Fiduciary Duty Proposal

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Adam Gilbert, Genevieve Gimbert, and Armen Meyer.

With fewer than 18 months left in office, President Obama has asserted that the Department of Labor’s (“DOL”) proposed fiduciary standard for retirement account advisors is a major priority. The DOL completed public hearings last week on this proposal, and we believe that the rule will be finalized early next year with the proposal’s core framework intact.

The DOL’s final rule is set to transform the competitive landscape and disrupt current business models, particularly for financial institutions that are reliant on traditional broker-dealer activities which are currently not covered by the existing Employee Retirement Income Security Act (“ERISA”) fiduciary standard.


Supreme Court: Fiduciaries Must Monitor Offered 401(k) Investment Alternatives

Boris Feldman is a member of Wilson Sonsini Goodrich & Rosati, P.C. This post is based on a WSGR alert.

On May 18, 2015, the U.S. Supreme Court unanimously held in Tibble v. Edison International that fiduciaries of 401(k) retirement plans have a continuing duty under the Employee Retirement Income Security Act of 1974 (ERISA) to monitor an investment alternative offered under a 401(k) plan after it is selected. In monitoring an investment alternative, the fiduciaries must engage in a prudent process. [1]

Although the principle described in Tibble was well understood by many 401(k) plan fiduciaries, the decision nonetheless serves as an important reminder that it is necessary for 401(k) plan fiduciaries to implement a due diligence process that will withstand scrutiny from the federal courts and the U.S. Department of Labor upon review.


DOL Re-Proposed Expanded “Investment Advice” Rule

Jeffrey D. Hochberg is a partner in the Tax and Alternative Investment Management practices at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication by Mr. Hochberg, David J. Passey, and Dana E. Brodsky; the complete publication, including footnotes, is available here.

On April 14, 2015, the Department of Labor (“DOL”) proposed a regulation (the “Proposed Regulation”) defining the circumstances in which a person will be treated as a fiduciary under both the Employee Retirement Income Security Act of 1974 (“ERISA”) and Section 4975 of the Internal Revenue Code (the “Code”) by reason of providing investment advice to retirement plans and individual retirement accounts (“IRAs”). As part of the regulatory package, the DOL also released proposed prohibited transaction class exemptions intended to minimize the industry disruptions that might otherwise result from the Proposed Regulation, most notably, the so-called “Best Interest Contract Exemption.”

The Proposed Regulation is a re-proposal of a 2010 proposed regulation (the “2010 Proposed Regulation”) that was withdrawn by the DOL after extensive criticism from the financial services industry and politicians of both parties.


The Use and Abuse of Labor’s Capital

The following post comes to us from David H. Webber of Boston University Law School.

Across the country, public employee retirement systems are investing in companies that privatize public employee jobs. Such investments lead to reduced working hours and often job losses for current employees. [1] Although, in some circumstances, pension fund participants and beneficiaries may benefit from these investments, their actual economic interests might also be harmed by them, once the negative jobs impact is taken into account. But that impact is almost never taken into account. That’s because under the ascendant view of the fiduciary duty of loyalty, pension trustees owe their allegiance to the fund first, rather than to the fund’s participants and beneficiaries. Notwithstanding the fact that ERISA and state pension codes command trustees to invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits,” the United States Department of Labor declared in 2008 that the plain text of the quoted language means that the interests of the plan come first. [2] Under this view, plan trustees should de facto ignore the potentially negative jobs impact of privatizing investments because that impact harms plan members, and not, purportedly, the plan itself. Thus, in the name of the duty of loyalty, the actual economic interests of plan members in plan investments are subverted to the interests of the plan itself (or, at a minimum, to an unduly constrained version of the plan’s interests that excludes lost employer and employee contributions). As a result, public pension plans make investments that harm the economic interests of their members. This turns the duty of loyalty on its head.


Carried Interests: Current Developments

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. This post is based on an article by Mr. Bachelder which first appeared in the New York Law Journal.

The tax status of so-called “carried interests,” held by private equity fund sponsors (and benefitting, in particular, the individual managers of those sponsors) is the subject of this post. A decision by the U.S. Court of Appeals for the First Circuit holding that a private equity fund was engaged in a trade or business for purposes of the withdrawal liability provisions of ERISA (Employee Retirement Income Security Act) has caused considerable comment on the issue of whether a private equity fund might also be held to be in a trade or business (and not just a passive investor) for purposes of capital gains tax treatment on the sale of its portfolio companies. Proposed federal income tax legislation, beginning in 2007 and continuing into 2013, also has raised concern as to the status of capital gains tax treatment for holders of carried interests. The following post addresses both of these developments.


Managerial Risk Taking Incentives and Corporate Pension Policy

The following post comes to us from Divya Anantharaman of the Department of Accounting and Information Systems at Rutgers Business School and Yong Gyu Lee of the School of Business at Sungkyunkwan University.

In our paper, Managerial Risk Taking Incentives and Corporate Pension Policy, forthcoming in the Journal of Financial Economics, we examine whether the compensation incentives of top management affect the extent of risk shifting versus risk management behavior in pension plans.

The employee beneficiaries of a firm’s defined benefit pension plan hold claims on the firm similar to those held by the firm’s debtholders. Beneficiaries are entitled to receive a fixed stream of cash flows starting at retirement. The firm sponsoring the plan is required to set aside assets in a trust to fund these obligations, but if the sponsor goes bankrupt with insufficient assets to fund pension obligations, beneficiaries are bound to accept whatever reduced payouts can be made with the assets secured for the plan.


