Some Oldies But Goodies - From ESOPs To Halloween

ESOP's Indemni-Fables

The unwillingness of some to accept uncomfortable but arguably correct legal results in the plan-assets area continues with Johnson v. Couturier, No. 08-17369 (9th Cir. July 27, 2009). Johnson, and the later district-court case of Fernandez v. K-M Industries Holding Co., No. C 06-7339 CW (N.D. Cal. Aug. 21, 2009), are the most recent in a line of cases subjecting indemnification provisions to ERISA scrutiny, even where the company offering the indemnification is not a plan-assets entity.

This inquiry puts pressure on the question of what it means for an entity's assets not to constitute assets of plans that have equity interests in those entities. It should mean that you're dealing with the company, not its plan investors. If you have a less-than-25% fund, and you're dealing with it, you might as well be dealing with IBM. If you have a 100%-owned ESOP company, and you're dealing with it, you might as well be dealing with a 0%-owned non-ESOP company. That's what it means not to be plan assets - deal with it, no matter how uncomfortable it makes you. Or, sometimes, as we'll see, if you're the courts, don't - when it suits you not to do so.

The issue manifests itself frequently when an allegation is made that a corporate action taken by a plan-owned entity should be considered to be governed by ERISA's fiduciary standards. On the one hand, time and time again, courts correctly make clear that corporate actions not taken in ERISA-fiduciary capacities are not governed by ERISA, merely because of equity ownership by ERISA plans.*

This result makes sense. The fiduciary standards underlying ERISA's fiduciary provisions, which include its prudence and prohibited-transaction rules, have been referred to as being "the highest known to the law." E.g., Donovan v. Bierwirth, 680 F.2d 263, 272 n.8 (2d Cir.), cert. denied, 459 U.S. 1069 (1982). They are designed to constrain and otherwise regulate fiduciaries, not to allow operating companies to conduct business. Thus, it should not be surprising that the rules wouldn't operate humanely or sensibly in the context of the operation of a business. Indeed, the plan-assets regulations appropriately recognize this result by having operating companies, including specifically those wholly owned when owned by an ESOP or other single-employer individual-account plan with qualifying employer securities (all of which are referred to herein as "ESOPs," for the sake of simplicity), act in effect as a plan-asset blocker even where a plan acquires an equity interest therein. See DOL Reg. § 2510.3-101(c), (h)(3) (second sentence).

Now don't get me wrong - I'm not advocating technical interpretations of the plan-assets rules that make a sham out of the applicability of this most-important-of-important fiduciary statutes. I've seen people try to do nonsubstantive structuring to avoid plan-asset treatment and, often, I think it's the wrong answer, and maybe clearly so, to respect that kind of abusive structuring.

But here we're talking about a straightforward application of the rules as they lay. If it says you're not plan assets if you satisfy the 25% test then, absent shenanigans, you're not. If it says you're not plan assets if you're 100% owned by an ESOP, well, then, you're not.

Unfortunately, in the ESOP context, the view of some may well be - so what if the result is that we unduly discourage ESOPs . . . we don't like ESOPs, anyway. For years, anti-ESOPers have sought to find existing rules that could effectively make ESOPs unworkable from a practical perspective, notwithstanding clear congressional incentives and permissions in favor of the establishment of ESOPs. Now, maybe the ERISAfication of corporate decisionmaking hinted at in Couturier is the silver bullet sought by those seeking to mute, hinder or even altogether circumvent ESOP formation.

How does this state of affairs come to be? The courts cannot seem to get out of their own way on what they perceive to be the particularly troubling issue of indemnification for service to the plan. To an extent, the confusion is understandable. In the case of indemnification by an ESOP-owned company for actions taken by an employee in respect of the ESOP itself, the cosmetics are admittedly entangled. Donovan v. Cunningham, 541 F. Supp. 276 (S.D. Tex. 1982), rev'd in part on other grounds, 716 F.2d 1455 (5th Cir. 1983), cert. denied, 467 U.S. 1251 (1984), when faced with these troubling cosmetics, long ago went down the road of indemnification-related look-throughs. The Cunningham court, however, could be forgiven by its pre-1986 timing.

