From the Pee-wee Herman / Fred Willard Dep't: "Holding" Your "Own" (under the 25% test)

With a wave of the hand (ahem) to Pee-wee and Fred (for those who don't get the references, I won't here endeavor to explain), I want to explore here the question of whether you "hold" your own assets, or whether you may also "hold" the others' assets that you don't "own," for purposes of determining which investments to exclude when applying the 25% limitation contained in the "significant participation" rules under the plan-assets regulation.  29 C.F.R. § 2510.3-101(f).  I've seen some raise the question of whether, under the 25% ("significant participation") test in the "plan assets" regulation, nonplan assets under the control of the fund manager (or an affiliate thereof) in a managed separate account should be ignored for purposes of the test, even where the assets belong to a third-party client of the manager.  It is argued below that only the manager's assets (and the assets of its affiliates) are properly excluded.

The basic exclusion rule in the regulation (the "Exclusion Rule")* says, "[T]he value of any equity interests held by a person (other than a benefit plan investor) who has discretionary authority or control with respect to the assets of the entity or any person who provides investment advice for a fee (direct or indirect) with respect to such assets, or any affiliate of such a person, shall be disregarded."  29 C.F.R. § 2510.3-101(f)(1).  Thus, on the face of it, you take investment into account (i.e., include the investment in the denominator (and the numerator)) unless the amounts invested are assets of the manager or its affiliates.  Further, it's arguably pretty clear that an investor does not become an "affiliate" of its manager merely because some of its assets are under the control of the manager.  Thus, the assets in the managed separate account of a third-party client of the manager are includible in the 25% calculation, right?

Well, some don't want to leave it there.  While I'm not sure how prevalent the discomfort is among practitioners generally, the potential concern as I understand it goes that, in the context of managed separate accounts, the DOL just can't POSSIBLY have meant only THAT.  The idea, supposedly, is that a rule that would permit a managed separate account under the control of the manager to count favorably under the 25% test would allow for manipulation by the manager. 

Well, to me, as written, the rule simply isn't worried about that particular kind of manipulation.  It's worried about the use of one's own money to spike the test.  And that's a perfectly logical place to draw the line.  If I'm managing $100 of plan money, maybe I shouldn't be able to throw $301 of my own money into the pot and now assert that I'm not a plan fiduciary.  I get that.

The stakes, however, are entirely different when it comes to managed money.  If I put $301 of someone else's money into a vehicle with $100 of plan money, I really do have a pot of managed money that is less than 25% plan.  Thus, given the principles underlying the 25% test, see 50 Fed. Reg. 961, 966 (Jan. 8, 1985) ("[I]t is reasonable to conclude that no special solicitation of investments by [benefit plan] investors has been made and that there is no substantial expectation that the assets of the entity will be managed in furtherance of the investment objectives of the plan ivestors."); see also 51 Fed. Reg. 41262, 41269 (Nov. 13, 1986) ("[I]n such circumstances the manager of the fund is likely to take the objectives of the investing plans into account in making investment decisions for the fund."), it seems perfectly reasonable to me to conclude that the entity is a nonplan-assets entity, notwithstanding that the manager is the one who directed the nonplan money into the entity. 

Simply put, on some level, there's plainly a huge difference between my money and (with apologies to Danny DeVito) Other People's Money.**  I can do whatever I want with my money, with impunity; but if I'm a manager and I decide to spike a fund with my clients' money just to beat the 25% test, I've got people - clients - to whom I may well have to answer.***  Now, does that mean I won't (like Rob Schneider, perhaps) behave badly?  Does it mean I won't try to spike the fund with client money?  Not necessarily, I acknowledge, but that's not my point.  My point is that the situation in which I use my own money is at base distinguishable from the situation in which I use client money, and that the DOL could have excluded, and, I maintain, plainly did exclude, investment only in the former case, not in the latter.  Could the DOL, when crafting the Exclusion Rule, have reasonably excluded both kinds of investment?  Sure!  It's just that, as I read the words on the page, the DOL just simply didn't.

Further to the point, if the DOL really were after controlled assets, they surely could have found words that are more straightforward to have gotten them there.  To wit, as one simple example, they could have so easily said, "[t]he value of any equity interests held **or managed** by a person . . . who has discretionary authority or control with respect to the assets of the entity."  

