Originally published in Blakes Bulletin on Pension & Employee Benefits, February 2007
Governance audits of pension plans can help minimize potential liability for the plan sponsor and administrator, as well as officers and directors.
Pension plan governance is a subset of overall corporate governance. For corporations that sponsor pension plans for employees, implementing a good pension governance structure is essential to ensuring its plans are administered in accordance with their terms and applicable law. Audits check whether the operation of a plan complies with plan documents, applicable law and best practices guidelines. As an increasing number of plan sponsors and administrators become aware of governance audits, many are asking questions about what a governance audit is and the basics of why, how and when audits should be performed. This article focuses on single employer pension plans registered under Ontario law.
WHAT IS PENSION PLAN GOVERNANCE?
Pension plan governance may be viewed as the process by which a plan administrator and/or sponsor discharges its legal obligations with respect to a pension plan. Sources of those legal obligations include statute and common law concepts, such as fiduciary duties, tort (especially, negligence) and contractual obligations. From a legal perspective, good governance reduces the risk to a plan administrator/sponsor of being subject to legal liability in the administration, operation and investment of a plan.
WHAT IS A GOVERNANCE AUDIT?
A governance audit is an independent review of a pension plan, including:
- Governing documents
- Operating procedures and practices
- Administrative and delegation structure, and oversight mechanisms
- Investment management structure
- Service provider services
- Documentation procedures.
The audit determines whether the plan documents comply with applicable law and if the plan is being administered in accordance with its terms, the law, best practices guidelines, and directions and intentions of the plan sponsor. A governance audit is also designed to ensure all plan administration activities are properly documented. Special audits may also be appropriate in particular circumstances, such as:
- Conversion of a plan from defined benefit to defined contribution or vice versa
- Partial plan windup
- Plan merger
- Insolvency of the plan sponsor
- Plan acquired as a result of a corporate acquisition.
WHY DO A GOVERNANCE AUDIT?
A governance audit serves three general purposes:
1. Improving Plan Administration. Regular governance audits of a pension plan conducted by an independent third party help improve the overall administration of the plan in a number of ways.
First, any problems with the way in which the plan is being administered or legal compliance issues can be quickly identified, and appropriate steps can be taken to remedy the problems.
Second, a governance audit forces the plan administrator to examine or re-examine plan administration issues which are raised during the course of the audit and which may otherwise not be brought to the attention of the administrator. For example, the audit may determine the individuals responsible for the day-to-day administration of the plan require a more thorough understanding of the plan’s terms, which is something that 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" (that is, the independent auditor) to review how the plan is being administered and suggest new or alternative ways of dealing with certain administrative issues. An advantage of having an independent auditor review the administration of the plan is the auditor will not be wedded to current administrative practices – which would more likely be the case if a review was performed by those responsible for administration of the plan and their service providers.
Fourth, a governance audit may save money. Small problems can be identified and addressed before they fester into significant financial risks. Maintaining a practice of regular plan audits may enable the plan sponsor to negotiate lower cost fiduciary liability or errors and omissions insurance coverage.
2. Legal Compliance. One of the most important reasons for having a governance audit is to ensure compliance with the various legal requirements imposed on a plan and the administrator, including:
a) Administrator’s Fiduciary Duties. Plan administrators are fiduciaries who owe fiduciary duties to beneficiaries of the plan. At law, a "fiduciary" is someone who has been impressed with the trust or confidence of another in certain circumstances. Fiduciaries owe a duty of loyalty to those in whom their trust or confidence has been placed. Fiduciary duties may be imposed by statute or by the common law.
In Ontario, section 22 of the Pension Benefits Act (PBA) states that the administrator "shall exercise the care, diligence and skill in the administration and investment of the pension fund that a person of ordinary prudence would exercise in dealing with the property of another person" and "shall use in the administration of the plan and in the administration of the pension fund all relevant knowledge and skill that the administrator possesses or, by reason of the administrator’s profession, business or calling, ought to possess."
