Friday, August 9, 2013

More On Private Equity and Retirement Plans

Just last week, I wrote about the ruling in Teamsters v Scott Brass. If you didn't read it, of course I think you should. The case, on its surface, focused on whether a private equity holding company (forgive me if I am not using the term exactly as an attorney would) and its funds were liable for multiemployer plan withdrawal liability when one of the fund companies that happened to participate in a multiemployer pension plan declared bankruptcy. The key to the First Circuit ruling was that the so-called Sun Funds were considered to be trades or business. In my previous post, I gave a bit of an explanation of the court's rationale for this. If you want a more detailed legal analysis, you can find one here.

I had an interesting conversation on this topic yesterday with an ERISA attorney who happens to no longer be practicing law. As the conversation progressed, we each realized (I think we already did, but to hear someone else agree with you makes it sink in a bit more) how complex this can be.

Think about the way a private equity company typically runs its portfolio. The holding company does make decisions about who will be in management at the portfolio companies. The holding company also usually makes some decisions about the way those business will be run. But, the holding company usually does not bother itself with the administrative details ("administrivia" if you need a cute little made-up word to describe this) of its portfolio companies' businesses. It leaves them to the individual companies.

Who cares?

The holding company should care. The portfolio companies should care. The employees of the portfolio companies should care. The officers and or directors of the holding company should care.

Consider a simple, but not irrational (purely hypothetical, however) private equity fund portfolio (we'll call it Fund 1):

  • Amazing Architects of Alaska
  • Brilliant Babysitters
  • Creative Candles 
  • Dreamy Doctors and Dentists of the Dakotas
  • Excellent Embroidery Experts
  • Fabulous Florists
  • Groovy Gambrelers (a gambreler is a person who prepares animal carcasses)
  • Happy Hypnotherapists of Hilo and Honolulu
Most of these companies have qualified retirement plans. The babysitters, all being young and also low-paid have never considered the day that they might retire, so they don't yet have one. All of the others have a 401(k) plan, but the embroiderers and florists don't have any matching contributions in theirs. At the same time, the doctors and dentists also have a profit sharing feature as well as a defined benefit plan to maximize their tax savings and their ultimate retirement benefits.

Still, who cares? For each company, these are the same benefits that they had before they were acquired by Fund 1.

In light of Scott Brass, all of the companies should care. They are part of a controlled group of corporations now. That means that unlike what they did when they were separate self-contained entities, they now must perform their nondiscrimination, coverage, and minimum participation testing on a controlled group basis. 

What does that mean in practice? Isn't this just administrivia? Let's consider some of the issues that we have here.
  • Company D has the highest-paid workers in the controlled group as well as the highest concentration of highly compensated employees (HCEs). Company D also has the richest benefits. And, Company D provides something known as benefits, rights, and features that no other portfolio company does. 
  • Company B is the lowest paid. It has only nonhighly compensated employees (NHCEs) who receive no retirement benefits.
  • Companies E and F have employees who are generally low-paid, but they get no matching contributions.
Do you get the picture yet? Fund 1 has a mess. Worse yet, by the magic of a fact pattern that I just created for this scenario, Fund 1 had a mess for the 2012 plan years (all calendar years). 

In a nutshell, the mess can be described this way. HCEs in total had benefits that were far more generous than NHCEs. Those HCEs also had benefits, rights, and features (BRFs) on a basis that was discriminatory in their favor for 2012. 

The good news is that there is a retroactive correction period to fix this problem (it ends on October 15, 2013). The complicating news is that the only way to fix the problem now is to provide additional benefits and BRFs to NHCEs. In other words, because of the extremely rich benefits at Company D, Companies B, E, and F are going to need to provide additional benefits.

The innocent onlooker says that's great. Surely, those poor babysitters, embroiderers and florists deserve something. But, benefits cost money. Who is going to pay for them? If we give benefits to babysitters, then that business goes from being profitable to one that is losing money. But, if we don't then, the plans for Company D risk disqualification.

Okay, you got me, this is just a bad dream, isn't it? Nope, this stuff happens and it happens frequently. To date, many private equity companies have chosen to ignore it, but post-Scott Brass, ignorance is probably not bliss.

These problems can be fixed, but not many people know how to do it. Such a person must have a good knowledge of the law, the suite of nondiscrimination regulations, and the mathematical/actuarial skills to perform the calculations.

There aren't very many of us. Call me ...


  1. I looked at your retirement plans and that was a very good experience after read it. Thanks a lot for sharing...

    Retirement Plans

  2. Mark, thanks for reading and commenting. Please let me know if you have any specific questions.