OK for 3 unrelated plans to own 1/3 shares of investment in single rea

[mming]

The trustees of 3 different plans would like buy a large piece of real estate with plan assets and apportion it among their plans.

One person owns 100% of plan 1's employer and 79% of plan 2's employer (other 21% owned by his brother). The majority owner is also a co-trustee of both plans, trusteeing with his son-in-law in plan 1 and trusteeing with his wife in plan 2. His daughter owns 100% of plan 3's employer and she co-trustees it with her husband, the above son-in-law.

They have obtained a legal opinion that a controlled group / affiliated service group does not exist. Is there anything that would prevent the three plans from purchasing and each owning a one-third interest in this investment?

[mbozek]

Ask for a second opinion. It has been a while, but why arent Corp 1 and 2 a controlled group since five or fewer persons own 80% or more of each corp and the same 5 or fewer persons together own more than 50% of the stock of of each corporation, taking into account the ownership of each person only to the extent such ownership is identical with respect to each organizaton. IRC 1563(a). If owner 1 owns 100% of corp 1 and 79% of corp then isn't the identical ownership in both corp 79% (greater than 50%)?

[Mike Preston]

Isn't 79% less than 80%?

[mbozek]

79+21=100 which is greater than 80% (5 or fewer persons own more than 80% of corp 1 and one person owns 100% of corp 2)

[Mike Preston]

I believe it is the Vogel Fertilizer case that brings us the concept that you included in your first message: "taking into account the ownership of each person only to the extent such ownership is identical with respect to each organizaton". Hence, for the 80% test, you have 79%. No control

[mming]

I think the 80% rule applies to parent-subsidiary groups and the 50% rule is for brother-sister groups. The Vogel Fertilizer case of 1982 touched upon this, although I've read there was a split among the judges who presided, and the arguement for the decision was somewhat weak. I wouldn't be surprised if a different outcome was reached if the case was tried today.

Anyhow, in my situation, the attorney evidently pronounced the relationship a parent-subsidiary group. Does controlled group status (or lack of) determine whether an investment can be split up or are there additional considerations?

[mming]

Mike, you got the drop on me - you're faster with the reply button...

[Mike Preston]

I would not characterize it as a parent-subsidiary vs brother-sister argument, although I'm willing to be proven wrong on the point.

I guess what is boils down to is that if the entities WERE controlled, there would be no question that such an investment would be allowed. However, with the entities not controlled, the co-investment, if you will, must now go down a different path. One that deals with the party-in-interest rules and prohibited transactions.

I admit that the prohibited transaction/party-in-interest rules are some of the most spaghetti-like in the Code and ERISA.

But, plowing through all of that, the decision as to whether or not it is not prohibited will probably rest on two issues. One is whether the transaction itself, as far as transferring ownership, is handled properly. That is, a third party, unrelated to any of these people will sell interests to each of the plans. If one plan buys the land and then sells a portion of it to the other two, there could be problems. I have one case right now with the DOL where just such a "form" problem exists. The DOL admits that if the transaction had taken place as indicated, instead of going to one party-in-interest and then to the others in the mix, it wouldn't be an issue. But it is to them. So, best to avoid it.

The other is that the DOL thinks that anything that smacks of a prohibited transaction probably is, even if it technically isn't. They have sound support for this in their rules regarding indirect prohibited transactions. Hence, if one of the plans that is investing in this investment is doing so only because somebody who controls one of the other plans is "playing a trump card", if you will, I think the DOL would have an easy time of labeling it a PT.

Bottom line is that there is nothing on its face that contraindicates this investment as a prohibited transaction.

But we don't have near enough details to conclude that it is not a PT, either. And the only individual who is likely to be able to get enough information from the parties to make an informed judgement is an attorney. Hie thee to one.

[Kirk Maldonado]

My guess is that if you look into the facts more, you would find other reasons that would pose problems. For example, they might want to lease the property back to the corporations (raising prohibited transaction issues) or it might be raw land that they want to develop (raising UBTI and UDFI issues).

Every deal that I've seen like that had some additional problems. You just need to dig more to find out what they are. I'd be surprised if some other problems wouldn't surface if you dug deeper.

My (standard) recommendation would be for the client to get independent legal advice in writing from a competent ERISA attorney as to the propriety of the investment. Believe me, that would be much cheaper than later having a fight with the DOL.

