Tuesday, July 30, 2013

Ruling Affects ERISA Compliance Issues for Private Equity Funds

Just last week, the First Circuit Court of Appeals ruled in New England Teamsters v. Scott Brass Holding Corp. So, what's the big deal and why am I writing about it here? Well, Scott Brass Inc. was wholly owned by a combination of Sun Capital Partners III and Sun Capital Partners IV, a pair of private equity funds under the Sun Capital Partners umbrella. Scott Brass participated in the New England Teamsters & Trucking Industry Pension Fund. When Scott Brass went into bankruptcy protection, it was assessed a withdrawal liability.

The District Court accepted the argument of Sun Capital Partners that their funds were not "trades or businesses" and were therefore not liable for withdrawal liability payments. But, the Appeals Court held that the Sun funds invested in Scott Brass "with the principal purpose of making profit." Further, although Sun argued that it had no employees, the Court noted that the partners of the Sun funds had and exercised the authority to hire, fire, and compensate employees of Scott Brass. Additionally, partners of the Sun funds were "actively involved in management and operation" of the company.

The implications of this ruling are potentially far more significant than just this withdrawal liability case. Diligent readers (I certainly hope I have a few) may recall that nearly two years ago, I wrote on retirement compliance issues for private equity funds. At least a few readers wrote to me to tell me that private equity funds were exempt because they were not, in fact, businesses.


While I am not an attorney and am therefore not technically qualified to opine on what the Appeals Court said, I can read. This seems to make clear to me that at least in the states of Maine, Massachusetts, New Hampshire, and Rhode Island as well as the Commonwealth of Puerto Rico, private equity funds can be businesses. Since there primary purpose generally is to make a profit and since they tend to exercise some management authority over the companies in their portfolios, it strikes me that this ruling can be construed to make them (where they have 80% common ownership) a controlled group of companies.

So, private equity funds beware. This means that:

  • you and your partners might be jointly and severally liable for funding of qualified retirement plans in the controlled group
  • all those retirement plans in the controlled group are subject to the nondiscrimination, coverage and minimum participation rules of ERISA and the Internal Revenue Code
  • we could say the same about welfare benefit plans and their nondiscrimination requirements
Of course, there are other requirements and pitfalls, but I thought it worth it to point out a few. The effect here could be significant. How many companies that are owned by private equity funds, for example, do their nondiscrimination testing on a controlled group? Or, conversely, how many do not? 

Somebody out there is going to latch onto this and stir up some trouble. The question to me is will other circuits follow the first?

Friday, July 26, 2013

Managing HR Risk: Micro Versus Macro

It's an interesting question, at least I think it is; when looking at risks inherent in benefits and compensation programs, should a company look at them on a macro basis or a micro basis? Or said differently, do lots of small unattended risks add up to a large risk that if it were in a single program would be viewed as untenable?

One could probably look at some of the variety of public entities which either are seeking or have sought protection under Chapter 9 of the United States Bankruptcy Code. Additionally, we could examine those that are probably considering such action whether or not deliberations have been in the public eye. What makes them especially relevant to this question is that in so many cases, the costs that are causing these cities and counties to go bankrupt are related to benefits and compensation. They are, after all, the largest budget items for many of these entities.

How did they get to this point? We could get into a political debate here, but that is not my objective. I know that some of my readers lean left while others lean right. We could get into a debate about public unions, but again that's political and one sentence later, it remains not my objective.

Many cities, counties and other government entities provide generous benefits. The often include defined benefit pension plans that would be unheard of in the private sector, health care benefits that would be considered "Cadillac Plans" under the Affordable Care Act (ObamaCare), large amounts of bankable paid time off sometimes as a single quantity and sometimes as vacation time and sick time separately.

The accounting profession through GASB standards has brought attention to the liabilities associated with these costs. Funding of these obligations, however, is usually subject to municipal or state law and there have been some notable cases where local government may have played fast and loose with those laws.

