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Pension Plan Investments 2008: Current Perspectives
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REVISITING VEBAs
Edmond T. FitzGerald
Davis Polk & Wardwell
Disclaimers and Suggested References: The outline that
follows provides a general overview of retiree medical
benefit VEBAs, with specific focus on the VEBAs recently
proposed by the Big Three U.S. automakers. The author is
by no means an expert on medical benefit plans or VEBAs.
Nor can the author claim special insight into any aspect of
the Big Three VEBAs. The information in this outline is
gleaned entirely from public sources. For two very practical
references on retiree medical and VEBAs see: (1) the ABAJCEB teleconference “Shifting Retiree Health Benefits from
Employers to VEBAs” (December 6, 2007 – available in
archived teleconf format or CD), in which Nell Hennessey,
Douglas Greenfield, Karen Handorf and Vicki Hood do a
terrific job describing the background on union retiree
medical and the Big Three VEBAs and (2) Jones Day
Commentary – Who Killed Yard-Man (Apr. 2007), a Jones
Day client newsletter available on-line which provides an
excellent summary of the state of the case law up to April
2007 concerning an employer’s ability to amend retiree
medical arrangements in a union context.
REVISITING VEBAs
Edmond FitzGerald
Davis Polk & Wardwell
Disclaimers and Suggested References: The outline that follows provides a general overview of retiree medical
benefit VEBAs, with specific focus on the VEBAs recently proposed by the Big Three U.S. automakers. The
author is by no means an expert on medical benefit plans or VEBAs. Nor can the author claim special insight
into any aspect of the Big Three VEBAs. The information in this outline is gleaned entirely from public sources.
For two very practical references on retiree medical and VEBAs see: (1) the ABA-JCEB teleconference
“Shifting Retiree Health Benefits from Employers to VEBAs” (December 6, 2007 – available in archived
teleconf format or CD), in which Nell Hennessey, Douglas Greenfield, Karen Handorf and Vicki Hood do a
terrific job describing the background on union retiree medical and the Big Three VEBAs and (2) Jones Day
Commentary – Who Killed Yard-Man (Apr. 2007), a Jones Day client newsletter available on-line which
provides an excellent summary of the state of the case law up to April 2007 concerning an employer’s ability to
amend retiree medical arrangements in a union context.
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REVISITING VEBAs
I.
Introduction
In 2007, General Motors, Ford and Chrysler (the “Big Three”) each entered into new
agreements with the UAW which provided for the transfer of all hourly employee
retiree medical benefit liabilities of the automakers to independent voluntary employee
benefit associations (VEBAs). If all goes according to plan, starting in 2010 these
VEBAs will assume all responsibility for the retiree medical benefits payable to the
current and future hourly retirees of the automakers. While retiree medical VEBAs
are not new, the VEBA deal struck by the Big Three is unprecedented in its scale.
Collectively the VEBAs will be funded with more than $50 billion in cash and
securities and will assume retiree medical liabilities for more than 700,000 employees
valued at over $80 billion. If the VEBA deal is completed, it will enable the Big
Three to significantly reduce their balance sheet liability for retiree medical benefits.
This outline summarizes the basic legal and practical aspects of retiree medical
VEBAs and the public information provided to date on the proposed Big Three
VEBAs.
II.
VEBA Basics
A.
Codes § 501(c)(9). A VEBA is an invention of Section 501(c)(9) Internal
Revenue Code (the “Code”), which bestows tax-exempt treatment on:
“Voluntary employees’ beneficiary associations providing for the
payment of life, sick, accident, or other benefits to the members of
such association or their dependents or designated beneficiaries, if
no part of the net earnings of such association inures (other than
