I am pleased to announce that I will be speaking as part of an upcoming Strafford live webinar, “Alternative Investments in ERISA Retirement Plans: Mitigating Liability Risks for Hedge and Private Equity Funds and Pension Plan Fiduciaries” scheduled for Wednesday, May 24, 1:00pm-2:30pm EDT. I am given ten (10) guest passes. If you are interested, please let me know.

Once the ten guest passes are gone, you can still attend the webinar. By referencing my name, you can receive a fifty percent discount. As long as you use the link shown below, the offer will be reflected automatically in your cart.

Our panel will provide ERISA and asset management counsel with a review of effective due diligence practices for institutional investors from both a legal and economic perspective. The panel will offer risk mitigation best practices at a time of increased government scrutiny and lawsuits by plan participants.

After our presentations, we will engage in a live question and answer session with participants so we can answer your questions about these important issues directly.

I hope you’ll join us.

For more information or to register >

Or call 1-800-926-7926 ext. 10
Ask for Alternative Investments in ERISA Retirement Plans on 5/24/2017
Mention code: ZDFCT

Sincerely,

Dr. Susan Mangiero, Managing Director
Fiduciary Leadership, LLC
Trumbull, Connecticut

 

If you open a box and a dog pops out, your enthusiasm will be curbed if you were expecting something else. Surely this is how several private equity funds must feel now about one of their investments. According to "Private Equity Funds Liable to Union Pension Plan" by Jacklyn Wille (Pension & Benefits Daily, March 30, 2016), a federal judge recently ruled that several Sun Capital funds are "jointly liable for more than $4.5 million in withdrawal liability" that one of its portfolio companies, Scott Brass, "owed to a Teamsters pension fund." (You can visit Bloomberg Law to read the March 28, 2016 decision by clicking here.)

I will defer to attorneys to address the legal issues. So far, I found two commentaries on the heels of this 2016 legal decision. See "District Court Concludes Private Equity Fund Is Liable for Pension Obligations of the Portfolio Company" (Fried Frank Harris Shriver & Jacobson LLP, March 30, 2016) and "Private Equity Funds Held Liable for Pension Liabilities of a Portfolio Company" (Sullivan & Cromwell, March 31, 2016).

From my perspective as an economist, any surprise claim on future cash flows could be disastrous if it is large enough to jeopardize the ongoing viability of a business. Even if a business has sufficient resources to maintain itself as an ongoing concern, utilizing cash for something that was not planned for could lead to a lower growth rate than originally expected. Keep in mind that pension funds, endowments and foundations frequently allocate monies to private equity on the basis of expected returns for this asset class.

Projecting cash flows as part of due diligence is nothing new for many investors. That said, I am not convinced that all enterprise investigations fully address the impact of an underfunded defined benefit plan. I was recently contacted by a firm that was tasked to render a fairness opinion and wanted my views about pension math. The investment bankers were reviewing documents from bidders that radically differed with regard to the treatment of the target company’s benefit plan burden. When I was asked to speak and also write about pensions and enterprise value, the invitation came from a senior valuation executive who felt that the topic was not being adequately addressed. See "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Dr. Susan Mangiero (Business Valuation Update, July 2013). Email me if you would like a copy of my 2013 slides about this topic.

In 2013, when this Sun Capital case originally made its way to the court, it struck me as an important issue. (I was not involved in this matter as an expert.) Several editors agreed and I ended up co-writing two articles with Groom Law Group partner David Levine. I’ve uploaded one of these articles to this pension blog. Click here to read "Private Equity Funds and Pension Plans: A Changing Dynamic" (CFA Institute Magazine, March/April 2014). At my request, Attorney Levine responded to this 2016 decision by emailing the following: "In short, while some private equity firms have already moved to evaluate and, in some cases, clarify their fund structures, this case is likely to lead to a second look at their structures and methods of involvement with their portfolio companies."

If certain limited partners are not already asking questions of their private equity fund general partners about the nature of portfolio company pension plans, controlling interest status and deal structure, their due diligence could quickly change in the aftermath of the 2016 Sun Capital litigation.