It is worth pointing out in this regard that the DOL is no stranger to identifying control concepts expressly, where it wishes to use them.  Such concepts are all over the Plan Assets Regulation.  The VCOC/REOC rules are loaded up with rules informed by control-type notions that focus on "influence".  And the rules governing the 25% test themselves specifically use the "control" concept in the definition of "affiliate" applicable for these purposes.  And, yet, one finds neither hide nor hair of the control/management concept in the operative provisions of the Exclusion Rule. 

So where do people go to conclude that exclusion of merely managed assets is called for under the 25% test?  Some find it buried in another concept, the concept of assets "held."  The idea, so the argument goes, is that when the reg. says that money "held" by the manager (or an affiliate) is excluded it extends so as to include assets other than the manager's (or its affiliate's) that are controlled by the manager (or its affiliate).

I would suggest that that's quite a stretch.  Do we really believe that a natural reading of "held" really gets you there?  If one weren't trying to shoehorn the words of the rule into an adverse result, would one really read the phrase "assets held by the manager" as including assets over which the manager has mere discretion?  Would one think that, without any indication thereof, the DOL used the "held" concept to convey mere management?****

It turns out that, just as one finds neither hide nor hair of the control/management concept in the operative rule excluding manager assets from the 25% calculation, one finds nary a hint of such a major interpretive result in either of the two extremely detailed preambles.  Indeed, if there is indeed any indication in the preambles, the indication pushes you away from managed money and over to proprietary money, in terms of identifying what's excluded, arguably belying an expansive view of "held."*****

The '85 proposed preamble says: "The Department intends that only the interests OF those who are independent of the management of an entity would be taken into account for purposes of the test. . . .  THUS, . . . equity interests . . . held by a person (other than a benefit plan investor) who would be a fiduciary if the assets were considered to include plan assets, and any equity interest held by an affiliate of such a person, are to be disregarded."  50 Fed. Reg. at 966 (emphasis added).  Then, maybe more tellingly, in the '86 preamble, addressing a particular commentator's point, the DOL said: "Some commentators also objected to the exclusion of equity interests OWNED by the entity manager (or its affiliates) . . . .  The Department has . . . concluded that it is necessary . . . disregard investments BY the entity's managers and their affiliates for purposes of applying the test.  In the Department's view, without THESE restrictions the test could easily be manipulated . . . , even where plans provide a substantial degree of the entity's capital and constitute most of the OUTSIDE investors in the entity.  None of the comments suggested ways of avoiding THIS potential for manipulation."  51 Fed. Reg. at 41269 (emphasis added).******

 
It's interesting, at the very least, that, to the extent there are indications of meaning, those indications seem to cut the other way - in favor of the more natural concept of owned money.   Again, the point here is not to make the case that the DOL could not have reasonably included merely controlled (as opposed to proprietary) money; the point is that they didn't (regardless of what they might say now if asked).*******  I would suggest that there are many examples throughout the law where prop. money is treated differently than managed money.  That's a valid distinction and one, I am submitting here, that's been drawn in this case.********

Happy Holidays!

_________

* I guess I could define it as the "Exclusionary Rule," but that could get confusing, couldn't it?

** Cf. Adv. Opn. 2003-15A (Nov. 17, 2003) ("Although Mellon would hold more than fifty percent of the value of the CIV interests, it would hold such interests on behalf of the Verizon Plans, not on behalf of itself or a third party."); Adv. Opn. 80-67A (Nov. 13, 1980) ("Ownership of 50 percent or more of an interest in an entity which interest is legally owned by a Company and allocated to a separate account for the benefit of employee benefit plans holding separate account contracts under which the results of . . . investment experience are credited or charged, directly and fully, to the accounts of participating plans does not cause the entity to be a party in interest . . . because the ownership interest in the entity is a plan asset the investment experience of whic is directly allocated to participating plans.  Similarly, [such] an interest . . . does noy cause the entity to become an affiliate of the Company for purposes of Prohibited Transaction Class Exemption 78-19."). 

