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Monday, November 22, 2021

Control: Let's Take It from Britney to . . . VCOCs?

OK, I admit it.  I like Britney Spears.  I like her music, and she seems (or at least at one time seemed) very nice.  I thought South Park nailed the feeding frenzy that surrounded her (gee, South Park getting something exactly right; what a shock), and I even felt an affinity to the Leave Britney Alone guy.  

The thought of family and hangers-on trying to control her really bothered me, as did her descent that followed.  I guess these stories get to me - I was (and there's no sarcasm here) also pretty broken up about the whole Anna Nicole Smith thing.  Oh well - a cross to bear, I guess. 

So I was really quite happy to see Britney's conservatorship end.  The end of this tragicomic* and horrifically public spectacle was a welcome end to the conservatorship chapter of her life, and we'll see if she's able to shed her anger and recapture herself.  

All of which inexorably now brings me to, of course (!), the topic of VCOCs.  Let's continue to talk about control.

A pet peeve of mine involves the question under the Plan Assets regulation of whether, under the vanilla opco rule (the first sentence of 29 C.F.R. § 2510.3-101(c)(1)) and its "majority owned" language, a parent must own a majority of the value, the vote or both of the operating subsidiary.  To me, it's a matter of value, not vote, and here's my thinking:

- The DOL seemed to be looking for a simple, non-technical approach to vanilla opcos, an approach that's in pretty stark contrast to the one used in respect of VCOCs and REOCs.  In the base case for vanilla opcos, the plan is investing in a widget or services company that's just going about doing its business.  While the majority-ownership thing could cause unexpected hiccups in some circumstances (where, for example, there are material subs. that are not majority owned), the ordinary expectation is that when the plan makes an investment in a widget or service company, the company's assets won't be plan assets that are subject to ERISA.  I don't think that the rules are looking for the plan fiduciary to call up the management of the target and start asking odd questions about the affiliated group's control structure.  Thus, for example, the preamble to the final reg. homes in on the factual nature of the analysis and the "vast number of different activities" in which companies engage; and states that, "other than with respect to [REOCs] and [VCOCs] [!], it would be impractical to provide detailed guidance concerning the types of activities necessary for characterization as an operating company."  (I take the point that the DOL was focusing on the nature of business "activities" rather than on organizational structure, but I would suggest that, consistently with the brevity of the governing rule in the first sentence of -101(c)(1) without any meaningful additional regulatory color, there's a general and palpable tilt towards a simplistic and streamlined regulatory approach to vanilla opcos.)

- I think it's worth further comparing the general vanilla opco rule to the VCOC/REOC rules.  VCOCs and REOCs are different from vanilla opcos at the core.  They are creatures of detailed regulatory provisions that serve as ERISA-specific exceptions (and, apparently, begrudgingly included exceptions) to being covered by the full panoply of ERISA's rules.  The VCOC/REOC exceptions generally have no meaning outside of the plan-assets reg.,** and were apparently included by the DOL only begrudgingly.  I frankly think that what I perceive to be an analytical disconnect here is that ERISA lawyers are often only really unpeeling the analytical onion regarding vanilla opcos in the context of exploring whether the opco is a qualifying VCOC investment.  So, the basic context in which the opco is being examined is marked by the control-type and highly detailed thinking surrounding VCOCs.  And then I think that color finds its way over to the consideration of the first sentence of -101(c)(1).  But I would respectfully suggest that that's missing the forest for the trees.  The vanilla opco rules just don't have all of this trouble-making baggage.  Again, in the base case, the plan is investing directly in a company that's just going about doing its business; there's not VCOC at all.  The reg. protects that company and the people running it, totally separate and apart from whether that company could be tucked under a VCOC.  Thus, the single sentence that governs vanilla opcos has fundamental import and meaning totally outside of the regulatory regime for VCOCs and REOCs, and, for me, should be applied intuitively, straightforwardly and simply, without the laying of complicated and potentially treacherous control notions over basic concepts of economic ownership. 