As well, subsection 19(1) of the PBA requires a plan administrator to ensure the plan and pension fund are administered in accordance with the PBA and its regulations. The PBA further requires the administrator to ensure the plan is administered in accordance with the terms of the plan documents.
Unfortunately, the PBA provides very little guidance as to how a plan administrator is to discharge its duties. One means by which a plan administrator can attempt to adhere to its duties, at least in part, is to arrange periodic independent reviews (that is, audits) of the plan’s documents and the manner in which the plan is being administered.
b) Minimum Standards Compliance. A governance audit is also useful for ensuring that plan documents, as well as the way in which the plan is administered, comply with minimum standards legislation. More specifically, the audit should include a review of the plan documents to ensure that they are consistent with each other and that they properly reflect the requirements of applicable pension and tax legislation.
Minimum standards compliance includes ensuring the plan is administered in accordance with its terms and applicable legislation. The audit should include a review of all administrative duties in this regard. Examples include: ensuring contributions are made within the time-frames set out in the plan and under applicable legislation; determining whether eligibility rules are adhered to; ensuring terminating or retiring members are provided appropriate portability options; ensuring forms used by the administrator (e.g., spousal waiver forms) comply with minimum standards legislation; and confirming compensation used for benefit determination is accurate.
Further, a governance audit should ensure duties and responsibilities delegated by the plan administrator (either externally to professional service providers or internally to employees of the sponsor/administrator) comply with the PBA requirement that such delegation is "reasonable and prudent" in the circumstances, and that those to whom the duties and responsibilities are delegated have the appropriate skills to perform the necessary tasks. Finally, a governance audit should ensure the plan administrator’s selection and monitoring of those to whom duties and responsibilities have been delegated is reasonable and prudent.
c) Compliance with Best Practices Guidelines. An audit should also review the extent to which the administration of the plan complies (or fails to comply) with applicable best practices guidelines. While best practices guidelines are not law, applicable industry standards may influence a court in determining whether a particular course of conduct should attract liability. Consequently, the extent of compliance (or non-compliance) by a plan administrator with governance guidelines issued by pension regulatory bodies may well be taken into account by a court in determining whether the administrator has met its statutory or common law obligations with respect to the plan. Best practices guidelines that should be considered as part of a pension plan governance audit (to the extent applicable) include the following:
CAP Guidelines. The Joint Forum of Financial Market Regulators has issued "Guidelines for Capital Accumulation Plans" (CAP Guidelines) which are best practices guidelines applicable to "capital accumulation plans," examples of which include defined contribution registered pension plans, group registered retirement savings plan and deferred profit-sharing plans.
CAPSA Guidelines. The Canadian Association of Pension Supervisory Authorities (CAPSA) has issued its "Guideline No. 4 – Pension Plan Governance Guidelines" (CAPSA Guidelines), which provides a broad, flexible outline of key pension plan governance practices that it recommends be followed by pension plan administrators. There is also a Self-Assessment Questionnaire attached to the CAPSA Guidelines, which is designed to assist plan administrators in self-assessing how successfully their own plan follows effective governance principles.
OSFI Guidelines. The Office of the Superintendent of Financial Institutions (OSFI), which regulates pension plans registered under the federal Pension Benefits Standards Act, 1985, has issued a "Guideline for Governance of Federally Regulated Pension Plans" (OSFI Guidelines).
d) Reporting Obligations. A governance audit should also ensure all plan-related reports comply with the requirements of minimum standards legislation. For example, the audit should review: information provided to plan members (e.g., annual benefit statements, termination statements, etc.); documents required to be filed with regulators (e.g., annual information returns, actuarial valuation reports, etc.); plan documents made available to plan members for inspection; and other reporting activities to which minimum standards legislation apply to ensure applicable minimum standards are being satisfied. A corporation in its capacity as plan sponsor also produces other financial statements and public disclosures that may be improved by undertaking an audit. For example, a plan sponsor may be required to disclose material pension arrangements and provide reasonable assurances that corporate financial statements and disclosures are free of material misstatements about pension arrangements.