through such payments) to the benefit of any private shareholder or
individual.”
B.
VEBA Form. A VEBA can be established as a trust, corporation or association,
but because ERISA § 403 generally requires plan assets to be held in trust, a trust
is the natural form of choice for most VEBAs.
C.
VEBA Beneficiaries. A VEBA can be established to fund benefits for union or
non-union employees. A VEBA can be established by a union, an employee
association or an employer. It can either provide benefits directly to the VEBA
members or act as a funding source for benefits provided under a separate plan or
insurance policy of the union or the employer. The membership of a VEBA (i.e.,
the covered participants) must consist of employees who are related by a common
labor union or by a common employer, affiliated employers or a consortium of
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employers in a particular line of business in the same geographical locale. VEBAs
are subject to nondiscrimination rules which require VEBAs to cover an employee
group defined by reference to objective standards that constitute an employmentrelated common bond. Eligibility and benefits must be determined based on
permissible objective criteria and cannot be skewed to officers, shareholders or
highly compensated employees. A VEBA might also be subject to the
nondiscrimination requirements of § 505 or § 79 of the Code, depending on the
benefits provided, but a VEBA maintained pursuant to a collective bargaining
agreement (CBA) is exempt from these requirements.
D.
Control of the VEBA. A VEBA must be controlled by its membership, an
independent trustee or trustees (e.g., a bank), or a trustee or trustees, at least some
of whom are designated by or on behalf of the membership.
E.
Application of ERISA. The administration and investment of assets held under a
VEBA are governed by the fiduciary and prohibited transaction rules of Title I,
Part 4 of the Employment Retirement Income Security Act of 1974 (“ERISA”) in
much the same way as a pension plan trust. Typically, a VEBA’s board of trustees
will be regarded as the “sponsor” as well as the primary “named fiduciary” of the
VEBA. It appears that ERISA preempts state laws (e.g., insurance laws) as to
most issues relating to the operation of a VEBA, although this conclusion is not
beyond doubt and a more probing analysis of preemption is beyond the scope of
this outline.
F.
Funding and Deductibility of Contributions to a VEBA. VEBAs can use a variety
of methods for recording and applying amounts contributed and held under the
VEBA. For example, a VEBA can have a defined contribution feature whereby an
employer and a union agree that an increment of each employee’s compensation
will be contributed to a VEBA on a pre-tax basis. These contributions can be
credited to a separate benefit account in the name of the employee and the account
can be applied to reduce the employee’s cost for benefits. Employees may not be
given a choice to receive a compensation directly in lieu of having the
compensation contributed to a VEBA. So typically, contributions to be credited to
an employee under a VEBA come from a per employee increment that is
automatically paid by the employer to the VEBA. At the same time, the same
VEBA (or a parallel VEBA) can allow other additional contributions by the
employer to be held under a general account in the VEBA and used to fund
benefits costs applicable across the entire VEBA population (e.g., to pay benefit
claims, off-set basic premium costs or fund a stop loss policy).
Contributions are subject to the deduction limits imposed by § 419 and § 419A of
the Code on the prefunding welfare benefits. Under these limits the annual
deduction that an employer can take is typically limited to the amount of the
benefit costs and expenses expected to be incurred within the tax year of the
contribution. But there are a few important exceptions:
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
Pursuant to Code § 419A(f)(5), a full deduction can be taken for all
amounts contributed to a VEBA pursuant to a CBA; and