Interested persons can click on the links provided below to read earlier blog posts about this topic:

Seeking to accomplish a goal without having the right tools can result in frustration and possible failure. One solution is to get outside help when needed as long as the party being hired is knowledgeable and independent. Otherwise, what looks like a solution could quickly become a problem. Applied to ERISA plans, trouble might take the form of costly and time-consuming enforcement and/or litigation. Over the last few years, that reality has set in for more than a few employers.

Recognizing the importance of abiding by good governance principles, several of us agreed to speak as part of an educational webinar on April 8, 2015 about fiduciary tools, pitfalls and lessons learned. Sponsored by fi360 and entitled "ERISA Litigation and Enforcement: The Role of the Independent Fiduciary and Best Practices for Financial Advisors," this webinar joined Attorney Tom Clark (Counsel with the Wagner Law Group), Dr. Susan Mangiero (Managing Director with Fiduciary Leadership, LLC) and Mitchell Shames, Esquire (Partner with the Harrison Fiduciary Group) to address the (a) use of an independent fiduciary (b) clarifying what an outside vendor should be doing and (c) avoiding legal and economic landmines that have revealed themselves in prominent court cases and regulatory examinations.

If you missed the event, email contact@fiduciaryleadership.com for a copy of the slides. Click here to download the written transcript. Edited for clarity (and because the audio file is spotty in some places), this fourteen page document lays out cornerstone concepts and includes suggestions for plan sponsors and the advisers who serve them. These include, but are not limited to, the following:

  • The outsourced fiduciary market is growing in the United States and elsewhere.
  • When an outside party is hired by a plan sponsor, it is critical to specify responsibilities and contract accordingly. When an "expectations gap" exists, some critical tasks may be left wanting or not addressed at all.
  • When multiple fiduciaries are in place, a plan sponsor must ensure that a central person or team is adequately coordinating the efforts of all fiduciaries.
  • The newly proposed Conflict of Interest rule is predicted to materially change the landscape of fiduciary relationships between plan participants and retirement advisers.
  • A fiduciary status may exist due to either a contractual agreement or by virtue of the functions assumed by an individual or organization.
  • ERISA litigation is getting more attention these days, with a particular focus on fees, use of proprietary funds, revenue-sharing and disclosure of compensation paid to investment consultants, advisers and asset managers.
  • Demonstrating procedural prudence in part depends on what others in the industry are doing (or not doing as the case may be) and whether actions make sense for a given plan.
  • A renewed focus on disclosure and transparency is in the works according to comments made by the U.S. Department of Labor.
  • An independent fiduciary can be engaged for a singular transaction or for a task that continues over a long period of time.
  • An independent fiduciary can be engaged by either a defined contribution plan or defined benefit plan or both.
  • When there is a perception or reality of a conflict of interest, it may be prudent for an independent fiduciary to be engaged. The participants pay for said party because the independent fiduciary works on behalf of the participants.
  • The concept of co-fiduciary status is important and should be paid heed by any adviser who has an ERISA plan as a client.
  • Before delegating duties (to the extent allowed) to a third party, a plan sponsor should decide what financial issues should be vetted. Liquidity, the use of leverage by asset managers and asset allocation are a few of the many topics that a delegated fiduciary could be asked to measure, monitor and manage.
  • A fiduciary audit can be extremely helpful as a tool for identifying areas of improvement for an ERISA plan sponsor.

It may be no surprise that over 500 people registered for this educational webinar about fiduciary foibles. After forty years since its inception, ERISA remains a force that cannot be ignored.

Nine years today marked the debut of www.pensionriskmatters.com. Since then, I am proud to say that traffic has steadily grown, with continued feedback and suggestions about all sorts of topics. I am deeply grateful to visitors to this independent website for their time and encouragement. While the specific feedback tends to vary by issue or job function, a central theme is clear. Ongoing education about topics such as due diligence, fees, risk management, asset allocation, hedge funds, liquidity and valuation is both needed and desired. In 2015, this award-winning blog will continue its focus on providing objective and helpful information about important subjects that challenge investment stewards and their advisors, attorneys and regulators who oversee the management of more than $30 trillion.