Why do I raise these issues? Benefits were not always as generous as they are today. But, they creep up. In good times, they are enhanced. Look, we have a surplus this year, we can afford to enhance this benefit. Each time this is done, there is a new, albeit small, risk added to the total risk pie.

Suppose a public entity has a $1 billion annual budget and this new enhancement only increases annual costs by $1 million. That's only 0.10% of the annual budget. Surely, it must be affordable. And, frankly, if you thought about it on a personal level, you would probably agree. If you have an annual income of $100,000, a $100 annual increase in costs would not change your life. It's only about $8.33 per month. It's less than 3 cents per day. But, you all know what happens, you don't just take on a single $100 increase, you take on a bunch of them and all of a sudden, you have a meaningful increase in costs and with it, a meaningful increase in risk. So go the public entities as well.

This sometimes happens in the private company world as well. Because of things like ERISA and the Internal Revenue Code, there are more funding rules and they cannot be ignored. But there are lots of benefits and compensation programs that need not be funded. You know what, they add up. Have too many of them and it starts to affect the bottom line. But when companies look at this on a micro basis, there doesn't appear to be a problem. You might hear a conversation that goes something like this:
"We have annual revenues of $1 billion, so where is the problem?" "I don't know, we haven't changed anything with meaningful cost." "Maybe our consultants messed up. When I look at our changes over the last few years, they didn't price any of them out to cost more than $500,000 per year [they forget to mention that there have been 25 such changes over the last 10 years each with estimated cost projections, but that all of those estimates come with inherent volatility and therefore risk], so maybe we should look to see where they messed up."
Suppose the company had looked at all 25 changes together. And, further, suppose they had looked at them stochastically and considered the dreaded left tail -- the worst 5% of all plausible occurrences. Wow, this entails some real risk!

So, while it's okay to consider changes that have costs and to be a bit more cavalier about ones that have small costs, companies should always consider them in a more macro context. What other changes have been made recently or are they considering? What is the interplay between the costs and attendant risks? How do they correlate? Will the costs escalate at the same time as business has a tendency to go bad?

Food for thought? What do you think?

Friday, July 19, 2013

Senate Finance Committee Mulls Executive Compensation Changes

In late May, the Senate Finance Committee released its seventh paper in a series discussing ways on which it might consider reforming the existing Tax Code. Earlier this week, I discussed some of the possibilities in the retirement arena; today, I explore executive compensation.

For years, the intermingling of executive compensation and the Tax Code was a pretty simple consideration. Companies paid their executives a lot of money (but nowhere near as much as they do today). Essentially, executives paid taxes on compensation when it was constructively received and companies got deductions at the same time.

Each time that there was an abuse or perceived abuse, Congress saw fit to fix it through changes to the Internal Revenue Code. Rather than solving a problem, they often created a newer and bigger one. Congress sought to control the amounts that executives are paid by creating the $1 million pay cap under Code Section 162(m). I wrote about this problem back in 2011. Then, there were the Enron and Worldcom debacles and Congress presented us with Code Section 409A as part of a jobs bill of all things.

In any event, here are the proposals that the Finance Committee "may wish to consider" as it moves forward with all deliberate speed.