Notwithstanding Cunningham and its progeny, in light of the plan-assets regulation, I continue to think that the result of the analysis should straightforwardly leave you outside of ERISA. In particular, where under bedrock plan-assets analysis the assets of a company are not plan assets, that result needs to be understood and accepted. If the cosmetics of indemnification are somehow particularly troubling, then, it seems to me, the appropriate solution is a regulatory exception (to the the exception) in the plan-assets regulation, or some other special regulatory provision under 406.

You might also suggest that you can get to an end result where these types of corporate decisions could potentially be prohibited, by focusing on the "indirect" language in Section 406(a) - but then what's the point of the plan-assets regulation? You wouldn't have a 404 issue, but you'd be creamed under 406? I submit that such a result is not contemplated by the statutory and regulatory scheme. If you went down that road, you could employ that thinking for a 10% shareholder . . . or a 1% shareholder, for that matter. (More on that type of thinking, later.)**

Regardless, the right answer should not be to figure out some way to look back indirectly under amorphous general principles to the fact that the shareowning plan owns an equity interest in the company. Doing so opens the door to characterizing virtually everything done by the ESOP company as being subject to ERISA and somehow viewed through the prism of ERISA's PT rules. The stakes loom large, and, disturbingly, Couturier is a circuit-court case which, right or wrong, may well hang out there for a long time.***

Fernandez, from a district court in Couturier's circuit, quickly piles onto the Couturier result, and is interesting in several ways. First, it's becoming clear that the courts are not messing around when it comes to this result. They really don't like indemnifications from ESOP-owned companies. Second, the facts in Fernandez are actually less conducive to looking through the company back to the ESOP shareholder than the Couturier facts, and yet the court, after clear reflection, nevertheless came to the look-through result. Third, on the other side of the ledger, I like that Fernandez in its thinking and reasoning seems more focused on indemnification than Couturier. While I think that Couturier and Fernandez are flat-out wrong altogether, at a minimum it's critical that it be narrowed to the indemnification question that consistently seems so to offend courts' sensibilities.

For example, in Fernandez, the company was minority-owned, but the court nevertheless traced indirect indemnification back to the ESOP ("The ESOP, which owns forty-two percent of KMH, would thus shoulder a large part of the burden of indemnification."). In terms of how much the plan needs to own before there's a problem, what's the Fernandez standard? Majority ownership? Material ownership? So, a PubCo plan owns 2% of PubCo and a PubCo plan fiduciary has an indemnity - the indemnity is invalid? 2% invalid? C'mon. . . .

It seems to me that the early guidance of IB 75-2, now found at 29 C.F.R. § 2509.75-2, which sets forth standards for when a nonplan-assets entity which purports to stand between an investing plan and a PT should be effectively ignored, provides a perfectly good basis for when the PT rules should apply notwithstanding the presence of such an entity. Thus, 75-2(c) states, with a distinctly anti-collusion/anti-sham tone:

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[I]f there is an arrangement under which . . . it is expected that [an] investment company [in which a plan invests] will purchase securities from a party in interest, such arrangement is a prohibited transaction.

Similarly, . . . an arrangement under which it is expected that the insurance company [issuing a policy to a plan] will make a loan to a party in interest is a prohibited transaction.

Moreover, notwithstanding the foregoing, if a transaction between a party in interest and a plan would be a prohibited transaction, then such a transaction between a party in interest and such corporation or partnership will ordinarily be a prohibited transaction if the plan may, by itself, require the corporation or partnership to engage in such transaction.

Similarly, if a transaction between a party in interest and a plan would be a prohibited transaction, then such a transaction between a party in interest and such corporation or partnership will ordinarily be a prohibited transaction if such party in interest, together with one or more persons who are parties in interest by reason of such persons' relationship . . . to such party in interest may, with the aid of the plan but without the aid of any other persons, require the corporation or partnership to engage in such a transaction. However, the preceding sentence does not apply if the parties in interest engaging in the transaction, together with one or more persons who are parties in interest by reason of such persons' relationship . . . to such party in interest, may, by themselves, require the corporation or partnership to engage in the transaction.

