Governance is a hot topic in the pension arena as well as in corporate boardrooms. Increased litigation, institutional shareholder activism, the impact of pension plans in capital markets and greater awareness of plan members and beneficiaries all point to the need to document and implement good governance practices. Pension plan governance can be viewed as the process by which a plan administrator or sponsor discharges its legal obligations. Sources of those obligations include statute and common law concepts, such as fiduciary duties, tort law (especially, negligence) and contractual obligations. From a legal perspective, good governance reduces the risk of a plan administrator or sponsor being subject to legal liability in maintaining a pension plan.
The Legal Framework
Provincial and federal legislation generally impose primary legal responsibility on the employer that maintains the plan in the administration and operation of such plan and its related fund. For a corporate employer, this generally means that ultimate legal responsibility rests with the board of directors of the employer.
The federal legislation, for example, requires the administrator of a pension plan to exercise the degree of care in the administration of the pension plan that a person of ordinary prudence would exercise in dealing with the property of another person. It also requires the administrator to use all relevant knowledge and skills it possesses or, by reason of its profession or business, ought to possess. This may impose a higher duty on more sophisticated entities who have or, by reason of their profession or business ought to have, certain knowledge and skills that are pertinent to the administration of a pension plan and/or the investment of a pension fund. The Ontario legislation imposes similar standards.
Over and above the statutory requirements, the sponsor/administrator of a pension plan may also be subject to general fiduciary duties under the common law. Typical plan administration and investment matters falling within fiduciary obligations include the investment of plan assets, calculation and paying of correct benefit payments, proper remittance of contributions, appropriate communications to plan members, and compliance with the law and terms of the plan.
The courts have also been prepared to impose liability on plan administrators on the basis of negligence, especially where communications were found to be erroneous or incomplete, and the plan member reasonably relied upon them to their detriment. Further, it is also possible for a plan sponsor/administrator to be liable for breach of contract with respect to the administration of a pension plan.
Although statutes and common law do impose duties relevant to the establishment and implementation of pension governance policy, the scope and specific requirements of a pension plan governance process are not comprehensively codified in any statute.
The Regulators’ Perspective
In 1998, the Office of the Superintendent of Financial Institutions ("OSFI") produced a Guideline for Governance for Federally Regulated Pension Plans. While this guideline was specifically targeted at federally regulated plans, the general duties imposed on plan administrators under provincial pension standards legislation are similar. According to OSFI, the following principles underline good governance of pension plans:
- Clearly stated objectives
- Independence of the governing body from the plan sponsor(s)
- Separation of governance from operations, clearly defined roles and responsibilities
- Accountability and internal controls
- Adequate knowledge and skill sets
- Due diligence in decisions and supervision of delegated work
- Controls for expenses and protection from conflicts of interest
- Transparency and full disclosure.
In 2000, OSFI again commented on plan governance and enumerated six governance principles:
One. Pension plans should have a clear mission statement.
Two. Pension plans have a primary fiduciary duty to plan beneficiaries.
Three. Responsibilities and accountabilities should be allocated clearly.
Four. Performance should be measured and reported.
Five. Plan administrators should be qualified and knowledgeable.
Six. Governance self-assessment.
The Canadian Association of Pension Supervisory Authorities ("CAPSA") has also been working on governance guidelines that reflect the views of all Canadian pension regulatory authorities. CAPSA has released revised draft guidelines and a governance self-assessment questionnaire setting out 11 principles that include, to name a few, establishment of governance objectives, requirements for performance measures, access to information, a code of conduct and conflict of interest policy, transparency and accountability in the governance process, a risk management plan, mechanisms to facilitate oversight and ensure compliance and regular governance overviews.
These principles, which are expected to be finalized in the Fall of 2004, are being presented as a "best practices" guideline, not law. However, applicable industry standards often influence a court in determining whether a particular course of conduct should attract liability.
The Growth of Governance Audits
In the absence of specific statutory or common law governance requirements, how can a plan administrator/sponsor ensure best practices are being documented and implemented? Audits are rapidly becoming an important element of good pension plan governance. Governance audits serve three general purposes:
One. To improve the overall administration of the plan.
Two. To ensure legal compliance, including compliance with fiduciary obligations of the administrator; minimum standards requirements; and reporting obligations.
Three. To minimize the risk of legal claims against the fund, the sponsor/administrator, its officers and directors and other related entities (i.e., funding agent, service providers, etc.)
Regular governance audits help improve the overall administration of the plan in a number of ways. First, any problems with the way the plan is being administered or with any legal compliance issue can be quickly identified and appropriate steps immediately taken to remedy the problems.
Second, a governance audit forces the plan administrator to examine or re-examine issues that are raised during the course of the audit and may otherwise not be brought to its attention. For example, the audit may determine that individuals responsible for the day-to-day administration of the plan require a more thorough understanding of the plan’s terms, which is something the administrator itself may be unable to determine without the assistance of a review by an independent third party.
Third, a governance audit allows for a "fresh set of eyes" to review how the plan is being administered and suggest new ways of dealing with certain administrative issues. An advantage of having an independent auditor review the administration of the plan is that the auditor will not be wedded to current administrative practices, which might be the case if the review was performed by individuals currently responsible for the plan.
Who Should Perform The Audit?
A governance audit focuses on the actual administration, decision-making and procedural aspects of the plan’s operation. As such, an independent third party should always perform it. Typically, an actuarial or management consultant is most appropriate, although review by in-house or external legal counsel is strongly recommended.
The reason for having the audit reviewed by legal counsel is twofold. First, legal counsel (especially with pension law experience) can add value by confirming whether the legal compliance issues have been satisfied. Second, by having the audit report prepared for legal counsel to review, there will be a stronger argument for maintaining confidentiality of the report on the basis of a solicitor-client privilege. To best protect this claim of solicitor-client privilege over the report, the plan sponsor should arrange for its legal counsel to directly retain
the consultant to conduct the audit and prepare the report.