[mming]

Thanks everyone for all the input - it's much appreciated

[Mike Preston]

Originally posted by Mike Preston

I believe it is the Vogel Fertilizer case that brings us the concept that you included in your first message: "taking into account the ownership of each person only to the extent such ownership is identical with respect to each organizaton".  Hence, for the 80% test, you have 79%.  No control

I think my message from above is far from clear, maybe even misleading. There are two parts to the test: the 80% test (the controlling interest test) and the 50% test (the effective control test). The first is better stated as: do five or fewer owners own, between them, 80% or more, taking into account only those people who own some part of both entities. The second is better stated as: do five or fewer owners own, between them, more than 50%, taking the ownership into account only to the extent such ownership is identical with respect to each organization.

In this case, since the brother owns nothing of the first entity, the only owner that owns part of both companies is A and he only owns 79% of the second entity. Therefore the two entities are not controlled because the controlling interest test is failed. It would not fail the effective control test, as A owns 79% of each entity. But you have to satisfy both tests to be controlled, courtesy of Vogel Fertilizer.

[E as in ERISA]

Purchase of non-traditional assets frequently raise questions of "exclusive benefit" and "prohibited transactions" in any context. But when three "unrelated" employers simultaneously decide that purchase of a non-traditional asset is a good idea, I think that it would tend to raise even more red flags about the basis for this decision -- i.e., there are even stronger suggestions that this decision may have been a good idea for some personal reasons as opposed to a good idea for the plans. It is certainly possible that they are in fact acting primarily on behalf of the plan when they make this decision. But it would be interesting to hear their "story" of how they decided to make this purchase.

[mming]

The main reason they're considering the purchase among the 3 plans is that the parcel costs too much to have in one plan, i.e., none of the 3 plans could buy it entirely and maintain reasonable diversification of their assets.

Personal reasons, arguably valid, are also partly to blame as you have suggested, Katherine. The main business performed by the three sponsors involves real estate. I know that it's a problem to try to run your business through your plan, but perhaps that may not be the case in this instance. If the trustees honestly believe that real estate will be a good investment in light of the weak economy, and there will be no commissions, kickbacks, etc. received by either the sponsors or the participants personally as a result of the transaction, do you agree there's no problem if the purchase is made following copious research and assessment of its FMV?

[E as in ERISA]

I agree its probably much less risk if the facts are as you say. But if the DOL audits the plan, it would probably scrutinize the transaction more closely. And if real estate goes south in a few years, then participants still probably have a few facts they could use in a lawsuit. Nevertheless, if the facts justify the transaction I would probably document the basis for the decision and move forward.

[Kirk Maldonado]

My strong recommendation is to get an independent fiduciary (with separate counsel) involved. That is the best "insurance policy" that you can buy against DOL audits or participant lawsuits. Believe me, having been involved as counsel in some truly ugly agency investigations and lawsuits, you will spend many times more money defending the action than you would spend getting an independent fiduciary involved.

[mbozek]

Before following Kirks good advice about retaining counsel, the buyers should talk to an accountant or investment advisor about the pros and cons of RE in a plan. RE is an illiquid asset and selling a minority interest is difficult since buyers dont want some one else to control the property. Usually there will be a discount at the time of sale of a minority interest unless there is a requirement that the other owners purchase the interest. Also a q plan as a tax exempt entity cannot get tax benefits from the ownership of RE- no depreciation, no capital gains, no deduction of payments for taxes and admin expenses. The plan cannot use the RE as collateral for a loan. The plans will have to allocate assets of the trust to pay for the expenses of owning the RE.

[mming]

There are some very good points being posted - no doubt you can end up in a world of hurt with one false step.

I suppose things can be worse for these guys. Fortunately, they do not employ anyone other than their spouses and all participants within the 3 plans are members of the same family, so the prospect of potential lawsuits is diminished (unless they get along like my fam, or a divorce occurs).

Assuming a reasonable level of familial bliss, enough consideration will likely be paid by all to sell the 3 portions of the RE at the same time or do whatever necessary to avoid probs with minority interests, discounts, etc. However, what is it they say about good intentions.........?

[Kirk Maldonado]

I agree with MBozek's comments; if the investment does not make economic sense, there is no reason to get counsel involved.

However, in my experience, the persons involved in these arrangements typically have expectations that they will earn much, much more than they actully make. But a belief that they will earn a huge rate of return skews their analysis of the economics.