Pursuant to Code § 419A(c)(2), even without a CBA, a full
deduction can be taken for contributions to fund a reserve over the
working lives of the covered employees where such contributions
are actuarially determined on a level basis as necessary for postretirement medical or life insurance benefits to be provided to the
employees.
G.
Tax-Exempt Status of a VEBA. Earnings on amounts and investments held under a
VEBA are tax-exempt. A VEBA is required to obtain a determination of
tax-exempt status from the IRS by filing an IRS Form 1024 within 15 months after
the VEBA’s establishment (subject to a possible 12-month extension).
H.
Taxation of Benefits Provided. Benefits funded or provided by a VEBA are
taxable to the beneficiaries at the time they are provided, unless the benefits are
tax-exempt under other applicable tax rules, such as the general exemption for
premiums and claims payments under a non-discriminatory employee and retiree
medical plan.
I.
Anti-Inurement Requirement. Amounts contributed to a VEBA by an employer
may not inure or revert to the employer. If all liabilities under a VEBA have been
satisfied, any remaining assets can be applied to purchase additional insurance or
benefits that would have been permissible benefits under a VEBA or to provide a
direct cash distribution to employees if so provided under a controlling CBA.
However, most other diversions of a VEBA’s assets will result in a 100%
reversion tax.
III.
Typical Process for Implementation of Defeasement VEBAs
A.
Bankruptcy Retiree Medical VEBAs. At the risk of oversimplifying, in the
bankruptcy context, the typical implementation of a VEBA is as follows:

For active employees, a debtor-employer is often permitted to unilaterally
modify or terminate retiree medical benefits under Bankruptcy Code § 1113,
which provides that an employer may make changes to benefits of active
employees (even benefits agreed under a CBA) if the changes are necessary to
facilitate the reorganization of the debtors.

For former employees in retiree status it is critical to determine whether the
debtor-employer has reserved the right to change the retiree medical benefits.
If so, the § 1113 standard above might apply (i.e., employer may unilaterally
change benefits if necessary to facilitate the reorganization). If not,
Bankruptcy Code § 1114 applies, which requires the retirees to be represented
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by a committee for purposes of participating in a process to determine what
will be done about the retirees’ benefits.
B.

In the end, it is not uncommon for a debtor-employer to entirely cancel the
retiree medical benefit rights of some or all of its active employees and
establish a compromise arrangement for the retirees and perhaps some class of
the active employees (e.g., employees over age 55 with 20 years of service).

The compromise plan may include a VEBA established to fund a portion of the
cost of benefits for the qualifying employees and the retirees (e.g., the
employees and retirees might be required to pay most of the cost for their
benefits, but a VEBA might be established to subsidize some portion of the
cost for as long as the VEBA’s assets are sufficient to do so.

The VEBA might be funded with a minimal amount of cash and a larger
contribution of employer stock.
Non-bankruptcy Retiree Medical VEBAs. In the non-bankruptcy context, VEBAs
with significant prefunding have historically been less typical. (See limits on prefunding deductions summarized in paragraph II.F. above.) But there have been at
least a few high profile pre-funded retiree medical VEBAs established in the nonbankruptcy context: Navistar (1993), Goodyear VEBA (2006) and AK Steel
VEBA (approved/pending 2007). And now we have the proposed Big Three
VEBAs (subject to court approval). A pre-funded retiree medical VEBA in the
non-bankruptcy context is a Hobson’s choice for both the employer and the
employees.
Employer Motives. From the employer’s perspective:
1.

The employer seeks to reduce its retiree medical costs and liabilities
both from a recurring cash flow perspective and an accounting
perspective.

Reducing or eliminating benefits, or increasing employee cost-sharing,
can entail legal risks and social costs. A review of the case law
regarding an employer’s ability to change or terminate benefits is
beyond the scope of this outline, but in many cases there is significant
legal and social risk.

Transferring the retiree benefit obligation to a VEBA is a difficult
process that often requires court approval (see below) and entails a
significant funding commitment over several years. The funding
commitment depletes the employer’s cash position, which can crimp
short-term capital raising, stall capital expenditures and increase
solvency risks if the company faces a downturn in the near term. But a
VEBA might be the most viable alternative for unburdening the
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employer’s balance sheet and eliminating the long-term drag on
earnings.
2.
Employee Motives. From the perspective of employees and retirees:
As long as retiree benefits remain an unfunded liability payable from
the employer’s earnings, the employees and retirees are at risk of
employer curtailments to the benefits or employer insolvency.

The more demonstrably onerous the benefits become for the employer,
the more likely a court will see clear to permitting employer
curtailments.

However, accepting a funded VEBA in lieu of an employer promise
shifts the funding risk to the VEBA, which raises issues of the
sufficiency of the employer contributions, investment performance of
the VEBA, healthcare cost inflation, etc.
3.

