The 1980 Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or ‘Superfund’) was enacted to address the most polluted properties in the United States. It forced the polluters or their successors (Potentially Responsible Parties (PRPs)) to manage and pay for the remedial activities. Some projects have hundreds of PRPs and cost hundreds of millions of dollars to cleanup. Typically, the PRPs form a group (Group) to manage the process, including collecting funds and establishing a trust to pay for the remedy. In many cases, this fund will grow to a significant size and will need an experienced, investment professional to maximize the fund’s potential. In this series of articles, EHS Support LLC will discuss the importance of determining Group operating parameters/preferences and investing/managing PRP Group funds in order to maximize the benefits for all stakeholders.
Privately-led Superfund projects can build sizable Trust balances through PRP allocation contribution, individual party buy-outs, and insurance recovery. However, typical PRP group members/representatives have excellent technical, business, or legal backgrounds but lack the necessary financial knowledge to efficiently manage the Trust. The funds often are placed into a low-or no-interest bearing checking account. While this may be a conscious decision, the Group sacrifices significant earning potential. Further, Groups tend to be led by the PRP with the highest allocation share (responsibility). These ‘major’ parties normally default to their internal company policies with regards to operations and finances. But investing funds related to a Superfund site cleanup is different than managing company assets, thus utilizing familiar financial providers and procedures will unlikely result in optimum results. Simply put, one cannot manage a PRP fund like a widget company manages its assets.
There are three entities involved in managing PRP funds: the PRP group (including counsel), the Fund Manager, and the Financial Advisor. The PRP Group has the ultimate responsibility and authority for the funds and therefore needs to determine their operation preferences when initiating a group account. Without proper forethought, PRP representatives will typically default to business unit investment strategies for these remediation project trust funds. Unfortunately, these procedures result in cumbersome and underperforming finances. The PRP groups should consider the operational constraints of the Fund Manager and investment advice of the Financial Advisor prior to making investment decisions.
Fund Managers collect assessments, pay the invoices, and prepare statements. Easy access to information, liquidity of necessary funds, and multiple payment/receiving options are keys to quick and effective (read: least costly) fund management. Financial Advisors need accurate cashflow estimates and client preferences for planning purposes. PRP Groups need to clearly and concisely convey their requirements, including tax implications, frictional costs threshold, risk tolerance, required investment return, and FDIC guarantees, among others. All three parties must spend time at the beginning of the fund management discussion to understand the mutual working constraints and implications of each other’s decisions. Creating an Investment Policy Statement (IPS) early in the process will keep interests aligned and provide guidance throughout the engagement.
Group Parameters and Desired Outcomes
PRP Groups with qualified settlement funds or trusts which exceed the immediate operational costs, should prioritize their desired investment outcomes. There are several factors to consider, including:
- Taxes – Are the members of your Group comfortable receiving a 1099 form at year end? Many Groups do not wish to be encumbered by tax implications and thus default to a non-interest bearing account to hold funds and pay invoices. While not recommended for large sums, it is less expensive to manage and will not require involving each party’s accounting staff for tax treatment.
- Investment return – Does the Group need to maximize the investment return in order to fulfill site obligations? Were some settlement payments made at a discounted rate that must be achieved? Has the project cost estimate changed and additional funds are now required to complete the scope? Have some PRPs gone out of business, thus leaving their financial share to be divided among the remaining Group members? These are just a few reasons why the Trust must work for the Group.
- Downside protection – Are the Group funds sufficient to meet site obligations with the minimum return so the desire is to protect against the market downturn or credit quality of the investment vehicle? Some investment options can be protected by the FDIC but understanding the pros and cons of these protections are important.
- Reduced frictional costs – Fund management is not inexpensive. Complicated or uncoordinated investment vehicles that do not mesh with Fund Manager operations will quickly incur additional labor charges.
- Access to information – Is the Group willing to incur more charges for increased investment return? How often does the Group want reports? What detail does the Group want? These will also affect cost. The Financial Advisor can provide input on different access options.