  1. Revise the limits on the deductibility of executive compensation.
    1. Repeal 162(m). In my opinion, repealing the limit would allow companies to pay executives more directly and would probably meaningfully decrease executive compensation.
    2. Expand the 162(m) group. This, again in my opinion, would serve to increase the number of people for whom large companies would try to get overly creative and overpay their top employees, especially on the sales side.
    3. Apply 162(m) to all equity compensation as well. 
    4. Change the 162(m) limit to 25 times the compensation of the lowest-paid employee in the company. This would cause companies to eliminate lower-paying jobs. I see no benefit to this proposal.
  2. Revise the rules related to nonqualified deferred compensation (NQDC). 
    1. Modify or repeal Code Section 409A.
      1. Repeal 409A and replace it with Treasury authority to promulgate rules that tax NQDC when it is constructively received. Didn't we used to have these rules?
      2. Repeal 409A for private companies. 409A was put in to stop a run on the bank like the one that occurred in the Enron debacle. Private companies truly are a different situation.
      3. Repeal the 20% penalty tax under 409A. Hmm! If you take the penalty out of a tax penalty, then you lose its teeth. Either repeal the section or keep it, but don't have it there with no teeth.
    2. Repeal NQDC. That is, tax service providers on compensation in the year that it is earned rather than allowing deferral.
      1. As an alternative, tax the employer currently on the buildup in deferred compensation.
      2. Allow either the company or the executive to pay that tax in the item immediately above.
  3. Revise the rules related to equity compensation.
    1. Repeal incentive (at the money) stock options. Since ISOs get special tax treatment, repealing them would remove the incentive for grantees of such options to hold the shares once they exercise their options.
    2. Modify deductibility of stock options.
      1. Limit the deduction to the amount recorded on the company's books when the options are granted.
      2. Deduct the stock option cost in the year that it is expenses.
  4. Revise golden parachute rules.
    1. Essentially repeal the excise taxes and the limitation on employer's deductions. This sounds like the pre-1984 rules.
This is certainly an interesting combination of proposals. I feel sure that even the least observant among my readers can work out which proposal came from Democrats and which from Republicans. Note that not a single one of the proposals talks about repealing Title IX of Dodd-Frank. Alas.

Tuesday, July 16, 2013

Senate Finance Committee Mulls Retirement Changes

In late May, the Senate Finance Committee published its seventh in a series of papers related to potential tax reform. As a 20-pager, it's far too dense for me to cover all the topics in one blog post. So, I'm going to use my editorial license to write about it in pieces. This first piece is on retirement issues.

In the words of the paper, this piece represents a non-exhaustive list of suggestions presented by witnesses at the Committee's hearings on the topic. Given the girth of this piece, those witnesses who suggested options that were left out must feel rather dismayed.

So, given that I have linked you to the Finance Committee piece and that its paper has links and official gobbledygook (that's English for political-speak), why should you read my post instead of the paper? Here are some good reasons for you:

  • This will be shorter
  • My blog is presumably more entertaining than things written by Congress and Congressional staffers
  • Reading my blog will give you a pithy analysis
  • When there is something that I don't agree with, I will tell you so
The paper points out that there are three means of retirement savings for individuals (Congress never mentions MegaMillions or PowerBall
  • Social Security
  • Qualified (employer-sponsored plans)
  • Other saving including IRAs, annuities [and the lottery?]
The paper also points out the qualified retirement plans are one of the largest single tax expenditures. Here I digress. It is true that qualified retirement plans are among the largest federal tax expenditures. Even with them, however, the vast majority of workers, in my opinion, will not be close to having enough money to retire when they turn 65. So, this tells me that the current system is failing.
  • Workers can't retire
  • The qualified retirement system adds considerably to the federal debt and deficit
So what are the proposals? I am going to number them the same way (except that Blogger does not let me use letters as subsections) that the paper does.
  1. Limit or eliminate tax preferences for retirement saving. In my opinion, this will have the effect of companies reducing their commitments to qualified plans leaving workers with an even bigger shortfall.
    1. Reduce or repeal tax expenditures for retirement savings and replace with automatic enrollment or expanded Social Security benefits. This seems to me to be an effort to allow the lower-paid workers to retire from contributions required of higher-paid workers. If you think that is the correct approach, you have a winner. If not, then you don't
    2. Reduce 401(k) limits (see Code Section 402(g)) from $17,500 to $14,850. Hmm. This is a reduction of slightly more than 15%. Why not either reduce by a fixed percentage or reduce to a nice number? For those who are unfamiliar, my personal dictionary says that nice numbers include those which are particularly round and or memorable. $14,850 is neither. And, this proposal would also make it less likely that as many peope are able to retire as under the current broken system.
    3. Cap the value of deductions and exclusions for DC plans to 28 cents per dollar contributed. If I understand this correctly, this would make 401(k) deferrals by higher earners not fully deductible on their federal tax returns.
    4. Disallow deductions for contributions to qualified plans once the total value for an individual is at the 415(b) (maximum benefit) limit. I didn't like this administration proposal when I first wrote about it and I still don't like it. It would be beyond impossible to administer.
    5. Eliminate catch-up contributions. Well, I guess it would reduce a tax expenditure, but the public policy rationale for this is devoid of reason.
    6. Require inherited IRAs to be distributed within 5 years. Ultimately, what this would do is limit the amount of tax-deferred build-up. It will accelerate the payment of taxes and it looks to me to be something intended to play a game with CBO scoring..
    7. Repeal the dividend deduction for ESOPs.
    8. Repeal non-deductible IRAs. Essentially, the purpose of this is to limit tax-favored build-up.
  2. Replace deductions, exclusions and credits for retirement savings with a single refundable tax credit. For the higher earners, this would appear to diminish the value of currently tax-favored retirement savings. For the lowest earners who are somehow able to save, it would be another way to refund them more in taxes than they actually pay into the system.
  3. Increase Savings Incentives. 
    1. Expand the Saver's Credit and make it refundable. The Saver's Credit is a tax credit (currently not refundable) that gives an additional tax credit to low earners who participate usually in 401(k) plans. Making it refundable might allow more low earners to retire someday, but will have a deleterious effect on the middle class as ultimately, this is a redistribution of income. When the lowest earners get a break, someone has to pay for it.
    2. Expand the credit for small employer pension plan startup costs from $500 to $1000. The intent of this is to make the cost of starting a small business qualified plan less prohibitive.
    3. Repeal nondiscrimination rules, contribution limits and restrictions on distributions. This is linked to a flat tax proposal.
  4.  Attempt to increase effect of tax expenditures for retirement savings on retirement security. Talk about pie in the sky and wishful thinking, this is a bunch of untested proposals which in my opinion will not work.
    1. Increase automatic retirement savings vehicles. Don't we already have one of those? It's called Social Security and since it has historically not been funded responsibly, it needs constant changes to have a chance of remaining solvent.
      1. Provide a credit for autoenrollment rather than a fee for failing to autoenroll.
      2. Require employers to make contribution for low earners. Wouldn't this much like the Affordable Care Act cause employers to hire fewer employees?
      3. Require IRAs to provide lifetime income benefit.
      4. Revise the auto-enrollment safe harbor to encourage more savings. This would increase the minimum and require auto-escalation.
    2. Increase the use of retirement savings for annuities or long-term care insurance.
      1. Provide incentives to use a portion of a qualified plan account to purchase annuities or long-term care insurance.
      2. Make life annuities the default distribution option from DC plans. In my opinion, most people will opt out and take lump sums.
    3. Require DC plans for long-term part-timers. Between the requirements proposed for low-paid workers and those for part-timers, companies will have a greater incentive to ship jobs overseas.
    4. Require Lifetime Income Disclosures.
  5. Simplify the plan start-up process.
    1. Combine all current employer-provided arrangements into one plan with one set of administrative rules. Where do I start? This would be a disaster. We have multiple industries, multiple geographies, multiple demographics. This is a horrible idea.
    2. Reduce the number of required notices and make it easier to for a company to distribute them electronically. Great idea.
  6. Create multiple-employer plans for unrelated employers.
  7. Reduce leakage.
    1. Prohibit complete DC withdrawal before retirement age.
    2. SEAL Act.
  8. Allow flexibility in distributions from qualified retirement plans.
    1. Withdraw money penalty-free to make mortgage payments. Doesn't this make it less likely that workers will be able to retire?
    2. Make SIMPLE plans more like 401(k) plans. Employers can always have 401(k)s instead of SIMPLE plans.
    3. Eliminate the minimum distribution rules for account balances under $100,000.
    4. Allow penalty-free withdrawals up to $10,000 for adoption expenses.
    5. Adjust rules for QDROs.
  9. Other vehicles
    1. Establish lifetime savings accounts by making a $500 government contribution for every child born in the US. 
    2. Expand 529 plans to provide for plans for the disabled.
So, there you have it. Next up, health care. What do you think so far? Which proposal is a real winner? And, by a real winner, I mean one that will allow more people to retire when they would like to while not adding to the federal debt.

