independent Business Foundation in Washington, D.C. That made it virtually impossible for ailing businesses to borrow their way through bad times, Dennis adds.

“We had run into financial difficulties, and I was unable to get a loan,” said a company owner who was sanctioned by the Labor Department for siphoning off worker pensions to pay the company’s bills. “It’s not something that I’m proud of. But when you’ve got to pay your light bill and make your payroll and your bank is telling you to find some other form of financing, you don’t have a lot of alternatives.”

While no statistics are compiled, Labor Department officials say the amount of pension and health insurance fraud is small compared to the 2.5 million plans in operation. But the incidence is high enough among ailing small businesses that labor officials suggest that employees carefully monitor their accounts.

Thanks to the way health and 401(k) plans are administered, some managers saw the growing employee contributions as an easily accessible source of cash that they could tap to tide them through bad times.

Employees contribute their own money to the plans, but the contributions are made through employer withholding. Employers then forward the money to a trustee or health insurer.

The problem is that trustees and health insurers rarely communicate with workers--or even with so-called “plan administrators,” who disseminate 401(k) information to employees, said Bruce Ashton, a labor attorney with the Los Angeles law firm of Reish & Luftman. As a result, the company can tell workers and “administrators” that contributions are being made but fail to forward the money. Unless the trustee or the health insurer objects, no one is the wiser.

Often, workers don’t know there is a problem until the company files for bankruptcy court protection or fails to pay several health claims, said Lebowitz.

For instance, employees of Imperial Millwork of West Bridgewater, Mass., found out their health insurance was canceled after the company failed to pay claims for several months, labor officials say. Last summer, the company’s insurance agent--which had failed to tell workers about the terminated coverage--was ordered to pay employee’s four- and five-year-old medical bills.

However, labor officials acknowledge that many violations may go undiscovered because there are no regular audits of pension plan trust accounts nor regular review of health insurance coverage. Labor officials have a computer program that they use to ferret out pension fraud, and they get tips. But, frequently, official action is late.

For instance, the Labor Department barred officials of Southern Architectural Woodworks Inc. from serving as fiduciaries of any qualified pension plan last summer. Owners of the Raleigh, N.C.-based company had diverted more than $29,000 of pension contributions to the company’s general account, labor officials said. However, the company was liquidated more than three years before the labor complaint was filed.

Last week, the Labor Department sued Voloshin Cadillac-Pontiac Co. of New Haven, Conn., for “improperly loaning” plan assets to the company. Voloshin, which had $84,313 in its 401(k) plan to cover 40 workers, is liquidating under Chapter 7 of the bankruptcy code. The Labor Department would not say how much of that money was missing nor what the prospects were for recovering worker funds. Company officials could not be reached for comment.

“Usually, there is a year or two lag before there is an enforcement action” because companies have about eight months to file plan reports and then it takes time to discover the problems and investigate, says Gloria Della, a Labor Department spokeswoman.

As a result, experts maintain that workers must try to protect themselves by keeping an eye on their own company’s financial picture and asking questions when things seem amiss.

“If your company is in financial trouble, you should do a cursory check of the 401(k),” said the Labor Department’s Ganz. “Call the plan administrator to check whether their records (of your account balance) match with your own. And call the trustee and ask whether there has been any problems with contributions being forwarded. If the answer is yes, call us.”