As I point out in "Financial Expert Susan Mangiero Celebrates Ninth Year as Lead Contributor to Pension Risk Governance Blog" (Business Wire, March 25, 2015), "There is never a shortage of subjects to discuss, thanks to ongoing suggestions and contributions from readers and the significant realities of changing demographics, market volatility and new accounting rules."

To date, there are over 900 published analyses, research updates and guest interviews that can be readily accessed by category and keyword. Simply click on the Archives section of www.pensionriskmatters.com. For a complimentary subscription to this blog, as posts are published, click here to sign up. Click here to read our Privacy Policy. If you are interested in contributing an educational essay or letting us know about a relevant news item or rule change, please email contact@fiduciaryleadership.com.

Until the next blog post, thank you for your interest!

Some pension plans invest in private equity funds or funds of funds. Certain private equity funds invest in companies with pension plans. This means that pension funds that invest in this asset class need to be aware of any deficiencies in their plans as well as those portfolio company plans to which they are likewise exposed. While the notion of "my brother’s keeper" may not resonate well with stewards of billions of dollars, it is a reality. This is especially true, in the aftermath of the Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund decision, No. 12-2312 (1st Circuit, July 24, 2013).

Despite the "record year" described by Wall Street Journal reporter Ryan Dezember, private equity investments, like any other, necessitate careful due diligence on the part of institutional investors that seek a seat at the limited partner table. (See "Private Equity Enjoys a Record Year: Firms That Buy and Sell Companies Are Set to Return More Than $120 Billion to Investors in 2013," December 30, 2013). A critical question is whether continued gains will be diminished if a portfolio company has to divert cash to top off an underfunded pension plan. One way to address the issue is for a pension plan, endowment or foundation to ask the private equity fund general partner how much attention they pay to ERISA economics.

There are numerous other queries to make. In the March/April 2014 issue of CFA Institute Magazine, ERISA attorney David Levine (with Groom Law Group, Chartered) and Dr. Susan Mangiero, CFA (with Fiduciary Leadership, LLC), provide insights for improved due diligence, in a post-Sun Capital world. Suggested action steps include, but are not limited to, the following items:

  • Ask whether a private equity fund is "relying on the position that it is not a ‘trade or business’ and is therefore not subject to liability for a portfolio company’s" ERISA plan deficit;
  • Request to see a list of the holdings for purposes of knowing whether a particular private equity fund has a majority ownership in any or all of its portfolio companies;
  • Investigate whether the Pension Benefit Guaranty Corporation ("PBGC") has red flagged any of the pension plan(s) of a business that is part of a private equity fund’s portfolio;
  • Understand how, if at all, a private equity fund is planning to solve a pension plan underfunding problem;
  • Acknowledge that a portfolio company’s ERISA liabilities could make an exit difficult, whether via an Initial Public Offering or an acquisition, and that this in turn could lengthen the time before a limited partner can cash out;
  • Identify the extent to which a private equity fund regularly examines the degree to which any or all of its portfolio companies are parties to labor contracts that may be difficult to modify; and
  • Be aware that this important legal decision could invite more litigation and regulatory actions that, regardless of outcome, have a cost and therefore a potential impact on future private equity fund returns.

If you have any difficulty in accessing our article, please send an email request to contact@fiduciaryleadership.com.

Adopting a "half glass full" attitude, my co-author and I wrote about the business opportunities for private equity fund general partners ("GPs") with portfolio company problems. In "GPs Eye New Ruling" (Mergers & Acquisitions, December 2013 Issue) by ERISA attorney David Levine and Accredited Investment Fiduciary Analyst, Dr. Susan Mangiero, we talk about the aftermath of a recent legal decision that has the private equity world on high alert.

By way of background, in Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund, the United States Court of Appeals for the First Circuit ruled that a private equity fund can be held liable for the pension obligations of a portfolio company. If left unchecked, private equity funds (and their limited partners such as pension plan investors) could see a diminution of performance for any number of reasons. For one thing, a GP may be unable to exit a position within a reasonable period of time if potential buyers get scared of being saddled with an expensive, underfunded retirement plan. In addition, cash that was otherwise earmarked to finance new growth projects may be used instead to comply with statutory contribution rules. Indeed, I have carried out financial analyses for prospective buyers on the basis of how much "extra" a pension problem is likely to cost.