Further, the [DOL] emphasizes that it would consider a fiduciary who makes or retains an investment in a corporation or partnership for the purpose of avoiding the application of the fiduciary responsibility provisions of the Act to be in contravention of . . . section 404(a) . . . .
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The foregoing narrowly constructed anti-abuse provisions are a far cry from unfortunate Couturier/Fernandez application of ERISA to look through to the company's plan investors when somethin' just don't feel right. And, if the potential expansiveness of the Couturier reasoning beyond indemnification takes hold, the overbreadth of that reasoning may start to have some truly unfortunate, and, it is submitted here, unintended, consequences.

Well enough about that. But, as long as we're resurrecting material from the latter half of the 70s (these segues get more and more attenuated, don't they?), let's set about considering the latest efforts in furtherance of . . .

Resurrecting Halloween

[SPOILER ALERT: DON'T read on if you do not want aspects of the movie revealed]

For anyone coming at Rob Zombie's new Halloween series, you need to see Carpenter's Halloween before seeing Zombie's. You would be too desensitized by Zombie's to be able to appreciate the accomplishment of Carpenter's. Go to the local library, if you have to (a good trick to remember, for oldies)! I watched it recently with family just to give everyone a sense of the enormity of Carpenter's seminal accomplishment, but, to my surprise, it actually held up, providing not only creeps but scares.

And then we watched Zombie's H-I. It was not an awful movie - a total reimagining/reinvention, to be sure. But it surely was the case that Carpenter's original would have been laughable played after Zombie's. The same was not true in reverse. Interesting.

H-II extends and transcends Zombie's H-I. I actually think that, in some ways, it might be the one of the best horror sequels ever made. It had something to say, was highly energized and didn't lapse into quirky self-parody. It was rough-and-tumble in the extreme, and represented a gritty take on Carpenter's original vision. There's no doubt that this wasn't Uncle John's movie. This ain't no foolin' around, as the Talking Heads might've said. "This ain't rock 'n roll - this is genocide," from Bowie, also comes to mind. (I still don't know quite what that means, but it seems apropos here.)

Isn't it ironic that a return to pure unfunny horror comes from the guy who did the over-the-top House of 1,000 Corpses? One would've assumed that Zombie would go down a Freddy/Evil Dead/latter-day Jason/ etc. road, maybe with some additional brutality, but definitely humor-based, no? Well, no.

Little touches abound. There's the barely perceptible use of the head-cock, perfected completely by Nick Castle's take on The Shape in Carpenter's original. And that's a lot of what's so good here - respectful homage without parody. There's no reason to be upset that this doesn't have the bloodless subtlety of Carpenter's. It's different, but different can be OK. Music evolves, humor evolves . . . and horror evolves. Later, and just different, is how I see it. Even the trademark (and utterly unsurpassed) Halloween music was saved 'til the very end - although take note that Zombie artfully used both musical themes, in perfect sequence, when the time was finally right. See also my earlier post on Carpenter's Halloween. And Margot Kidder as Laurie's therapist?! Could anything be more ironic, without degenerating into crass yuks?

I wonder if we now go down a horror revival, really started by Michael Bay with the highly effective revisiting of the Chainsaw saga and his bring-it-all-together take on Friday the 13th. Chainsaw even became a breakout movie for Jessica Biel, harkening back to what Halloween did for Jamie Lee. It could be a fun, albeit exhausting, run.

On the other hand, maybe I'm going too far here. I recognize that H-II is not a blockbuster (I cannot figure out the marketing strategy of not waiting until releasing it until October, around . . . uh . . . Halloween). In addition, the reviews, which sometimes can be pretty good even for a horror movie, are mixed. But Zombie is a pretty high-profile guy, and H-II really is pretty good stuff.

