Part I:

This section focuses on the period before the merger or acquisition closes. Part II of this series covers the work to be done after the closing of the transaction.

The starting point is to understand the different types of M&A arrangements. Generally speaking there are two broad categories.

• A stock acquisition - There are two general types of stock acquisitions:
  • A merger: In this case, two corporations merge together, with one being the surviving entity. In a merger, the 401(k) plans of the two entities automatically become the plans of the surviving entity.
  • An acquisition of a subsidiary: In this case, the Buyer acquires the stock of another corporation (the Target) and the Target becomes part of a controlled group with the Buyer.
• An asset acquisition - There are two type of asset arrangements:
  • Purchase of all of the assets of the Target and the Target corporation terminates all of its employees and stops doing business
  • Purchase of only some of the assets of the Target and the Target corporation continues in business

The next step is to understand the 401(k) consequences of those arrangements.

• Stock acquisitions: mergers and subsidiaries - When two companies merge or one company acquires another as a subsidiary, the 401(k) plan of the acquired company, the Target, automatically (that is, by operation of law) becomes a plan of the new controlled group (in the case of the purchase of the stock of a company that becomes a subsidiary), or of the surviving corporation in the case of merged companies. In effect, that means that the Target’s 401(k) plan is now treated as if it’s sponsored by the Buyer.
  

  However, in some cases the Buyer does not want to be responsible for the Target’s 401(k) plan. This could be because one effect of the “automatic” transfer of the Target’s plan is that any issues related to the plan are assumed by the Buyer. Those issues could include possible tax qualification problems, potential fiduciary liability, and protected benefits in the Target’s plan that the Buyer does not want to administer.
  

  In this case, the Buyer will want to negotiate that the Target company terminate its 401(k) plan before the closing of the transaction. For this purpose, “terminate” means that the Board of Directors of the Target adopt resolutions terminating the plan before the deal closes. The actual distributions can occur after the closing.

• Asset acquisitions - The purchase of assets of a Target company can involve all of the Target’s assets or just the assets of one of the Target’s businesses.
  • In both cases, the Buyer will not ordinarily acquire the plan of the Target
  • If the Buyer acquires all of the assets of the Target company, the Target will likely stop doing business, and will terminate and distribute its 401(k) plan
  • If the Buyer acquires only some of the business assets of the Target, the Target will ordinarily continue to operate with its remaining businesses and will continue to sponsor its 401(k) plan for the employees who work for the retained businesses. In that case, the Buyer would not acquire the plan.

Depending on the arrangement, the role of a 401(k)’s financial professional will vary:

• Merger or stock acquisition - Where the plan of the Target will be terminated before the closing, the financial professional for the Target plan should help with the termination of the plan and the distribution of the plan’s benefits. This will require coordination with the plan’s service providers (e.g., the recordkeeper).
  In some cases, though, the Buyer will agree to sponsor the Target’s 401(k) plan after the closing of the transaction. In that case, there will not be much involvement by the financial professional for the Target’s plan, unless the financial professional will be retained to work with the plan after the closing.
  Most of the work for the financial professional for the Buyer’s plan will be after the closing.
  
• Asset acquisition of all of the business assets of the Target - In this case, the Target doesn’t usually continue in business, and the Buyer typically doesn’t acquire the 401(k) plan of the Target. As a result, the Target company will ordinarily terminate and distribute its plan. The financial professional for the Target will need to help prepare for that, for example, by alerting the plan fiduciaries to any issues to be considered (e.g., any investments that are hard to liquidate, or that may have surrender charges or adjustments or other impediments to liquidate) and to coordinate with the plan’s other service providers (e.g., the recordkeeper). Since substantially all of the work is for the Target’s plan, the financial professional for the Buyer’s plan will usually not be involved at this stage. 
  However, in some cases, the Buyer may permit the direct rollover of benefits from the Target plan to the Buyer’s plan upon participant request. In that case, the financial professional can work with the Buyer to make sure that the Buyer’s plan accommodates direct rollovers of that type and that the recordkeeper is prepared to accept them. 
  Since the Target terminates all of its employees on the closing date (and then the Buyer hires the employees that will continue with the business), the Target’s plan will be terminated for purposes of the Internal Revenue Code, and the benefits in the plan will become fully vested. The financial professional for the Target plan should alert the Target to that outcome.
  