While the downside possibilities are real, Attorney Levine and I point out that "lessons learned" from the Sun Capital decision enable a GP to take action preemptively as a way to potentially "maximize value from portfolio companies while also mitigating future risk." Savvy asset managers can adapt their due diligence process to help avoid any issues that could preclude an exit within the typical three to seven year time period from an initial funding round. Some of the many steps that a GP can take include, but are not limited, to the following:

  • To the extent that a private equity fund is relying on the position that it is not a “trade of business” and is therefore not subject to liability for a portfolio company’s pension underfunding, it is wise to review the potential economic, fiduciary and legal risks should this position be challenged in court.
  • Review its holdings that are at least 80 percent owned by the private equity fund. Total equity exposure should include common stock, preferred stock and possibly economic rights associated with warrants and/or equity derivatives such as swaps. Although a core focus of any such review should be with respect to holdings subject to jurisdiction in the First Circuit (Maine, Massachusetts, New Hampshire, Puerto Rico, and Rhode Island), a broader review of holdings elsewhere might also be considered.
  • Review underfunded pension plans before and after each acquisition of a portfolio company in order to develop strategies for addressing the Pension Benefit Guaranty Corporation’s aggressive litigation positions that it has been taking lately. Failure to do so could result in unnecessary delays in connection with corporation transactions, including the sale of portfolio companies. Examine the collective bargaining agreements for any or all portfolio companies. Although the Sun Capital Partners case was about liability for pension funding obligations under a multiemployer pension plan (i.e., a pension plan maintained independent of an employer pursuant to collective bargaining), there is some concern that the logic of Sun Capital Partners might be extended to conclude that a private equity fund is conducting a “trade of business” under the Internal Revenue Code through its management and oversight of portfolio companies. A decision concluding that a fund is a trade or business for Internal Revenue Code purposes could impact a fund’s representations of its attempts to minimize its unrelated business income tax liability and/or its acceptance, pursuant to the Internal Revenue Code, as a trade or business.
  • Assess the economic, fiduciary and legal attractiveness of all employee benefit plans that are offered by private equity portfolio companies. This includes traditional defined benefit pension plan, 401(k) plans, and health and welfare arrangement. Individually and collectively, ERISA plans can carry significant liabilities that have the potential to (a) materially reduce overall business profitability (b) increase insurance premiums (c) lead to expensive litigation and/or regulatory enforcement (d) impede liquidity and (e) hamper capital raising. As a result, a general partner may never be able to realize the growth targets that motivated a particular investment in the first place. Just as significant, a private equity fund may find itself limited in its ability to exit a particular investment.
  • Meet with retirement-focused advisers, actuaries and counsel before investing in a new portfolio company. The due diligence analysis should be comprehensive. This means that a private equity fund will want to assess both the current and projected pension plan liabilities for a portfolio company as well as the riskiness of its investments in its pension and 401(k) plan. If a pension plan’s assets are illiquid or overly conservative, a deficit may occur or grow bigger. It is likewise important to understand whether the assumptions underlying actuarial calculations are overly optimistic. The objective is to understand the seriousness of a given situation in terms of economic, fiduciary and legal vulnerability.
  • Assess the accounting impact for any and all retirement plans. Be prepared to explain performance volatility to LPs as the result of an ERISA problem.
  • As the family of “de-risking” products continues to expand, consider restructuring a portfolio company’s ERISA plan if, by doing so, a private equity fund owner can improve the likelihood of an exit within its target time horizon. However, because ERISA’s fiduciary rules impose a duty of loyalty to participants and beneficiaries, decisions on de-risking should be evaluated under these standards.
  • Determine, in conjunction with ERISA counsel, whether to engage an “independent fiduciary” for purposes of evaluating an array of possible restructuring solutions. Buying annuities to settle pension liabilities or investing in employer securities or other “hard to value” assets are examples.
  • Recognize that the Sun Capital Partners decision could encourage further litigation and regulatory activities. Private equity funds might be well served to consider whether minor tweaks to their structure merit use, including the creation of additional services entities that are commonly used in operating company structures. Clarification of offering documents, careful monitoring of activities and/or comprehensive documentation of its involvement with portfolio companies can go a long way to help insulate a private equity fund from a finding that it is engaged in an Internal Revenue Code trade or business.