- Liquidity – PRP Groups have a litany of invoices to pay on a regular and irregular basis: service providers (contractor, consultants), financial assurance, insurance, regulator invoices, etc. Quick access to funds via multiple avenues assists Fund Managers and reduces frictional costs.
- Data Access – Access to a visual dashboard is another tool Fund Managers use to communicate with Groups or individual PRPs. Instant access to data also assists Fund Managers to estimate and prepare statements and assessments, if needed.
- Flexibility – All the parties involved can benefit from investment flexibility, i.e., the ability to change course if the project needs or the economic winds are in flux. The Financial Advisor should explain the upside of flexibility and the downside of fees to the Group.
- Group restraints – Occasionally, a Group member will cite company ‘policy’ which may restrict placing Group funds in perceived ‘risky’ investment options. These policies of a single party can hold hostage the entire PRP Group. It is highly recommended that the initial Group escrow agreement make very clear which investments are available to the Group. It is further recommended that the agreement provide latitude to the Fund Manager/Trustee/Financial Advisor in order to meet Group needs.
Selecting the Financial Advisor
There is no shortage of Financial Advisors in today’s market. However, a PRP Group should select their Financial Advisor based on the characteristics they feel are most important. Some basic Financial Advisor characteristics are:
- Experienced with CERCLA and PRP Groups – PRP Groups can be fickle and often have internal competing interests. Further, the somewhat unpredictable cash flow patterns resulting from environmental remediation projects need to be addressed in the investment portfolio. A Financial Advisor with CERCLA experience will understand Group dynamics and anticipate the issues specific to these engagements.
- Transparent and predictable – Fund Managers collect accounting and investment data to distribute to the PRP Groups. When multiple parties are reviewing documents, nothing will go unseen. Financial Advisors must be able to communicate the portfolio performance in simple yet complete terms. The Groups must have the confidence there are no hidden fees, limitations on liquidity or undue risk being taken in the portfolio.
- Competent and consistent – The Financial Advisor must demonstrate adherence to conservative investment thesis with an emphasis on principal preservation. They must show a history of creating income streams and cash management expertise. Further, the Financial Advisor must be proficient in developing and adhering to an IPS which is the blueprint for investing assets without increasing Group expenses.
Getting to Work
A disciplined approach is crucial to achieving the Group’s goals. The Group will benefit from a proven planning process that analyzes the site’s full financial picture and constraints and results in a customized plan that is designed specifically to meet the Group’s goals. At a minimum, the selected Financial Advisor should perform the following steps:
- Listen to understand the Group’s goals.
- Act as a liaison for the parties involved with the site
- Act as fiduciaries and assist the Group to understand risk and return objectives, including an explanation of the downside risk and worst-case scenarios.
- Develop customized investment solutions tailored to the site’s objectives.
- Provide a documented methodology for the portfolio. Establish and maintain a comprehensive IPS to document all processes and procedures that will be used to manage the portfolio.
- Analyze the site’s financial information and constraints to match objectives with strategies, then illustrate the expected risk and return.
- Analyze, recommend, and optimize the portfolio to better align with the site’s specific investment objectives.
- Review fund results regularly to ensure the site’s objectives are being met.
- Communicate with the Groups representatives and Fund Manager with both verbal and written documentation (i.e., minutes, quarterly reports, quarterly investment commentaries) regarding performance monitoring and benchmarking.
- Adjust the investment strategy as needed to achieve the Group’s goals.
Managing PRP funds is a unique endeavor that requires preparation, patience, and flexibility. To achieve the best outcome, groups should seek out Fund Managers and Financial Advisors with CERCLA experience. All parties should set expectations and communicate regularly to avoid unexpected results. Individual members need to recognize and accept the differences between corporate and Superfund financial management and employ best practices, not necessarily familiar and comfortable processes.
The next article in this series will discuss specific investment options to match particular Group parameters.