(Note: I think there's a big M&A issue in the health-care arena, discussed below. So. if you want to skip over my initial dalliances, go (scroll) down to the end to the discussion of new Section 162(m)(6).)
OK, so here's an ERISA lawyer's try at a Milleresque rant. I continue to be fascinated by the world's fascination with round numbers. I mean, when Alex Rodriguez earlier this year (finally) reached the milestone of 600 home runs and became the "youngest person ever to reach 600," hadn't he already become the youngest person ever to reach 599? I'll bet he was even the youngest person ever to reach 598. I remember when Bobby Bonds fell one home run short of 40 in a year when he had over 40 stolen bases, and missed out on being the first player to reach the "40/40" club (for 40 home runs and 40 stolen bases). Dare I suggest that he was, however, the very first member of the exclusive "39/39" and "39/40" clubs? Sometimes, I wonder why we don't bemoan that Joe DiMaggio's hitting streak fell tantalizingly close to reaching the elusive 60 plateau. We talk about people reaching six feet in height - should we stop doing so because as an underlying matter they're simply reaching 72 inches?
The effect of this focus, or mis-focus, is not without import. Two examples:
- In lieu of an analytical approach, draftspeople will throw round numbers into critical statutes. So, for example, the beloved 162(m) gives us a magical $1MM limit (see also below), as though the number were a platonic from. And 280G incisively talks about three times comp. (which, amusingly became almost a floor for severance for certain CEOs). How about that great bonding requirement in ERISA that focuses on the anachronistic $500K level (which has been amended in the PPA to reach that carefully pegged amount of $1MM under certain incomprehensible situations involving employer securities (all of which would be amusing if it weren't a bit sad))? Boy, the round-number lobby must just hate cost-of-living adjustments, such as those applicable in the case of tax-qualified plans, that, at the expense of roundness, actually keep some of the statutory limits current, relevant and at least maybe rational.
- Moving to a more accessible example, take the Oscars. They decided that five films for Best Picture were too few. And maybe that was so. So what's the right number? It must be the next milestone, right? So it must be 10. Unfortunately, I think, it was pretty clear that 10 was waaaaay too many. The movies bringing up the rear just didn't belong. Worse, who knows how having these stray movies skewed the voting, by causing a siphoning off of votes from other worthier nominees? SNL had a hilarious take on this, when it had a skit that started including old television shows and other absurd nominees in the list of nominated movies (I must have SNL on the brain). Hey - maybe the right number really was seven, or six or eight, rather than 10? Oops - HERESY - my apologies.*
Section 162(m)(6) - Health Reform (Unintentionally?) Meets M&A
So, while we're on the topic of provisions that have hard-dollar caps like the 162(m) we've come to know and love, we now come to new Section 162(m)(6), added by Section 9014 of PPACA (the Health Reform legislation). Here, we have the $500,000 hard-stop limitation on per-employee deductibility of compensation that applies, for years after 2012, to a company (public or private) that, in very general terms, has more than 25% of its premium income coming from premiums for health-care coverage that is "minimum essential coverage" (essentially, core health-care coverage). (For years before 2013, the situation is murkier still, in that it's not clear just how the rules will apply in the case of deferrals made before 2013 but for which the deduction would be taken after 2012.)
Now there's a scientific and carefully drawn limitation, huh? As with the TARP rules, and putting aside all the confusion about which companies are affected before 2013, the rule is an inflexible one, with no exceptions for performance-based comp. or anything of the sort (and there are provisions designed to address avoiding the rules through the use of deferrals).
Hey, there's an idea - let's fix the health-care system by designing a tax structure that maybe sorta somewhat discourages the best executives from staying at or coming to the insurance companies we're supposedly trying to improve by exerting some type of indirect downwards pressure on their compensation. Certainly, the companies can run themselves, and don't need any help from the best, high-paid executives. Really!?! (With a second set of apologies to latter-day SNL-ers Seth Meyers and Amy Poehler.) And, if that's not bad enough, let's make it be that any exceeding of the applicable limitations punishes the companies' shareholders and, maybe, policyholders. Really!? (Still ranting, I guess.)
But enough general venting. Let's forget for the moment any overall objections to the use of deduction limitations to effect compensation-related policy goals, and the almost random use of the $500K threshold, and the fact that the people left holding the bag could well be a bunch of shareholders and policyholders. Forgetting all that, this little Section 162(m) present has additional, and potentially very serious, problems.
Let's review what the statute was supposed to do - it was supposed to regulate the compensation of employees of health-insurance companies regulated by PPACA. A health-insurance company might heartily object to the new 162(m)(6) rules, but, ultimately, it will have to come to terms with the fact that, until changed, those are the rules that govern it and its industry. 'Tis what 'tis, I guess. OK.
But now take the following hypothetical:
- Multi-billion dollar company in some type of health-care business decides it wants to buy (let's say, 100% of) some $10,000 company is North WhoKnowsWhere, which gets $1000 in premiums a year, of which $250 is for minimum essential coverage.
- Buyer has some executives that are paid millions of dollars, and many employees making over $500K counting all compensation.
- The target company will be the buyer's first and only foray into the provision of actual insurance.
Uh oh. Has the acquiror just lost untold millions of deductions for the compensation paid to its executives and other employees? Maybe. Why?
Well, (i) the 162(m)(6) rules operate on a controlled-group basis (using the 414 rules, including both the ownership rules of subsections (b) and (c) and the other aggregation rules such as those relating to affiliated service groups), and (ii) the operative 162(m)(6) rule (A) has no express qualifier pursuant to which the gross amount of premiums that need to be received, either as an absolute matter or as a relative matter, in order for the $500K limitation to be triggered, but, rather, (B) operates on its face by reference to the percentage of premiums (however low the aggregate total premiums may be) which are for minimum essential coverage (or, in the case of deferrals in years before 2013, maybe even for a lower amount and wider range of premiums). So maybe deductions are lost across the board for the acquiror.
Is that really the result? If so, will someone (please) fix it? Could the solution be a regulatory fix, or would it have to be a legislative one? Who knows, who knows and who knows?
Even a risk of lost deductions in a case like this, however uncertain that risk may be, is awful, and could (i) on the buy side, impede a potential sale, or at least factor into pricing, or (ii) on the sell side, cause a company to want to jettison a business that collects premiums for minimum essential coverage, particularly it that's not the company's core business.
And, just to make it a bit worse, the parade of horribles may arise before 2013 even if there's only a dollar of premiums, and even if the premiums are for certain types of insurance not generally regulated under Health Reform.
Well, it's interesting - to me anyway - and we'll have to see if 162(m)(6) in its present incarnation indeed has any real impact in the transactional market. Maybe it just won't be considered relevant unless and until it affects, oh, 10 major deals. That seems like a nice round number, no?
* On an unrelated note, based on what may be the best trailer ever, at least since the one for Poltergeist II, it looks like The Social Network, even before I've seen it, may cause me to have to rethink my Oscar prediction for Toy Story 3. (Hey, The Dark Knight became one of my favorite movies of all time before I even saw it, based on a glimpse of the opening eight minutes alone, so there's precedent here.)