- With that said, and taking a step back, I would argue that, intuitively, ownership for these purposes is economic ownership.  If some asks me if I own something, I look to whether or not I have the economics of the thing.  Indeed, engrafting a control requirement under the "majority owned" rule could have the perverse consequence of rendering a parent not an opco, even where that same parent could be a VCOC.  In this regard, let's say (see also the 95-04A discussion below) an entity owns 99% of an operating subsidiary as an LP.  If the entity gets management rights, it could be a VCOC.  Are we really suggesting that the very same entity, which could be a VCOC under the specific and delineated requirements applicable to hybrid operating companies / investment funds, can't be a vanilla opco, under rules where the bar is so much lower?***

- Maybe most significantly in respect of the structure and text of the reg., the DOL darn well knew how to worry about control-type considerations in the operating-company rules of the reg.  Indeed, arguably at the very heart of the VCOC/REOC rules are the rights "to substantially influence"**** downstream activities.  It would have been so easy for the DOL to establish express control/influence requirements in the first sentence of (c)(1), but the DOL rather proceeded with a "majority own[ership]" approach.  I think that reading a control requirement into that generic language is unwarranted.  

- Under 95-04A, I can run a VCOC through a wholly-owned sub., and have the sub. essentially be completely disregarded.  Footnote 8 of the AO expressly contemplates a GP not owned by the VCOC.  So the DOL is allowing an entity controlled to no extent by the VCOC (so long as there is mere substantial influence) to be used as a way of having the VCOC make qualifying investments, and yet an entity that is a 99% LP in an operating entity is somehow not an "operating company"?  I'm not saying it's steel trap, because the VCOC-related considerations do not foursquare line up with the considerations surrounding vanilla opcos, but I would suggest that the 95-04A footnote pushes you away from control concerns, except where the control-related requirements are specified expressly in the rules.  

For me, some ERISA lawyers who day in and day out deal with complicated control/influence issues under the VCOC/REOC rules may be making unnecessary mischief under a simple rule (in the first sentence of -101(c)(1)) for run-of-the-mill operating companies.  I would suggest that, if I own most of the economics of a company, I, simply put, majority-own the company.  Sometimes, the obvious and straightforward answer really is the right answer. 


** Well, there is at least one place where the VCOC rules have some impact, and that's under (believe it or not) the Small Business Administration regulations (and I'm not talking about 95-04A here).  Indeed, under what seems like an utterly bizarre result (maybe, I would suggest, resulting from the mistaken belief on the part of the drafters of the SBA rules that being a VCOC allows the VCOC and its managers to satisfy ERISA while investing and managing plan assets, whereas to the contrary being a VCOC causes the fund or other entity and its managers to get out from under the ERISA rules altogether), Section 29 C.F. R. § 121.103(b)(5) seems generally to say on its face that if I park a parent holding company over an SBA borrower and have the parent be a VCOC (even without any ERISA investors in the VCOC), which is really really easy to do where the borrower is an operating company (indeed, I would suggest that somewhere between 99.8% and 100% of the time I can plop a holding company over an operating company and have the holding company be a VCOC), then the general affiliation rules of Section 121.103(a) do not apply.  The result?  That the owners of the VCOC, even if behemoths, would not be taken into account for purposes of determining whether the "small" borrower is an eligible to borrow under certain SBA rules. 

*** I recognize that a possible analytical weakness here centers on the DOL's use of the word "through" when discussing how the parent operates in respect of its subs.  I happen to think that the use of that word was nothing more than a way of referring to the existence of the subsidiary.  Having said that, I would concede some marginally increased level of concern where for whatever reason the parent is not allowed to have any contact whatsoever with anyone at the subsidiary regarding how the subsidiary's business is run (although, even on those extreme facts, I'd ultimately get comfortable).

**** Boy, do I hate that split infinitive.  How about "substantially to influence" or "to influence substantially"?  And that's to say nothing of the lack of parallelism of "directly or through".  I mean, c'mon.  How about "directly, or indirectly through a majority owned subsidiary or subsidiaries,"?  But there I go again, tilting at windmills.

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