An audit should ensure internal control procedures are in place to enable the plan sponsor to identify fraud or error in the development of management estimates of accrued liabilities as well as inconsistencies between plan administration, plan provisions, and tax and minimum standards requirements. A comprehensive pension governance audit can help reduce the risk of material misstatement or misrepresentation in securities commission filings, credit agreements, and warranties provided in merger, acquisition or sale transactions.
3. Minimizing Legal Risks. By conducting regular governance audits of a pension plan, errors or other problems relating to plan administration are much more likely to be identified at an early stage. Early detection will often allow the plan administrator to take the necessary steps to correct the problem before it results in a legal claim against the fund, sponsor/administrator, officers and directors, or other persons in the administration of the plan.
Specifically, as to personal liability of officers and directors of the plan sponsor or administrator, it is important to keep in mind that under section 110 of the PBA, every director, officer, official, agent or other person acting in a similar capacity may be found personally liable if he or she causes, authorizes, permits, acquiesces or participates in the corporation contravening any of the requirements of the PBA or its regulations, or for failing to take all reasonable care in the circumstances to prevent the corporation from contravening any such requirements.
Consequently, by having regular governance audits performed, the potential liability of officers and directors of the sponsor/administrator is minimized by reducing the likelihood of claims through early detection and correction of problems. Also, in respect of claims relating to problems with plan administration that were not identified in the audit report, and which were not otherwise brought to the attention of the officers and directors of the plan sponsor/administrator, the officers and directors would have a much stronger argument that they satisfied their obligation to take reasonable care to prevent a contravention of the PBA and its regulations by having the audit performed.
WHO SHOULD PERFORM THE AUDIT?
A governance audit focuses on documentation, administrative structures and operational process. As such, an outside and independent third party should perform the audit. Lawyers are well suited to review documents and ensure there are basic structures or mechanisms in place for dealing with conflicts, benefit claims and dispute resolution. It is one thing, however, for a document to say something or for a structure to be put in place and quite another to determine if the document is being administered in accordance with its terms or if the process intended by the legal structure is being followed in the day-to- day operation of the plan. Accordingly, an actuarial or management consultant is the most appropriate party to conduct the audit from an operations standpoint, although we strongly recommend it be supervised or directed by in-house or external legal counsel.
The reason for having the audit supervised by legal counsel is two-fold. First, legal counsel with pension law experience can add value by confirming that: the legal compliance issues have been satisfied; sufficient documentation is in place with service providers; documents (plan texts, trust agreements, collective bargaining agreements and plan booklets, etc.) are consistent; and reporting and other structures are sufficient to deal with conflicts and avoid errors. Second, legal counsel can assist in determining an appropriate strategy for best resolving any compliance issues that may be uncovered by the audit.
An advantage in having an outside independent party conduct the audit, rather than an employee of the plan administrator, is that an independent party is also not wedded to past administrative practices and brings a fresh set of eyes to plan administration issues. Another benefit is that the findings of an independent auditor are likely to have more credibility with pension regulators and plan members in case of a future dispute over the practices and procedures of the administrator. In addition, CAPSA Guidelines suggest a plan administrator seek the advice of independent professionals in reviewing the administration of the plan to ensure impartiality. 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?
Minimum standards legislation does not require audits of a plan be performed. There are no statutory requirements setting out what an audit should cover or how an audit is to be performed. Both the CAP Guidelines and CAPSA Guidelines, however, state periodic reviews of a plan’s administration should be conducted. The CAP Guidelines refer to periodic reviews of service providers, investment options, records maintenance and decision-making tools provided to members. CAPSA Guidelines refer to periodic reviews of governance procedures and practices and assessments of the administrator’s performance and the plan’s governance structure.
Generally, a governance audit involves reviewing:
All plan documents. It is surprising how many plan administration problems that arise could have been avoided by simply amending a plan provision to clarify the intention of the plan sponsor/administrator.