Process for Implementing a VEBA. Under the National Labor Relations
Act (“NLRA”), retiree medical benefits being provided to former (i.e.,
retired) employees at any given time are a permissive topic of bargaining
for union negotiations but not a mandatory topic of bargaining. Therefore,
while the employer and the union may agree to negotiate over retirees’
benefits, neither the employer nor the union can force this negotiation, the
union cannot strike over the issue and the employer cannot announce a
lock-out over the issue. Moreover, even if an employer and a union
negotiate a deal concerning the benefits of retirees, the union cannot bind
the retirees. So the process for transferring to a VEBA the retiree medical
benefits of both active and retired employees will typically be as follows:

The employer will get the union to agree to include retiree benefits
as part of the negotiation relating to the new labor contracts.

The employer might give the union access to company books in
order to validate the dire financial straits that the retiree benefits
create for the employer.

The employer and the union will reach an agreement providing for
the funding of a VEBA and a transfer to the VEBA of all liabilities
for the retiree medical benefits of active and retired employees.

Once the union contract is ratified, active employees are bound by
the contract. Separately, legal counsel is appointed to represent the
retirees and class representatives are appointed and a class action
suit is brought in the name of the retirees.
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
The employer seeks to consolidate the entire class of potential
plaintiffs and have the class representatives agree to the proposed
plan for the implementation of the VEBA and the transfer of the
retiree medical liabilities to the VEBA, which will then become
binding on all retirees under a court-approved settlement agreement.
Core Accounting Issue. Assuming that an employer’s liability for reiree
medical benefits is transferred to a VEBA in a binding transfer, there are
apparently two possible accounting treatments for the employer:
settlement treatment or negative plan amendment treatment. Settlement
treatment involves a removal from the employer’s balance sheet of the
entire liability for the benefit obligations that have been transferred and
would apply, for example, in the case of a one-time contribution to a
VEBA and an immediate and binding assumption of all future benefit
obligations by the VEBA. Negative plan amendment treatment applies
when benefit obligations are transferred but the arrangement entails an
agreed long-term schedule for employer contributions to the VEBA. In
this case, the employer’s balance sheet continues to reflect an OPEB
liability equal to the present value of the future contribution obligations.
The liability is limited to the present value of the future contribution
obligations and is not affected by healthcare cost trends. The liability is
defrayed as the contributions are satisfied.
4.
This is essentially the process followed in the recently proposed Big Three
VEBAs.
IV.
Big Three VEBAs
A.
Background on GM and Ford. Before discussing the newly proposed Big
Three VEBAs, some background on an earlier UAW deal at GM and Ford
might be helpful.

In 2005, GM and Ford each reached an agreements with the UAW for
the institution of retiree cost-sharing on retiree medical benefits (i.e.,
premium cost contributions, deductibles, co-payments, prescription and
dental coverage changes).

In exchange, GM and Ford agreed to establish a VEBA to help defray
retiree costs.