Thursday, July 11, 2013

Getting Around Code Section 162(m)(6)

This is an article that I wrote that was published by Bloomberg/BNA. They have the exclusive copyright. You may print an article for your own use. You may not distribute it physically or electronically without the express written consent of Bloomberg/BNA.

I am working to remember how to embed it in this blog, but in the meantime, you can go to it by clicking on this link.

Monday, July 8, 2013

More on the Dodd-Frank Pay Ratio

I've written many times on the Dodd-Frank pay ratio rule found in Section 953(b) of that voluminous law. You can read about it here if you haven't before. Recently, and I can't tell from the online version what the date was, the Washington Post wrote on the topic. The 1104 online comments to the Washington Post article tell me that there are certainly a lot of opinions on this.

Interestingly, nobody seems to have consulted an actuary or any type of retirement consultant. Why does this matter? The most variable calculations of the lot that can go into the 953(b) pay ratio calculation are defined benefit. They can be qualified plan or nonqualified in the US and they can be executive or broad-based in other countries. Each will be different and each will use different actuarial assumptions.

Last week, the Economic Policy Institute (EPI) declared that the average chief executive officer last year made 273 times what the average employee made. Is average a mean, a median or something else? Does EPI know how the 273 was calculated? Do the values for the average employee include the same components that the CEO calculations do? I would be willing to wager a lot that the answer to the last question is no. The reason for that is that such calculations do not exist for the average worker. However, most reporters, unless of course they read my blog will never work this out.

I understand what Section 953(b) was supposed to do. Like so many other provisions of ultra-long laws, however, their intent and their drafting are often very different.

Unfortunately, we will probably have guidance soon.

Wednesday, July 3, 2013

ACA Delay or Treasury Blogs and People Take Notice

It has to be a sign of the times. Yesterday, Mark Mazur, the Assistant Secretary for Tax Policy at the US Department of Treasury announced delays in implementation of the Patient Protection and Affordable Care Act (PPACA, ACA, or ObamaCare) through a blog post on the Treasury Department blog.

The stated reason for the delay is that the Treasury Department has been discussing employer and insurer reporting requirements with a number of larger (undefined term) employers who already offer broad-based health care coverage to their employees. Treasury has learned, in what can only be considered a startling revelation if tongue is planted firmly in cheek, that employer and insurer reporting required under ACA is going to be overly complex and place a significant burden on affected businesses.

Now, tell the truth -- if Treasury hadn't blogged about it, would you have known this would create a burden?

So, Treasury has announced that Treasury will be announcing (I can't make this stuff up) the following:

  • There will be a one-year delay (until 2015) until mandatory employer and insurer reporting requirements begin.
  • Treasury will issue proposed rules this summer for information reporting by insurers, self-insured employers and others that provide health insurance.
  • The Administration will work with reporting entities to seek voluntary, but not mandatory, compliance with the not yet effective reporting rules during 2014.
  • Because of this relief, Treasury will not be able to determine which employers owe "shared responsibility" payments for 2014, so these will be delayed until 2015.
  • During 2014, Treasury strongly encourages employers to maintain or expand health care coverage.
Translation: the law is to complex and tangled and the government needs an extra year to figure out what to tell employers they have to do. My readers are smart; they probably knew this was going to happen.