*** As Ricky might have said, "Luceeee, you've got some 'splainin' to do!"

**** Presupposing what the words must mean in order to give them meaning contrary to their plain meaning reminds me of efforts to use legislative history to find meaning in operative language that just isn't there.  There is an old witticism that may be paraphrased as decrying an inclination to look to the statute only when the legislative history is unclear.  See Greenwood v. United States, 350 U.S. 366, 374 (1956) (Justice Frankfurter quipping, ‘‘This is a case for applying the canon of construction of the wag who said, when the legislative history is doubtful, go to the statute’’); see also Easterbrook, ‘‘Challenges in Reading Statutes,’’ (Sept. 26, 2007) (presented at a dinner talk for the Lawyers Club of Chi.) (‘‘The canonical way to [look for legislative intent] was to look at what legislators said — at legislative history.  One wag — who happened to serve on the Supreme Court — quipped that the judge would turn to the statute only when the legislative history was unclear’’); Scalia, A Matter of Interpretation: Federal Courts and the Law 31 (Princeton Univ. Press 1997) (joking that ‘‘one should consult the text of the statute only when the legislative history is ambiguous’’). 

***** Further, are we supposed to look to the form of the management arrangement as a salient factor?  If a manager doesn't take custody of or otherwise have signing authority over assets, but rather just tells a third party (e.g., a trustee or other custodian) where to invest, is that no longer a "hold" situation?  That would seem to me to be a pretty odd basis on which to apply (or not apply) the Exclusion Rule.  For that matter, do we think, if that's really how the "hold" question should be analyzed, that we reach (and exclude assets held by) affiliated nondiscretionary custodians?  (Boy, I sure hope not.)

****** One taking a position contrary to mine, and trying to narrow the meaning of the preamble passages, might argue that, especially in the '86 preamble, the DOL may well have been speaking to a specific point - exclusion of prop. money - in the quoted language. Viewed in that light, the preamble does not necessarily throw off a negative implication that merely managed money is included, and maybe the preamble simply doesn't address the managed-money scenario.  I have two responses.  First, I disagree with the premise underlying the foregoing, and believe that the DOL's comments do support the view that the Exclusion Rule does not apply to managed third-party money.  Second, as indicated above, at a minimum there's no indication that, through the simple use of the word, "held," the DOL intended the major substantive result of excluding managed money (something to which they easily could have gotten with a straightforward "managed" or "controlled" reference).

******* I'm aware that there were early incarnations of the PPA in which it was proposed that the "hold"/"own" question would be clarified in favor of "own," and that these proposals fell out of the legislation, maybe even with the support of the DOL.  Some might argue that the eventual deletion is evidence that Congress was OK with having the DOL extend the Exclusion Rule to managed assets.  But I would submit that it's not like the provision was a high-profile proposal that was rejected, in a way in which one could reasonably characterize Congress as having decided to leave "hold" alone implicitly because it felt that "hold" meant something other than "own."  Rather, the provision was rejected at a relatively early stage.  Further, and maybe moreover, this is not a provision where Congress rejected a proposed change to its own legislation, which might indicate an implicit view of what the legislation means.  Rather, what we had here was the deletion from a bill of an unusual attempt to ask Congress to second-guess the nomenclature of a regulation.  (Interestingly, Section 3(42) as enacted did ultimately countermand the DOL on the question of who's included as a "benefit plan investor.")  Frankly, turning the tables a bit, I'd argue that a basis for dropping the provision from the PPA was that the regulation already meant what the unnecessary proposed legislative language said.

******** Before leaving this topic, it's worth exploring this question where there is investment not from managed separate accounts, but rather from actual discretionary entities controlled by the same manager (or an affiliate)?  From a policy perspective, if it is OK not to exclude investment from a managed separate account, shouldn't it also be OK to exclude investment from a controlled investment fund?  Well, maybe, but the controlled investment fund is, for me, a trickier question, because the regulatory words on the page relating to "affiliates" may be more directly implicated in the case of a commonly controlled entity.  It seems possible to me that the rules on their face confer an overbroad result as applied to controlled entities, notwithstanding that the result for managed separate accounts may be inconsistent with the result for controlled entities.  Stated another way, just because the words used by the DOL may under certain facts run against the underlying policy and cause controlled investment funds to be excluded doesn't mean that one should conclude that there's an adverse result in the case of managed separate accounts.  Having said all that, it is noted in this regard that a certain June 25, 2004 request for an Advisory Opinion argues that a manager's other investment funds, even where where actively managed, may not need to be excluded for purposes of applying the 25% limitation.