For further reading about this important legal decision and the economic and compliance imperatives, you can read earlier blog posts and link to various law firm memos on this topic. See "Pension Liability Price Tag For Private Equity Funds and Their Investors". Also see "More About Private Equity Funds and Pension IOUs."

As I discussed in my July 29, 2013 blog post entitled "Pension Liability Price Tag For Private Equity Funds And Their Investors," a recent court decision by the First Circuit could mean the difference between "good" deals and "bad" ones. In "Doubling Down on a Bad Bet: Liability for Portfolio Company Pension Obligations After Sun Capital" (August 5, 2013), ERISA trial attorney with the McCormack Firm, Stephen D. Rosenberg refers to this legal opinion as "tremendously significant" as it will directly impact how acquisitions are structured, "in terms of examining whether it is possible to legally structure the acquisition and ownership of a portfolio company in a manner which will insulate the acquirer from unfunded pension obligations or, if it is not certain whether that can be achieved, will at least make it as hard as possible for potential plaintiffs to recover, thus hopefully dissuading future lawsuits…"

As creator of the popular and insightful Boston ERISA & Insurance Litigation blog, Attorney Rosenberg talked about the imperative to think ahead. Instead of trying to fix a problem after an acquisition has take place, he references my recommendations, as a business expert, to thoroughly value "the pension exposures of the target company" and account "for that exposure financially in the purchase price."

School is still out as to whether these actions are being done to the extent they should be. I have worked on due diligence initiatives that included a forward-looking assessment of cash needs and investment considerations. However, if everyone was tackling this type of economic analysis, in conjunction with a legal review, there would be no headlines about post-deal pension surprises. In other words, there are obviously some buyers that have not done sufficient homework and end up paying more than they had anticipated. If that happens too often, a private equity fund’s general partners are ultimately going to get push back from their limited partners such as other pension plans, endowments and foundations. Why? Post-transaction costs impede performance.

Attorney Rosenberg and I both agree that doing the right things, prior to the closing of a transaction, is a good offense. As relates to pension-centric due diligence by a private equity fund, he adds that "Do that correctly, and you have already accounted for the possibility of being forced to cover the portfolio company’s exposure; do that incorrectly, and you may have – as occurred in Sun Capital – doubled down on a losing proposition."

I have long maintained that any individual or organization that invests in a company needs to check under the employee benefits hood before allocating money initially, and regularly thereafter. I can give you countless examples where incomplete due diligence led to an overly rich acquisition or investment that resulted in a new owner having to deploy cash to write checks to retirees and/or incur the costs of restructuring an otherwise untenable situation.

Failure to carry out a comprehensive ERISA-focused due diligence of a target portfolio company is not good for numerous reasons. Having done economic analyses of companies with underfunded pension plans, I know firsthand that it is often a rude awakening for investors such as private equity funds when they are confronted with the reality that what they want and what they end up with in terms of buying forecasted growth are not always the same. Reasons to worry include, but are not limited to, the following:

  • A private equity fund may not be able to realize its target rate of return because a portfolio company cannot sufficiently grow without cash that is now redirected to support employee benefit plans.
  • A pension plan that has invested in said private equity fund will be none too happy if performance falls short of expectations, especially for something that arguably should have (and could have) been considered and addressed as part of the original deal.
  • An unhappy pension fund investor may turn around and sue a private equity fund for alleged failure to have properly researched "what if" situations, taken on "too much" risk and disclosed too little information. Litigation in turn can be an expensive proposition for a private equity fund, making it even more difficult to achieve even minimum hurdle rates.

The issue of private equity ownership and portfolio company pension liabilities was heavily discussed as the result of a 2007 Appeals Board of the Pension Benefit Guaranty Corporation ("PBGC") decision about ownership, control and responsibilities for portfolio company pension plan gaps. In "Private Equity Funds: Part of the ERISA Controlled Group?" (December 19, 2007), O’Melveny & Myers LLP attorneys Wayne Jacobsen and Jeff Walbridge explained that "[i]f the PBGC’s position endures, it could have significant ramifications for private equity fund investments in portfolio companies that sponsor defined benefit pension plans…[t]he fund could be required to use any or all of its assets, including the ownership interests of the fund in any or all of its portfolio companies, to fund the pension obligations of the bankrupt portfolio company."