Monday, July 1, 2013


The times, they are a-changing. When the Defense of Marriage Act (DOMA) became law in 1996, it defined marriage, for federal purposes as between one man and one woman. From a human resources standpoint, this has been causing problems for years. And, actually, at least for the time being, it will continue to cause problems.

Unless you were hiding under a rock last week, you know that in United States v Windsor, the Supreme Court overturned the key provisions of DOMA making legal (or at least failing to make illegal, but I guess those are the same things) marriage between one woman and another woman or one man and another man. I won't get into whether this will also open the door for polygamist or incestual marriages; this is for another prognosticator, far more clairvoyant than I.

I'll discuss some of the new issues, but first I digress. Often in this blog, I discuss things related to the Employee Retirement Income Security Act (ERISA). ERISA is federal law. By statute, generally, it preempts state law. Therefore, DOMA affected ERISA plans. Marriage has been defined under federal law. But, marriage is also defined under state law, and as we all know, there are 50 states. This leaves room for 50 separate laws. I will describe this as not a pretty picture.

Anyone with virtually any knowledge of ERISA knows that bona fide spouses have certain special rights under ERISA. Among them are these (by no means an exhaustive list):

  • In some plans, spouses are entitled to preretirement death benefits. So, in the case where two people of the same gender were legally (under state law) married before this case was overturned and the participant died, is the spouse retroactively entitled to preretirement death benefits? Suppose they are and suppose those benefits were already paid to someone else, does that mean that the plan can recoup the money that it already paid to another beneficiary? Does it mean that the plan must recoup the money it paid to another beneficiary?
  • In the event of divorce, spouses may be entitled to qualified domestic relations orders (QDROs) or qualified medical child support orders (QMCSOs). I think this one is generally simpler. You see, divorce orders, even where QDROs and or QMCSOs could apply are not required to include them. But, wait, there's more. Suppose two individuals had been legally married under state law, but not under federal law and got divorced. And, suppose the value of a pension that one of them had was not considered in a divorce settlement because of DOMA. Would a court revisit this? That's pretty complicated.
  • Participants in an ERISA health benefits plan can make pre-tax contributions for spousal (and spouse's children) benefits. They missed the opportunity in some cases. How does this get rectified?
  • And, since spouses are generally eligible for coverage under these plans, that makes them eligible for COBRA coverage. But, COBRA coverage needs to be elected on a timely basis. And, in fact, it needs to be offered on a timely basis. And, this is another one where I can see the problem, but don't know the answer.
  • Many elections under ERISA require spousal consent. Since ERISA is federal law, spouses who had been valid under state law did not have the opportunity to give consent in these situations. So, obviously, they didn't give such consent. Now what?
And, then there are the tax issues. Does a legally married same-sex couple get to refile taxes? For how many years? For open tax years only, or are they entitled equal protection? What about their employers who offered same sex marriage benefits? Do they get to refile taxes? Suppose they covered domestic partners as well? Are they covered by this decision in states that don't yet condone same-sex marriage? (I don't think so, but please don't come to me for legal advice that I am neither qualified nor authorized to provide).

Finally, I can't leave this topic without commenting on a special issue that arises in my home state for the last 25 years. Georgia, at least since I have been a resident, has chosen to simplify its income tax process by basing it on one's federal tax filing. Suppose a same-sex couple was legally married in a state that permits it (Georgia does not yet permit it). Further suppose that couple now chooses to file their federal income taxes as "married" or using their other option of "married, but filing separately." Georgia income tax forms tell me that I must file for state purposes using the same status as I do for federal purposes. Do we still do this? If a same-sex married couple can't do it, then are other couples entitled to not do it? How does this work?

What does the Supreme Court think of this? Actually, the justices probably don't care. it's not their problem. They've made their decisions. Implementation, except where it does not comport with their rulings, is neither their purview nor their concern. Maybe they should all need to take a turn in a human resources department. On second thought, maybe not.