As its true test, H-II might, a la Wes Craven's Scream, fundamentally reinvigorate the genre, both bringing it back and simultaneously turning it in new directions. And, by the way, if you're interested in a take on a franchise that is utterly ignored but absolutely creative, clever, tight, suspenseful and downright scary, check out 1994's Wes Craven's New Nightmare. (Look for the scene where John Saxon, playing himself rather than Heather Langenkamp's father until the movie shifts gears, wonders why she's calling him "John".)

As to Michael Myers himself, let's only hope they're done now. The ambiguous ending notwithstanding, there's nothing more to do here, and the respect for the genre would best be manifested by an acknowledgment that we don't have to convert every one of these once-memorable characters into a supernatural goof-ball killing machine. They've made him real again; they made him scary. They now should leave him the heck alone.

Looking at Corpses followed by The Devil's Rejects and now H-I/H-II, Zombie seems to move in twos rather than trilogies. I like it - you ramp it up and then, with the benefit of some reflection, wind it down. Particularly in the case of highly charged moviemaking like this, that seems like all you should really need . . . or want.

We get a better ending this way. Put yourself back to Carpenter's Halloween and remember how totally cool it was when Pleasence**** looked down, Myers was gone, and Jamie Lee***** knew it, without even having to see. It was frightful, eerie and unexpected, because we didn't know then that he'd come back (again and again and again and again . . .). I always thought that moment, followed by the montage, was spot on. I also think the out-of-the-water scene at the end of the first F-13th, followed by Adrienne King's he's-still-there hysteria, all following the Jason's-mom arc, was spectacular. I think the later, dilapidated endings all come from unfortunate efforts to preserve the inevitable sequels that eventually became genre staples.

Having said all that, I really liked the ending here. The killer SHOULD be able to be killed. And the dementia that will now follow Laurie was well-executed. It reminded me of what they briefly tried with Jason, before they made him an unkillable supernatural monstrosity. In particular, they tried the concept that he would effectively live on in others, who had been touched and affected by him. People, to my surprise, didn't like that at all, and they degenerated into sci-fi. While they've sorta set that up here, with Laurie's having embraced her brother's violent leanings, I really hope that they're indeed done. I just don't think there's any more to say in the Michael (Michelle?) Myers saga. But what was said thus far was said well. Happy Halloween. . . .

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* Indeed, there is ample precedent for restraint, even where ERISA might directly apply. For example, the basic 3(21) fiduciary definitions are carefully balanced so that someone (who doesn't want to have potential fiduciary liability) might actually want to perform services for a plan. One might look at the regulations there and ask why the effort to circumscribe rather than expand fiduciary status. But, were the status unduly expanded, even aside from pure fairness considerations, there could have been the practical impact that otherwise willing service providers would be understandably unwilling to serve.

** The DOL, when faced with a desire to look through an entity where the underlying analytics didn't necessarily support doing so, recently used a look-through approach in connection with the new 5500 requirements, first coming up with a new underdeveloped concept of "investment fund" to get at disclosure issues where plans make equity investments in entities and there's some general feeling that an indirect path can or should be traced back to the plan. Notably, there may be some evidence that the DOL considered an unfortunate extension of this approach to the PT rules of 406(a) and 408(b)(2); more recent anecdotal indications appear to be that the DOL later (wisely, if you ask me) rethought the inclination to do so. Eventually, the initially undeveloped "investment fund" concept received greater and more careful attention, in Q&A-7 of the July 14, 2008 DOL FAQs on the new 5500 requirements. A lesson here is that there should be some effort to remain true to the underlying governing principles. And note that, even where the DOL did opt for looking through nonplan-asset entities in the 5500-related FAQs, it understood that it should not be looking through operating or even quasi-operating companies.

*** . . . like, for example, Harley v. Minnesota Mining and Manufacturing, 284 F.3d 901 (8th Cir. 2002).

**** Good as Malcolm McDowell is, he's was not quite Donald Pleasence.

***** Good as Scout Taylor-Compton may or may not have been (she got better towards the end), she was no Jamie Lee Curtis.