One of my clients paid out 2 lump sum distributions early in 2002 directly to the participants (brokerage accounts liquidated and paid out) without witholding the 20%. Without going into specifics, let's assume that the money is irretrievably gone.

Do I now simply file the 1099 showing no money withheld and hope that the plan doesn't get audited? This surely has to be a red flag for administrative deficiencies.

you still need to issue a 1099R, without the withholding.

Likely will not cause a problem if the recipient pays all of his/her taxes; but if not all taxes are paid, plan may be liable for the undeposited withholding.