• Asset acquisition for only some of the assets of the Target - When the Target company sells only some of its business assets, the Target usually continues to operate its remaining business. As a result, it continues to sponsor its 401(k) plan for the remaining employees. The participants transferred to the Buyer can leave their benefits in the Target’s plan or take distributions from the plan, or, if permitted by the Buyer’s plan, the transferred employees can transfer their benefits in a direct rollover to that plan. The financial professional for the Target’s plan can educate the Target’s plan committee and benefits personnel on these alternatives and coordinate with the recordkeeper to help facilitate the roll overs.
  Concurrent with the closing, the Target company will terminate the employees who worked in the business unit that is being sold. As a result, there is the potential for a partial termination that would require full vesting of the affected accounts. The financial professional for the Target plan should alert the Target plan committee and benefits personnel of that possibility and, if there is a concern, a plan consultant or recordkeeper should perform the calculations necessary to determine if a partial termination will occur.
  If the participants in the Target plan will be allowed to directly roll over their benefits to the Buyer’s plan, the financial professional for the Buyer’s plan should work with the plan committee and service providers to arrange for an orderly transfer and reinvestment of the money.

 

Conclusion

From the perspective of 401(k) financial professionals, most of the M&A pre-closing work is for the Target’s plan. However, that changes after the closing. Part II describes that work. 

 

PART II:

This section discusses the post-transaction issues of importance to 401(k) financial professionals. As with the pre-closing considerations, the issues for financial professionals will vary depending on the type of transaction:

 

Post-Transaction Work for Mergers

Before the closing of the transaction, one of two decisions was made about the acquired (Target) company’s 401(k) plan. That is, a decision was made either to terminate the Target’s plan before the closing or to maintain that plan after the closing. Stated differently, if the Target plan is not terminated before the closing, the merger will automatically transfer sponsorship of the plan to the Buyer. Because of technical rules in the Internal Revenue Code, if the Buyer already sponsors a 401(k) plan, it cannot then terminate the Target’s 401(k) plan and distribute its deferral accounts. (Internal Revenue Code section 401 (k)(10)(A); Treasury Regulation section 1.401(k)-1(d)(4).

If the Target’s plan is terminated before the closing (e.g., a terminating resolution was adopted by the Target’s Board of Directors, effective before the transaction), the plan will need to be wound down and distributed in an orderly fashion. The winding down and distribution can be done by the Buyer, so long as the plan was “terminated” before the closing. In most cases in which the Target’s plan is terminated pre-closing and distributed post-closing, the participants in the Target’s plan will be allowed to directly roll over their benefits to the Buyer’s 401(k) plan. In this case, the Buyer’s plan is free from any concerns about protected benefits in the Target plan, and there is a straightforward process for avoiding the taint of any unknown disqualifying defects in the Target plan.

The financial professional for the Buyer’s plan can help coordinate the rollovers with that plan’s service providers, including the recordkeeper. In addition, the financial professional will need to help the plan committee make decisions about how to invest any rolled over money when a participant does not make an election (for example, should the plan’s default option be used). The financial professional can coordinate with the plan’s lawyers and service providers to ensure that the plan document has provisions that permit those rollovers.

In a corporate merger scenario, the employees of the Target company are automatically credited with their service in the Buyer’s 401(k) plan (e.g., for purposes of eligibility and vesting) since the merged company is considered to be a continuation of their employment with the Target company. Nonetheless, it would be a good practice to amend the plan and the communications materials to specify that result.

If the Target plan is not terminated before the merger, it will automatically become a plan sponsored by the Buyer after the merger. As a general rule, it would need to satisfy the coverage and discrimination requirements, in combination with the Buyer’s other plans, for annual testing. (One exception would be if the newly acquired business satisfied the criteria to be a Separate Line of Business, or SLOB. The SLOB testing rules are complicated and beyond the scope of this article. Suffice it to say, though, that those rules are complicated and are not easy to satisfy).  However, there is relief from the coverage and testing requirements for the year of the merger and the following year. (A special transition period under Internal Revenue Code section 410(b)(6)(C)). During that time, the Buyer can decide whether to merge the plans or whether to continue to operate them individually (and perform the required testing).

If the plans are to continue to be operated separately (and during the special transition period), the Buyer will need to decide whether the financial professional for the Target plan should continue to work with that plan, or whether the plan should be transitioned to the financial professional for the Buyer’s plan. As a practical matter, many companies prefer to have their financial professional take over the acquired plan (because of a desire to have consistent practices with their existing financial professional).