Imagine the happy faces in private equity land when the U.S. District Court of Massachusetts opined on October 18, 2012 in favor of Sun Capital Partners III, LP and related parties. According to "Potential ERISA Title IV Liabilities of Private Equity Firms – Eliminated by the Sun Capital Decision?" (November 2012), Edwards Wildman attorney Mina Amir-Mokri describes the decision as a "significant victory for private equity firms" but explains that Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund was to be appealed.

On July 24, 2013, the U.S. Court of Appeals for the First Circuit reversed the earlier decision and put private equity funds in a potential liability position once again. According to "Private Equity Funds Further Exposed to Portfolio Company Pension Plan Liabilities" (July 29, 2013) Latham & Watkins attorneys Jed Brickner and Austin Ozawa offer post-opinion practical hints such as the need for private equity firms to "carefully consider how to structure their funds and acquisition structures to avoid characterization as a trade or business and avoid inclusion in the same controlled group as their portfolio companies." Additionally, they urge private equity funds to pay attention to the "structure of their funds’ investments"…possibly "dividing their investment between two or more of independently managed funds with distinct portfolios to support a finding that no individual fund (or group of ‘parallel’ funds) controls any portfolio company (and no set of funds is treated as a joint venture). Paul Hastings attorneys Stephen H. Harris, Eric R. Keller, Ethan Lipsig and Mark Poerio assert that private equity funds would do well to own "less than 80% of a portfolio company"…perhaps via "thoughtful adjustments to ownership structures and management operations" that can help to reduce the exposure to portfolio company pension liabilities. See "Private Equity ERISA Alert: Consider ERISA Pension Liability Risks from Portfolio Plans" (July 2013).

While legal experts weigh in on the important issue of what responsibilities belong to private equity funds, if any, to portfolio company ERISA plan participants, institutional investors such as pensions, endowments, foundations and family offices – and their investment consultants and advisors – should take heed. If a private equity fund’s exposure to a portfolio company with a problem pension plan ends up shrinking the wallets of institutional investors, serious questions will understandably be asked about who should have done what and when.

I am happy to announce that I will be joined by esteemed colleagues Howard Pianko, Esquire (Seyfarth Shaw) and Virginia Bartlett (Bartlett O’Neill Consulting) on September 10, 2013 from 1:00 to 2:30 pm EST to talk about QPAM and INHAM compliance audits. See below for more information. Click to register for this forthcoming educational event about ERISA requirements. (Note: I am given a few complimentary guest passes. Contact me if you are interested and they are still available.)

This CLE webinar will prepare counsel to advise asset manager clients regarding Qualified Professional Asset Manager (QPAM) and in-house asset manager (INHAM) audits as required by the Department of Labor. The panel will review the new exemption rules, who can conduct an audit, what the process entails, and how to showcase good practices with existing and prospective plan sponsors.

Continue Reading ERISA Assets: QPAM and INHAM Audit Legal Requirements and Best Practices

If you missed the Strafford CLE event on June 5, 2013 entitled "ERISA Pension Plans in 2013: Due Diligence for Hedge and Private Equity Funds: Avoiding the Pitfalls with Alternative Investments for Institutional Investors and Fund Managers," there is still an opportunity to purchase the recording. Click here for more information.

In the meantime, click to access the due diligence slides that were used by Dr. Susan Mangiero (Fiduciary Leadership, LLC), private fund attorney Rosemary Fanelli (CounselWorks) and ERISA attorney Tiffany Santos (Trucker Huss).

While we ran out of time with so much left to discuss beyond our assigned 90 minute slot, the two attorneys who spoke with me talked a lot about their perception of a changed environment. Their message was that institutional investors seem to be under a lot more pressure now to demonstrate that comprehensive due diligence activities have taken place. One attorney listener in the audience echoed this sentiment presented by the two legal speakers. He offered his opinion that an investment consultant or financial advisor should work closely with both an ERISA counsel as well as a fund attorney as part of the due diligence process.