stantially similar if a plan covering salaried employees is replaced with one covering salaried and hourly workers?

And, when will plans be regarded as substantially similar? Will the doctrine be invoked if an employer replaces a final pay plan with another final pay plan, but not if a career average plan is replaced by a final pay plan? What if a plan not integrated with Social Security is replaced with one that is, or vice versa? Or, what if a step-rate integrated plan is substituted for an excess-only plan, or vice versa? If the old benefit formula was 12 percent per year for the first 25 years of service, is a replacement plan substantially similar if it provides 2 percent accruals for the first 20 years and 1 percent accurals for the next ten? Are two plans substantially similar if one has 10 year cliff vesting and the other graded vesting from 5 to 15 years of service? What if one plan offers subsidized early retirement and joint and survivor annuities and the other does not? What if one provides automatic post-retirement cost of living adjustments and the other does not? There is, in no finite limit to the ways in which one plan can differ from another. Moreover, superficially similar plan designs can produce significant differences in actual benefits, and apparently dissimilar designs can produce remarkably similar results. Will the IRS look to some factors but no others? Similarity in stated provisions or in results? Whatever lines might be drawn or distinctions made, it seems certain that the agile minds and pens of plan drafters will be able to create plans that are not "substantially similar" according to those rules, but that in fact are very much alike.

Timing is another critical element in the application of the step transaction doctrine. It is not an issue, of course, if all of the "steps" occur more or less simultaneously. If they occur five years apart, however, the transaction may not be recharacterized even if it is in all other ways identical to a transaction that would be recharacterized if everything had occurred at once. How much time has to elapse before a transaction is so "old and cold" that the step transaction doctrine does not apply? Obviously there can be no certain answer to such a question-but this very kind of uncertainty makes the doctrine difficult both for the government to apply and for taxpayers to predict.

Then there is the elusive matter of intention. A transaction will apparently not be recharacterized unless obtaining a reversion was the motive or purpose of the transaction. However even if a desire to get back surplus assets is present, a transaction would not be recharacterized if there was a substantial independent reason for it.11 What, though, is to count as such a reason?

Suppose that an employer maintaining an overfunded defined benefit plan desires to terminate the plan and institute a defined contribution plan. However, because of union resistance, the employer is forced to spin-off and terminate only that portion of the plan covering noinunion employees, for whom a defined contribution plan is subsequently established. Would the termination and replacement of the nonunion plan go unrecognized in light of the continued existence of the defined benefit plan for union employees?

Alternatively, suppose the employer, as a fundamental change in retirement income philosophy, decides to replace its defined benefit program with a defined contribution plan funded with employer stock. Further, the new plan is designed and funded so that, if the company's profits increase significantly, the annuity value of the defined contribution accounts will exceed the value to of the pensions that would have payable under the pension plan. In order to provided protection against a downturn in the stock market and to ensure that employees always get a least a minimum pension, the employer adopts a "floor" defined benefit plan. Under this plan a pension is paid to each employee equal to the amount, if any, by which the annuity value of the defined contribution account for any employee at retirement falls below a stated pension amount contained in the floor plan formula. Does an employer who changes its retirement program in this fundamental way risk having a District Director determine that the prior pension plan was never "really" terminated?

Or, to take another example, suppose that an employer terminates a defined benefit plan in order to get the surplus, and replaces it with a defined contribution plan.

11 Apparently, a desire to use surplus assets to stave off bankruptcy or to build a new facility is not to be allowed as a "substantial independent reason," though why this so is not entirely clear. And, what if a pubicly traded company that must reflect surplus plan assets in its financial statement justifiably fears that it will be the target of a hostile takeover bid that will be financed out of the surplus assets if the bid succeeds (because the takeover company will have no compunction about terminating a defined benefit plan and replacing it with a defined contribution plan). Would the target company be acting out of a permissible or an impermissible motive if it sought to get the surplus out to avoid a takeover, but wanted to continue to maintain a defined benefit plan for its employees?

Suppose that the investment performance under the defined contribution plan does not live up to expectations and that the company has difficulty hiring and retaining key employees, in part because most of its competitors maintain defined benefit plans. For these reasons, the employer freezes the defined contribution plan and readopts a defined benefit plan. Will this cause the initial termination to be retroactively disregarded? What if service credit for benefit accrual purposes is given back to the date of the initial termination? What if the defined contribution plan is retained but a floor plan is added?

