IRS Rules That Wall Street Cannot Buy Your Company's Pension
Plan--Yet
By Michael G. Kushner,
Esq.
Curtis, Mallet-Prevost, Colt & Mosle LLP, New York, NY
Recently hedge funds, private equity funds, investment banks, and
insurance companies (“Institutional Investors”) have been
seeking approval from the IRS, the Department of Labor and the PBGC to
“buy” frozen defined benefit pension plans (i.e., ones
where participants are no longer earning new benefits because they
have been shut down by their sponsoring employers). Such an
opportunity could arise pursuant to a corporate transaction, such as
where Company A buys the stock or assets of Company B but does not
wish to assume B's frozen pension plan. Opportunities to sell pension
plans also could arise in the context of a corporate bankruptcy, or
they simply could arise because the plan's sponsor wishes to get the
liabilities associated with the plan off its books. Citigroup Global
Markets Ltd. in the U.K. recently received regulatory approval to take
over the frozen defined-benefit plan of Thomson Regional Newspapers,
but there is no evidence that this has been attempted in the U.S., as
there are a plethora of regulatory issues that would have to be
resolved under the Internal Revenue Code and ERISA before such a
transaction would be feasible. Institutional Investors are interested
in managing the plans and their assets for profit, since pension
assets represent such a lucrative potential source of new investment.
Private pension assets in the U.S. currently total approximately $2.3
trillion, of which approximately $500 billion is held in frozen plans.
These include the assts held in the frozen plans of such corporate
titans as IBM, Hewlett-Packard, Verizon and Alcoa.
Advocates of this concept point to the benefits that plan
participants would receive by having their benefits managed by a
professional manager and to the fact that a well-capitalized
Institutional Investor could help shield an underfunded pension plan
and its participants from having to rely on the limited guarantees of
benefits offered by the PBGC should the plan not have sufficient
assets to pay benefits when due.
Critics point to the fact that an entity that has never had an
employment relationship with plan participants has never been allowed
to sponsor--much less purchase--a pension plan and that, because of
this, non-employers are less likely to be “employee
friendly” toward plan participants, since, to an outside
investor, the plan and its benefits were never intended as a device to
attract and retain employees. Critics also argue that an Institutional
Investors might take greater risks in investing pension assets than is
traditionally considered prudent and that reporting of the underlying
assets of many of such Institutional Investors, particularly in the
hedge fund and private equity areas, is considered by many to be too
opaque. Critics also believe that allowing such transfers would
encourage employers to freeze their defined benefit plans in order to
package them for sale.
On August 6, 2008, the IRS issued Rev. Rul. 2008-45, clarifying
that such pension plan buyouts by unrelated companies are
impermissible under ERISA and the Code because such arrangements would
violate the requirement that pension plans be operated for the
“exclusive benefit” of plan participants and beneficiaries
under §401(a)(2) of the Code. Therefore, any such attempted
transaction would subject the frozen plan to disqualification.
Under one model structure, Oldco, the employer, is the sponsor of
an underfunded frozen defined benefit pension plan. Oldco transfers
sponsorship of the plan to Newco, a pension management company which
is not part of Oldco's controlled group. This was the situation
described in the revenue ruling. Presumably Newco then would manage
the plan's assets for profit and in exchange for a fee. Although this
was not addressed in the revenue ruling, it is conceivable that Newco,
in turn, might sell interests in itself to other investors, perhaps in
the form of limited partnership or limited liability company
interests, i.e., a securitization of pension plan assets.
In addition to possible exclusive benefit rule violations as cited
in the ruling, practitioners also have raised concerns under ERISA
that would have to be addressed before such transactions could take
place. For example, ERISA requires that a plan be sponsored by an
“employer.” Employer, for this purpose, includes a
successor employer but not any other entity that has not had an
employment relationship with the plan participants at some time.
Practitioners also have questioned whether Newco's purchase of a
frozen plan would be considered a fiduciary decision subject to the
fiduciary duty rules of Title I of ERISA and whether the transfer
would relieve Oldco of its contribution and other responsibilities
under ERISA. Other questions include whether Oldco's decision to sell
the frozen plan is a fiduciary decision subject to ERISA and whether
the PBGC retains the authority to regulate a transferred plan. For
example, could the PBGC still terminate a transferred plan under
§4042 of ERISA by going to court?
The ruling, however, may not be the end of the matter. Accompanying
the ruling, the Administration has set forth a framework of principles
intended to guide the development of legislation that could permit
such transactions in circumstances where the transaction is in the
best interest of “plan participants, their beneficiaries,
employers, and the pension insurance system.” The legislative
framework was developed by the Treasury Department, the Labor
Department, the Commerce Department, and the PBGC. Thus, if
Institutional Investors are to be permitted to buy private pension
plans, Congress will have to pass enabling legislation. The IRS has
made clear that such transactions are not permissible under current
law but the Administration has suggested that Congress may wish to
change current law to permit this type of purchase.
Under the Administration's “framework” for legislation,
a frozen pension plan (or a portion of a plan) could be transferred to
an entity unrelated to the employer of plan participants if the
following conditions were met:
1. Participants, their representatives, and the government must
receive advance notice of a plan transfer and the parties must make
certain disclosures and secure approval from the appropriate federal
agencies.
2. Only “financially strong entities” in
“well-regulated sectors” could buy a pension plan.
3. The parties to the transaction must be able to demonstrate that
participants' benefits and the PBGC would be exposed to less risk as a
result of the transfer, and that the transfer would be in the best
interests of participants and beneficiaries.
4. Transfers cannot be exposed to “undue concentration of
risk.”
5. Transferees and members of their controlled groups must assume
full responsibility for the liabilities of transferred plans and
comply with certain post-transaction reporting and fiduciary
requirements.
6. Subsequent transfers must be subject to the same rules as the
original transfer.
The proposal has its advocates and its detractors. The fact that
the idea has arisen now certainly reflects the desperate situation in
which many defined benefit pension plans find themselves in light of
the recent bear market, which has exacerbated an already troubled
funding situation. One has to wonder, however, whether the timing of
such a proposal is propitious, in light of the current instability of
financial institutions and the ongoing credit crisis. Furthermore, a
Democratically controlled Congress presumably would be reluctant to
adopt such a measure, particularly in view of the strenuous opposition
that has been voiced by the AFL-CIO and AARP, among others.
Nonetheless, as the saying goes, desperate times require desperate
measures and in these desperate times for defined benefit plans, this
is a novel idea that Congress certainly will consider. One thing seems
certain: given the amount of time and effort devoted to this proposal
by the investment community, consulting firms, law firms and the
federal regulatory agencies, the concept will remain on our horizon
for the foreseeable future.
For more information, in the Tax Management Portfolios, see
Finston and D'Alessandro, 351 T.M., Plan Qualification--Pension
and Profit-Sharing Plans, and in Tax Practice Series, see
¶5590, Other Laws and Considerations Affecting Employee Benefit
Plans.
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