Credit Crisis Litigation Update: It is Settlement Time

The following post comes to us from Faten Sabry, Senior Vice President at NERA Economic Consulting, and is based on a NERA publication by Ms. Sabry, Eric Wang, and Joseph Mani; the full document, including footnotes, is available here.

It has been more than six years since the onset of the credit crisis and we have documented for the first time in the past few months a significant increase in the number and size of settlements. Meanwhile, the pace of new filings has slowed as housing markets continue to improve and delinquencies and defaults decline. However, litigation arising from the credit crisis is far from over.

In this post, we discuss the recent trends of settlement activity and review some of the major settlements in credit crisis litigation. We also discuss mortgage settlements that are related to repurchase demands mainly between mortgage sellers and Fannie Mae and Freddie Mac. We then examine the current trends in filings, including the types of claims made, the nature of defendants and plaintiffs in the litigation, and the financial products involved.

Our main findings, which are discussed in greater detail below, include the following:


Court: Private Equity Funds Potentially Liable for Portfolio Company Pensions

The following post comes to us from Brian D. Robbins, Partner and the Head of the Executive Compensation and Employee Benefits Practice Group at Simpson Thacher & Bartlett LLP, and is based on a Simpson Thacher memorandum.

In December 2012, we published an Alert after a Federal District Court concluded that: (1) a private equity fund was not a “trade or business” for purposes of determining whether the fund could be liable under the Employee Retirement Income Security Act of 1974 (“ERISA”) for the pension obligations of one of its portfolio companies and (2) consequently, the private equity fund could not be liable for its portfolio company’s pension obligations under Title IV of ERISA, even if the fund and the portfolio company were part of the same “controlled group.” Our December Alert, which contains background on the issue and a summary of the state of the law through December 2012, may be found here. This post is to advise that the First Circuit Court of Appeals has reversed the 2012 Federal District Court opinion.

In Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund (No. 12-2312, July 24, 2013), the First Circuit Court of Appeals has concluded that: (a) a private equity fund can be a “trade or business” for purposes of determining “controlled group” joint and several liability under ERISA and (b) as a result, the private equity fund could be held liable for the pension obligations of its portfolio company under Title IV of ERISA, if certain other tests are satisfied. Under ERISA, a “trade or business” within a “controlled group” can be liable for the ERISA Title IV pension obligations (including withdrawal liability for union multiemployer plans) of any other member of the controlled group. This “controlled group” liability represents one of the few situations in which one entity’s liability can be imposed upon another simply because the entities are united by common ownership, but in order for such joint and several liability to be imposed, two tests must be satisfied: (1) the entity on which such liability is to be imposed must be a “trade or business” and (2) a “controlled group” relationship must exist among such entity and the pension plan sponsor or the contributing employer.


PBGC Initiates Pension Plan Termination in Leveraged Acquisition

The following post comes to us from Lawrence K. Cagney, partner and chair of the Executive Compensation & Employee Benefits Group at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton client update by Mr. Cagney, Jonathan F. Lewis, Elizabeth Pagel Serebransky, Alicia C. McCarthy, and Charles E. Wachsstock.

Elisse B. Walter is a Commissioner at the U.S. Securities and Exchange Commission and was the Chairman of the SEC from December 2012 to April 2013. This post is based on Commissioner Walter’s recent remarks at the SEC and Financial Reporting Institute Conference, available here. The views expressed in this post are those of Commissioner Walter and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.Buyers and sellers in typical leveraged buyouts of subsidiaries and divisions have long recognized that the Pension Benefit Guaranty Corporation (“PBGC”) could perceive its own interests as threatened in the transaction and, consequently, might choose to interfere with the parties’ bargain. This concern has to date been viewed as largely theoretical, as the PBGC typically either does not appear in a transaction at all, or, if it does appear, extracts relatively modest protections from the parties. Two recent developments suggest that the PBGC intends to become more active in buyout transactions:

  • In April, the PBGC initiated proceedings to terminate a pension plan in connection with Compagnie de Saint-Gobain’s sale of its US metal and glass containers business to Ardagh Group. Initiation of a plan termination is typically viewed as an attempt to scuttle a transaction.
  • In a recent interview, a senior PBGC official announced that the PBGC intends to become more aggressive in scrutinizing future buyout transactions and to allocate more of its resources in this area.


Court Rejects ERISA Challenge to Pension De-Risking Transaction

The following post comes to us from Nicholas F. Potter, corporate partner at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton client update by Mr. Potter, Sarah A.W. Fitts, Jonathan F. Lewis, Edwin G. Schallert, Alicia C. McCarthy, and Vincent J. Bianco.

For many employers, underfunded defined benefit pension plans present significant ongoing challenges. These challenges arise not only because of the underfunding itself, but also because of the significant volatility that the underfunding can create on its balance sheet due to changes in interest rates and other key assumptions over time. An employer has always had the ability to seek to improve its longer-term financial profile by “de-risking” its pension plan through the purchase of an annuity from a suitable annuity provider that commits to pay benefits to plan participants without further financial support from the employer. The transfer of pension obligations in this manner, which may include the termination or partial termination of the pension plan, can significantly improve an employer’s financial profile. De-risking transactions have become more prominent in recent months because of two transformative transactions, one involving General Motors and the other involving Verizon. We are pleased to report that the first judicial test of these transactions in court under ERISA, the Federal benefits statute, has resulted in a victory for the parties involved in the transaction. And, while the decision was based only on a request for preliminary injunctive relief, and while future litigation will be based on the manner in which future de-risking transactions are structured (including on the key issue of annuity provider selection and suitability), the decision validates the central thesis of pension de-risking and provides an important and helpful roadmap through some of the potential ERISA challenges to these transactions.