On the other hand, if a decision is made to merge the plans, the Buyer’s financial professional should become involved very quickly. That is because the merger of plans is a lengthy process that often involved an RFP for recordkeepers, and the Buyer typically wants to complete the plan merger within the special transition period. In addition to deciding on the service providers for the combined plans, the financial professional should assist the plan committee in revisiting the investments for the combined plan, including the qualified default investment alternatives (QDIA). In some cases, the combination of plans may result in sufficient assets for the plan to qualify for lower cost share classes or collective investment trusts.

 

Post-Transaction Work for Subsidiary Scenario

The post-transaction issues for acquisition of a subsidiary are much the same as for a merger. If the subsidiary (Target) plan was not terminated before the closing of the acquisition, the subsidiary will be part of a controlled group, and the plan will be subject to coverage and discrimination testing (unless it qualifies as a Separate Line of Business). However, similar to a merger scenario, the plan is not required to satisfy the coverage and discrimination rules until the end of the year following the acquisition. Of course it must satisfy the qualification requirements as a stand-alone plan, for example, the ADP and ACP tests.

If the plans of the subsidiary and the Buyer are merged, the issues are virtually the same as for the corporate merger scenario. However, there is one important difference. That is, the surviving plan should be reviewed to determine if it automatically includes the employees of the subsidiary or if it needs to be amended to do that. Surprisingly, this straightforward issue is often overlooked.

 

Post-Transaction Work for Acquisition of All of the Assets of the Target

As described in 401(k) Issues After a Merger or Acquisition, when all of the assets of a company are acquired, the Target company ordinarily terminates its plan and distributes the benefits to its former employees. While the Buyer may not allow the plan to be merged with its plan (e.g., due to concerns about possible qualification defects, administration of protected benefits, or fiduciary liability), it often allows the newly acquired employees to directly roll over their benefits from the Target plan into the Buyer’s plan. The financial professional for the Buyer’s plan can help with this process by coordinating with the Target plan’s recordkeeper and keeping the plan committee informed of the issues and status.

A significant issue that is often overlooked is whether the Buyer intends to credit the newly acquired employees with their service with the Target. It is a common practice to do so, but this is sometimes overlooked. If the Buyer decides to credit the past service of the acquired employees, the plan document should be amended to state this.

 

Post-Transaction Work for Acquisition of Some of the Assets of the Target

In this scenario, the Buyer acquires the assets of only one of the businesses of the Target, and the Target continues with its remaining businesses. Since the Target company stays in business, it will continue to sponsor its 401(k) plan for its remaining employees. However, the Target will have terminated the employees in the line of business sold to the Buyer, and those employees will have severed from employment with the Target, entitling them to distribution of their benefits. In this case, the Buyer’s 401(k) plan will ordinarily accept rollovers for those employees from the Target’s plan.

The financial professional for the Buyer’s 401(k) plan should alert the Buyer’s plan committee and benefits personnel, and help them coordinate with their plan’s recordkeeper. In addition, the committee, financial professional, and recordkeeper should consider a communications campaign to reach out to those new employees about their opportunity to roll over their benefits.

The financial professional can also educate the Buyer’s benefits personnel and plan committee about the need to amend the plan to grant past service credit for the newly acquired employees, if that is their intent.

 

Concluding Thoughts

When a Buyer acquires assets of a Target company, the Target’s plan is usually not acquired. As a result, the role of a financial professional is administrative, in the sense of educating the plan committee and benefits personnel on issues for them to consider and resolve. Those include whether to encourage direct rollovers from the Target plan and whether to amend the Buyer’s plan to credit past service for the acquired employees.

However, a corporate merger or acquisition of a subsidiary often involves the merger or continuation of an acquired plan. If the acquired plan is merged into the Buyer’s plan, this can result in a significant increase in the assets in that plan. In turn, that can mean that the investment lineup and the service providers of the combined plan should be evaluated and a Request for Proposal could potentially be used to decide if improved services and lower costs can be obtained as a result of the increase in assets. The Buyer’s financial professional can be an invaluable part of that process. On the other hand, if the acquired plan will continue to operate as a separate plan, the financial professional can help with the evaluation of the investments, services and pricing of that plan. In most cases, the Buyer will want their financial professional to help with that review and to provide consulting services going forward.