For example, the UAW and GM agreed that GM would fund its VEBA
with: (1) a $1B contribution in each of 2006, 2007 and 2011, (2)
specified stock appreciation and profit sharing payments and (3)
diversion of certain wage/COLA increases into the VEBA.
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
B.
The 2005 arrangement followed the process outlined in paragraph
III.B.3. above. After the UAW and the automakers reached a
negotiated deal, a class action was initiated on behalf of retirees and the
arrangement was ultimately blessed by a court-approved settlement and
an outside challenge against the class certification and the process was
recently overruled by the Sixth Circuit Court of Appeals.
The Newly Proposed VEBAs. In the 2007 negotiation of their new contracts
with the UAW, the Big Three decided to propose a full transfer of retiree
medical obligations to the UAW. The parties followed the process outlined in
paragraph III.B.3. above and reached agreements that were ratified by the
active employees. Under the agreements, future hires will not be eligible for
retiree medical benefits and the UAW has agreed not to request bargaining
over retiree benefits again at any future date. All obligations for retiree
medical benefits for the existing active and retired employees will be shifted to
new VEBAs effective January 1, 2010.
The details and analysis that follow in the remainder of this outline were
pieced together from public sources and are bound to be flawed in some
respects. Because Chrysler is a privately held company, information on
Chrysler is more limited and more prone to inaccuracy.
The Proposed Big Three Auto VEBAs
Company
Estimated
Hourly Retiree
Liabilities
Estimated VEBA Funding
General Motors
$46.7 B
- $16 B cash and funding obligations
transferred from 2005 VEBA
- $9.1 B add’l cash contribution
- up to 20 payments of $165 M cash
- $4.3725 B convertible note
Ford
$23.7 B
- $3.8 B cash transfer from existing VEBA
- $2.7 B add’l cash contributions
- up to 20 payments of $52 M cash
- $3.3 B convertible note
- $3.0 B second lien note
Chrysler
$20 B
- $7.1 B cash contribution
- up to 20 payments of $50 M cash
- $1.2 B debenture
- Common stock warrant (potential $605 M)
As described below the convertible notes to be issued to the GM and Ford
VEBAs come along with registration rights. The Chrysler securities
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presumably do not entail registration rights, given that Chrysler is privately
held.
The In addition to the VEBA contributions above, the Big Three have also
agreed to specified monthly pension increases for retirees which are intended
to offset the retirees’ contributions to cost of their medical benefits. The
automakers have also agreed to make contributions to a union-sponsored study
of retiree medical costs and funding.
Although assets and liabilities will not be shifted to the VEBAs until 2010, the
agreements require each of the automakers to establish a temporary asset
account (“TAA”) and to begin funding the agreed VEBA amounts immediately.
For example, GM is required to contribute to its TAA an initial cash amount
and the $4.4B convertible note. The note will begin to accrue interest
immediately, but will be held by GM’s TAA until it is transferred to the GM
VEBA in 2010. For more on the potential ERISA treatment of the TAAs
ERISA see paragraph V.C. below.
C.
The Notes Issued to the GM and Ford VEBAs. Taking the convertible note to
be transferred by GM to its VEBA, for example, this note entails the following
terms:

senior unsecured and unsubordinated debt

6.75% interest paid semi-annually

5-year maturity from issuance on 1/1/08

callable by GM any time after year three

convertible for approximately 109 million GM shares based on $40 per
share conversion price (approx. 20% of current outstanding)

may only be converted (i) during any earlier calendar quarter if the
average price of GM stock for any 20 trading days in the last 30 trading
days of the prior quarter exceeds $48 per share or (ii) if the issuer calls
the note or (iii) during the last three months before maturity regardless
of the stock price or call

demand registration rights applicable to note and shares (described
below)

prohibition on sale to any one buyer of notes representing more than
2% of the outstanding shares on an as converted basis

sale limited to approximately 50% of note/shares per year
10
Shares issued on any conversion of the note must be voted by the VEBA in
proportion to the voting of outstanding shares generally and the shares will be
subject to standard registration rights/restrictions, as follows:
D.

demand registration of up to 50% of shares (54 million shares) per year,
less number of shares sold in private sales during year

permitted private sales of up to 13.5 million shares per quarter (54
million per year)

piggy-back registration rights

VEBA may be subject to standard 180 blackout on sales in event of any
registered offering by GM (whether or not VEBA participates in the
offering)

no sales of more than 2% of outstanding shares to any one buyer and no
sales to any 5% holder seeking influence