Another advantage is that the findings of an independent auditor are likely to have considerably more credibility with pension regulators and plan members in any future dispute regarding the practices and procedures of the administrator. Plan sponsors and administrators should also be aware that applicable pension regulators have the authority to conduct random audits of a pension plan.
What Should The Audit Cover?
There are no statutory requirements setting out what an audit should cover or how an audit is to be performed. That said, here is a list of the most significant issues that need to be addressed.
Plan Documents. First and foremost, a governance audit should include a full review of all plan documents. It is surprising how many plan administration problems that arise which could have been avoided by simply amending a plan provision to clarify the intention of the plan sponsor/administrator.
Plan Design. An audit should ask certain fundamental questions, such as whether the plan design is appropriate for the sponsor, its sector of the economy and for the current and contemplated workforce.
Disclosure & Communications. The audit should also include a review of the form and content of all disclosure and communication materials provided to plan members. In many cases, pension litigation involves circumstances in which the information provided to plan members was inconsistent with the terms of the plan. Plan administration problems often occur, for example, where plan member booklets contain descriptions or investment information that is inconsistent with actual plan practices.
Regulatory Filings. Another important aspect of a governance audit is a review of the various regulatory filings which the administrator is required to provide under minimum standards legislation, including plan amendments, annual information returns, actuarial valuations and cost certificates, audited financial statements, and board of directors’ resolutions and approvals relating to the administration of the plan.
SIP&P. A review of the Statement of Investment Policies and Procedures ("SIP&P") for the plan is essential, ensuring it complies with requirements of minimum standards legislation (including the requirement that the SIP&P be reviewed at least annually) and that it accurately reflects the investment objectives of the fund. The audit should also ensure that the investment managers are aware of the requirements of the SIP&P and are promptly notified of any changes thereto.
Investments. The audit should specifically review the investment of the plan assets and should review issues such as:
- does the plan have a cost-effective audit program in place?
- are contributions to the plan invested as soon as possible?, and
- how are the investment managers and/or investment options chosen and monitored?
In the case of a defined contribution plan, the overall performance of employees’ investments should be monitored.
Funding & Reporting. A governance audit should include a review of the funding policies and financial reporting practices for the plan.
Benefits Processing. An audit should examine how benefits are processed. This includes whether benefits are being paid in accordance with the terms of the plan and whether individuals who make these decisions are properly trained and supervised.
Delegation. The audit should review the delegation of the administrator’s duties and responsibilities to ensure such delegation is reasonable and prudent, including the manner in which the administrator supervises and monitors those to whom it delegates any of its duties and responsibilities.
Service Providers. There should be a review of the contracts and performance of any external service providers to determine whether: (a) they are operating under reasonable contracts; (b) they are paid reasonable compensation; and (c) their work is sufficiently monitored.
Expenses. The audit should include a review of all administrative expenses being charged to the plan to determine if they are reasonable and defensible in light of all facts and circumstances. If the plan is a defined contribution plan, fees paid by members should be reviewed to ensure that they are competitive.
Special Concerns. The audit should also focus on any special problems or concerns that may have arisen. Are there any threatened or filed lawsuits which could merit further inquiry? Is there a funding deficiency? Are there any other red flags that should be looked into?
Documentation. Finally, the audit should examine whether the issues above have been properly documented. Next to failing to follow the provisions of the plan, poor documentation procedures are probably the cause of the most problems for plan administrators.
What Kind Of Problems Might Be Found?
The most common types of problems uncovered by a governance audit are:
- benefits processing issues (misinterpreting the plan terms, records protection and retention, etc.)
- improperly documenting plan administration procedures
- ineligible expenses being paid from the plan
- confusion regarding the role of plan administrator and plan sponsor
- membership eligibility issues
- member communication material is out-of-date
- funding issues
- investment issues (performance measurement, manager selection and supervision, out-of-date SIP&P, etc.)
- the plan terms and/or plan administration are inconsistent with the terms of applicable collective agreements, and
- out-of-date or unreasonable contracts with service providers.
What If Problems Are Found?
Since pension governance audits are not statutorily required, there is no requirement to have a written audit report prepared. A plan administrator should not first learn of a serious plan administration problem through a written audit report. Any problems uncovered, as well as appropriate solutions, should be discussed and agreed upon so that, if a written report is prepared, it will contain the solution together with a description of the problem. In most cases, compliance can be achieved by prospective changes to a plan’s practices and procedures, greater attention to proper documentation and monitoring and, in some cases, selective plan amendments.
Provided the cost of the audit and report are paid by the plan sponsor directly and not out of the plan assets, the report should not constitute plan property. As such, there is a strong argument that an audit report need not be disclosed to the plan members.
The fact that the audit report need not be disclosed to plan members does not, however, obviate the administrator’s fiduciary duty to the beneficiaries of the plan. In other words, a plan administrator cannot "stick its head in the sand" and pretend the problems do not exist. The administrator will be required to take all necessary steps to correct any problems and ensure the continued compliance of the plan with applicable legislation.
The Bottom Line – Governance and Risk Management
Appropriate pension plan governance is an important tool in minimizing the exposure to legal liability and associated financial risks. Establishing and implementing a reasonable pension plan governance policy will not completely insulate a sponsor from liability, but the absence of a policy or failure to implement it is likely to be a factor that encourages a court to find against a plan sponsor.
A properly constructed governance process coupled with periodic governance audits should allow plan sponsors to identify potential sources of obligation and deal with them before they result in financial cost to the plan sponsor and, possibly, its directors and senior management.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.