What if a defined benefit plan is terminated in a bankruptcy proceeding, either by agreement between creditors and the debtor in possession or at the direction of the trustees in bankruptcy, so that the surplus can be used to restore the company to financial health? Suppose again that the company emerges from bankruptcy and, as its first act, the new management adopts a defined benefit plan. Suppose even that it was known at the time of the termination of the old plan that the new management would install another pension plan.12 Could the step transaction doctrine be successfully applied in a case like this?13

Finally, the Service would be forced to determine in some instances whether the doctrine will apply where an employer is able to obtain the cash value of surplus assets without terminating a plan. Suppose that company A acquires company B at a price below the fair market value of company B because it agrees to assume responsibility for company B's underfunded pension plan. The plans of A and B are then merged and virtually all of the surplus of the original A plan is absorbed by the underfunded liabilities of the company B plan. Suppose then that company A liquidates company B (thereby terminating all of the company B employees and vesting any unvested benefits for them in the merged plan), and sells company B's assets for a price equal to their fair market value. Company A has effectively, albeit indirectly, obtained the value of the surplus of an ongoing plan without terminating either plan, yet the transaction would seem unasasilable.

The foregoing examples only begin to suggest the innumerable difficult decisions that District Directors would be required to make. Because all such judgments could not possibly be covered by general principles promulgated in Treasury regulations or directives from the National Office, the result would be haphazard and unpredictable determinations at the District Director Level. Finally, and worst of all, the step transaction doctrine would be, not so much an impediment to abusive transactions, as an inducement, and even a reward, for cunning, artifice, and indirection. -In fact, if the doctrine of substance over form were adopted Treasury and IRS and upheld by the courts, the only clear and unassailable choice for an employer would be to terminate the defined benefit plan and switch to a defined contribution plan, or no plan at all, in order to recapture the pension surplus free of any penalty. The rash of pension plan terminations followed by adoption of defined contribution plans that would almost surely ensue would be a major blow to sound federal retirement income policy. Moreover, the employees most affected would be older participants and those least able to protect themselves. Older participants would be at risk during their final years that a sharp market decline would erode their benefits for those years, yet would not be able to benefit from the "old and cold" rule that would let the employer reinstate a pension plan after a period of years had passed. Strongly organized employees might well be able to preserve their pension benefits through collective bargaining, albeit at the cost of other things they might have had, whereas nonunion or more weekly organized employees might not be able to resist employer's an determination to change to a DC.

3. Conclusion.-Any attempt to administer the recharacterization doctrine in a consistent and even-handed manner in the pension plan area would be an exercise in frustration. Application of the doctrine will inevitably produce inconsistent results and may in some instances unfairly penalize legitimate transactions. The ultimate effect will be to deter the formation or sound funding of defined benefit plans or to encourage employers to engage in increasingly complex and devious maneuvers to avoid application of the doctrine.

12 Here, as in all these cases, the evidentiary problem would be severe. If, as the old maxim of the common law has it, the Devil knoweth not the mind of man, how much more inscrutable is the "intention" of a corporation.

13 This problem could of course arise not only in the context of bankruptcy proceedings, but wherever a change of management occurs in connection with a plan termination.

To assess the financial status of the companies on the tape that terminated defined benefit plans, we computed liquidity, asset, efficiency, profitability, leverage, and market ratios for each company for ten years. We also did trend analyses using ten years of data for earnings per share, net profit to common, net sales, dividends per share, average market price, book value per share, and cash flow per share.

Key results from our analysis are reported in Tables 4 and 5. Table 4 shows the current ratio, return on common equity, and cash flow per share for each company for 1979-1982. These traditional measures of short-term solvency, profitability, and cash flow, indicate that seven of the companies had a weak financial position. The seven companies (identified by asterisks) are Bobby Brooks, Continental Airlines, Fedders, Sharon Steel, Superscope, Western Airlines, and Whitaker Cable. When the full set of financial ratios was considered, Gino's and Questor (also identified by asterisks) also appeared to be performing poorly. The financial performance of the remaining companies was comparable to the performance of other companies operating in the same lines of business.

The results of the ten year trend analyses, reported in Table 5, show that the earnings per share and market performance of the poor performers identified in Table 4 tended to be negatively correlated with time. In other words, the financial condition of the companies appeared to be deteriorating over time.

For the remaining twelve companies, the plan terminations do not appear to have been motivated primarily by the poor financial condition of the employer sponsoring the plan. Although not conclusive, this suggests that some employers may not view their pension commitments to be as binding or as long-term as is generally assumed in the accounting literature.

8 Bank of New England, Chemetron, Cook Paint & Varnish, Houdaille, and Merchants Inc.

were included on the tape but had insufficient data for analysis.

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