trustee may not tender into any hostile tender offer

GM right of first offer if VEBA seeks to sell any shares
Conditions to the VEBA. The automakers intend to seek comfort from the SEC
that transfer of the retiree medical obligations to the VEBAs will permit the
automakers to apply settlement treatment or treat the arrangement as a
substantive negative plan amendment for accounting purposes. If the
automakers are unable to get SEC comfort, the agreement with the UAW
provides that the parties will negotiate in good faith to reach an acceptable
alternate arrangement and if no such arrangement is agreed, the existing
tentative arrangement will be void. Whether settlement treatment or negative
plan amendment treatment is applied, the effect will not be reflected in the
automakers’ financial statements until 2010 when the VEBAs assume the
benefit obligations. Given the structure, substantive negative plan amendment
treatment is more likely. Under negative plan amendment treatment the
liability shown on the automakers’ balance sheet beginning in 2010 will be
based on the present value of (i) the notes issued to the VEBAs and (ii) the
future VEBA funding payments. The liability will decline when the note is
paid and when funding payments are made. GM estimates, for example, that
its OPEB liability will be $6B-$13B in 2010 and will decline to $2B-$9B by
the time its convertible note has matured.
The VEBA deal is also conditioned on reaching a court-approved settlement
with the retirees. If court approval of the arrangement is not obtained by
January 1, 2010, the VEBA transfer will be delayed until a settlement is
approved.
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E.
The VEBAs: Each of the Big Three automakers negotiated separate CBAs with
the UAW. Each will have its own separate VEBA, but the papers suggest that
one consolidated VEBA could be formed if the UAW prefers. If so, the assets
and liabilities of each automaker will still be segregated.
In connection with benefit plans negotiated and administered by a union but
funded by an employer, the Taft-Hartley provisions of the NLRA typically
require that the board of trustees of the plan comprise an equal number of
employer and union representatives. NLRA § 302(c) states that “[i]t shall be
unlawful for any employer… to pay… or agree to pay… any money or other
thing of value… to any labor organization… which represents… employees of
such employer.” NLRA § 302(c)(5) offers an exception for the contribution of
cash or other assets to a trust fund established for the sole and exclusive benefit
of the employees of an employer, and their dependents, provided, that certain
conditions are met, including a condition requiring that the employer and
employees are equally represented in the administration of the fund. However,
apparently, an exception has been recognized that permits a union-sponsored
benefit plan to satisfy this requirement without necessarily having employer
representatives serve on the board, provided that the board has a sufficient
complement of independent members. It appears that the Big Three VEBAs
will use this approach. The UAW has expressed a desire that the automakers
nominate company representatives to serve on the VEBA committees, but it
seems that the accountants for the automakers are concerned that this might
jeopardize the automakers’ ability to achieve the preferred accounting
treatment. Therefore, it is contemplated that the automakers will only place
representatives on the board of trustees if the accountants and the SEC
conclude that this will not affect the accounting treatment. If the accountants
or the SEC conclude that it would affect the accounting treatment, then the
board of trustees will consist of a majority of independent members (e.g., the
board would be 3 union officers and 4 independents appointed pursuant to
rules established under the VEBA).
F.
Securities Law Issues. Neither the notes to be issued to the VEBAs nor the
shares that would be issuable on a conversion of the notes will be issued to the
VEBAs as part of a registered offering under the Securities Act of 1933 (“’33
Act”). Accordingly, the notes and shares will be restricted securities for ’33
Act purposes. The VEBA trustees will have to consider the resale limits
imposed under the terms of the notes (described above) and the appropriate use
of the registration right provided. But, generally speaking, the GM and Ford
VEBAs will have three possible methods available for selling the notes/shares,
while the Chrysler VEBA will only have the second and third alternatives
below, at least until there Chrysler goes public again:
1.
In the case of GM and Ford, registered offerings pursuant to the
registration rights. As noted, GM and Ford have each promised their
VEBAs demand registration rights to register and sell approximately one
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half of the note/shares in a single registered offering in any year. The GM
and Ford VEBAs also have piggy-back rights to sell into any registered
offering by the automakers.
V.
2.
One or more private sales pursuant to the so-called § 4(11/2) exemption
under the ’33 Act (i.e., a private sale to one or more sophisticated private
investors).
3.
One or more unregistered resales into the market pursuant to the Rule 144
safe harbor under the ’33 Act. The constraints imposed on market resales
pursuant to Rule 144 depend on whether the VEBAs are considered
underwriters, i.e., affiliates, of the issuers for purposes of the ’33 Act and
Rule 144. It is always risky to analyze these issues from 500 paces, but
taking the GM convertible note, for example, at least until the note
becomes freely convertible it would seem that the GM VEBA should not
be regarded as an affiliate of GM, based on the fact that the VEBA will
exist solely for the benefit of its members and will neither control nor be
controlled by GM (although the public documents do suggest that GM
representatives might serve on the VEBA board of trustees at the UAW’s
request if this will not negatively impact the accounting result). For as
long as the GM VEBA is respected as a non-affiliate of GM, Rule 144
would permit the VEBA to resell the notes/shares in regular market
transactions, without any volume limit, any time after the notes have been
held by the VEBA for at least six months. The GM note is convertible
into approximately 109 million GM shares (based on $40 per share
conversion price), which represents approximately 20% of the currently
outstanding shares of GM. Thus, unless the VEBA sells down the note, it
is possible, if not likely, that it will be regarded as an affiliate of GM if
and when the note becomes convertible. In this case, sales by the VEBA
in reliance on Rule 144 will be subject to the volume limits under Rule
144 (i.e., sales in any 3-month period are limited to the greater of 1% of
outstanding class or the weekly trading volume, subject potentially more
liberal limits for the notes/debt (as opposed to shares)).
ERISA
A.
Contribution of Employer Securities. Both ERISA and the Code prohibit the
sale or exchange of property, including securities, between a plan or VEBA
and an employer whose employees participate in the plan or VEBA, unless the
conditions of ERISA § 408(e) are satisfied.
It is settled law that an employer’s contribution of property to a pension plan in
satisfaction of the employer’s funding obligation with respect to the plan is a
“sale or exchange” for these purposes. By the same token, a transfer of
property by an employer to a union VEBA in exchange for the VEBAs
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assumption of employer liabilities would presumably be treated as a sale by the
employer to the VEBA.
In addition, whether or not the transfer of securities to a VEBA involves a
prohibited transaction, ERISA places a more general prohibition on any
acquisition or holding by a plan of securities issued by an employer whose
employees are covered the plan (or by an affiliate of the employer), unless the
conditions of ERISA § 408(e) are satisfied.
ERISA § 408(e) exempts the acquisition and holding of employer securities by
a plan if:

the employer securities are “qualifying employer securities,”

the plan pays no fee or commission in acquiring the securities,

the plan pays no more than adequate consideration for the securities,
and

as of the moment immediately following plans the acquisition of any
employer securities not more than 10% of the plan’s assets are invested
in employer securities and employer real property collectively (subject
to a limited exception for individual account plans (e.g., 401(k) plans
and ESOPs).
Qualifying employer securities include:

stock, provided that immediately following each acquisition of shares
of the stock by the plan not more than 25% of the stock class
outstanding is held by the plan and at least 50% is held by persons
independent of the issuer, and

obligations (i.e., debt) provided that immediately of any such debt
interests following the acquisition by the plan not more than 25% of the
debt issue is held by the plan, at least 50% is held by persons
independent of the issuer and not more than 25% of the assets of the
plan are invested in obligations of the employer or an affiliate of the
employer.
In the case of the proposed Big Three VEBAs, the notes contributed by
automakers will exceed the basic 10% limit on employer securities (i.e., 10%
of the VEBAs total assets). In addition, the notes might not be qualifying
employer securities (i.e., the notes might not be held by other investors
independent of the issuer and might exceed 25% of VEBAs assets).
Accordingly, the automakers will have to obtain an individual exemption from
the U.S. Department of Labor (“DOL”) to permit the VEBAs to acquire and
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hold the debt securities that will be contributed by the automakers. Similar
exemptions have been issued in the past by the DOL, but these exemptions
have involved employer stock, rather than debt securities. In addition, as noted,
the notes to be issued to the Big Three VEBAs include features such as call
rights, rights of first offer and voting restrictions. Accordingly, it is doubtful
that the automakers will be able to use the expedited exemption procedure
under Prohibited Transaction Class Exemption 96-62, but they have time to go
through the regular process, since the notes will not be transferred to the
VEBAs until 2010.
Prior DOL exemptions have imposed a number of conditions on the terms and
administration of the employer securities contributed to the relevant plan. A
typical condition is that the plan be represented by an independent fiduciary in
matters relating to the employer securities. The proposed design of the Big
Three VEBAs calls for each to have a board of trustees composed of a
minority of union representatives and a majority of independent representatives.
This satisfied the DOL in the case of the Navistar exemption (1993). Although
the UAW has requested that the Big Three automakers appoint company
representatives to serve on the VEBA boards, even if this would not adversely
affect the accounting result, the DOL might not permit this or might require
that an outside fiduciary be given authority over the employer securities.
B.
More General ERISA Issues. Stepping back from the per se prohibited
transactions that might be implicated by the contribution and holding of the
employer securities by the Big Three VEBAs, there is the more general
question of whether any of the fiduciary rules of ERISA are implicated by the
elements of the agreements struck by the automakers and UAW (e.g., the
automakers’ transfer of the benefit obligations, the consideration promised to
the VEBAs, the conditions and limitations on the voting, resale and tender of
the contributed securities). Separately, there is the ongoing administration of
the VEBAs and fiduciary issues and standards that will apply there (e.g., the
investment decisions, decisions regarding the benefits to be provided and the
arrangements to provide those benefits (insurance, etc.)). The VEBA trustees
will have to engage advisors to help them make a variety of decisions, from
long-term benefit design decisions to day-to-day investment decisions. In both
the initial agreement and the ongoing administration of the VEBAs it might be
difficult to discern a clear line between fiduciary decisions that are subject to
ERISA’s fiduciary rules and settlor decisions that are not subject to the
fiduciary rules. But, in any case, it would seem that the process has and will
continue to be one infused with adequate independence and prudence on the
employee side so as to avoid any ERISA fiduciary implications.
C.
The Temporary Asset Accounts. The notes and a portion of the cash to be
contribution to the VEBAs will be funded immediately and held in the
automakers’ Temporary Asset Accounts (“TAAs”) until these assets are
transferred to the VEBAs on January 1, 2010. The automakers will seek to
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ensure that the assets will not be considered plan assets subject to ERISA while
held in the TAAs prior to transfer to the VEBAs. ERISA does not identify
when assets become “plan assets” subject to ERISA. In seeking to identify the
scope of ERISA’s bonding requirements, the DOL temporary regulations
under Section 2580.412-5(b) state that “contributions made to a plan . . . would
normally become [plan assets] if and when they are taken out of the general
assets of the employer . . . and placed in a special bank account or investment
account; or identified on a separate set of books and records; or . . . otherwise
segregated.” However, those regulations are not particularly germane to the
VEBA scenario at hand. DOL Advisory Opinions 92-02A, 92-24 and 94-31A
would appear to be more relevant. DOL Advisory Opinion 94-31A, for
example, states that assets set aside to fund an employer’s future obligation
under a welfare benefit plan will not constitute plan assets unless the
arrangement gives the plan a beneficial interest in the assets. The opinion
acknowledges that under ordinary notions of property rights, such assets would
become plan assets if, under common-law principles, the property is held in
trust for the benefit of the plan or its participants and beneficiaries or the plan
otherwise has an interest in such property on the basis of ordinary notions of
property rights. The DOL notes that the identification of plan assets therefore
requires consideration of any contract or other legal instrument involving the
plan, as well as the actions and representations of the parties involved. The
Big Three VEBAs will not have any control over the assets of the TAAs until
the assets are transferred to the VEBAs. In the case of the GM TAA, for
example, the agreement with the UAW specifically states that the assets of the
TAA are not intended to be regarded as plan assets under the DOL opinions,
and if GM concludes that the assets would be deemed to be plan assets, it may
apply to the DOL for any necessary exemptions from ERISA’s prohibited
transaction rules.
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