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. For example, plan administration problems often occur where plan member booklets contain descriptions or investment information that is inconsistent with actual plan practices. Amending such booklets is a relatively simple undertaking that may avoid serious problems in the future.
Various regulatory filings the administrator is required to provide under minimum standards legislation. These include:
- Plan amendments and corresponding regulatory filing forms
- Annual information returns
- Actuarial valuations and cost certificates
- Audited financial statements
- Board of directors’ resolutions and approvals relating to the administration of the plan.
Statement of Investment Policies and Procedures (SIP&P). Ensure the SIP&P complies with the requirements of minimum standards legislation (including compliance with the requirement that it 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.
Investment of plan assets. For example, the audit should review the following issues:
- Does the plan have a cost-effective audit program in place?
- Are contributions to the plan invested as soon as possible?
- How are the investment managers or investment options chosen and monitored?
- Are procedures in place for assuring that the investment managers understand the plan’s investment objectives and that such objectives are properly carried out?
- How are new investment managers and options added and existing ones removed?
Manner in which benefits are processed. This includes a review of whether benefits are being paid in accordance with the terms of the plan and if the individuals who make these decisions are properly trained and supervised.
Delegation of administrator’s duties and responsibilities for reasonableness and prudence. This includes the manner in which the administrator supervises and monitors those to whom it delegates any of its duties and responsibilities, and a review of mandates of all committees and functional groups playing a role in plan administration, and mandates of applicable staff.
Contracts and performance of any external service providers. This is to determine if: a) they are operating under reasonable contracts; b) terms of engagement are certain; c) they are paid reasonable compensation; and d) work is sufficiently monitored.
All administrative expenses being charged to the plan to determine if they are reasonable and defensible. If the plan is a defined contribution plan, fees paid by members should be reviewed to ensure that they are reasonable and competitive.
Any special problems or concerns that may have arisen. For example, are there any threatened or filed lawsuits that could merit further inquiry? Have there been any circumstances under which the pension regulator could declare a partial wind-up of the plan? Is there a funding deficiency? Are there any other red flags that should be looked into?
Whether all 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 greatest number of problems for plan administrators.
WHAT IF PROBLEMS ARE FOUND?
Since pension governance audits are not statutorily required, there is no requirement to have a written audit report prepared and a plan administrator should not first learn of a serious problem through a written audit report. Any problems uncovered by the audit should be discussed with the plan sponsor and its legal counsel. Appropriate solutions should also 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 preparation of the report are paid by the plan sponsor directly and not from plan assets, the report should also not constitute plan property. As such, there is a strong argument an audit report paid for by the sponsor need not be disclosed to the plan members. However, the fact the audit report need not be disclosed to plan members does not 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 raised by the audit do not exist. The administrator will be required to take all reasonable steps to correct any such problems and ensure the continued compliance of the plan with applicable legislation.
If the audit is paid for out of the plan, there is a stronger argument the report is plan property and findings should be disclosed to the plan beneficiaries. Thus, the advantage of the plan sponsor paying the cost of the audit is the sponsor is more likely to have an opportunity to determine an appropriate solution to problems revealed by the audit and be in a position to explain the proposed solutions as part of the written audit report. This allows the plan sponsor to be proactive in correcting plan administration problems, rather than dealing with such problems defensively.
WHAT KINDS OF PROBLEMS MIGHT BE FOUND? The most common types of problems uncovered by a governance audit include:
- Benefits processing issues (e.g., 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 (e.g., performance measurement, manager selection and supervision, out-of-date SIP&P, etc.)
- Lack of appropriate delegation and oversight mechanisms
- Plan terms or plan administration are inconsistent with the terms of applicable collective agreements
- Out-of-date or unreasonable contracts with service providers.
COST AND TIMING CONSIDERATIONS
The length of time to complete a governance audit and its cost will, understandably, depend on the size and complexity of the plan and the condition of the plan records. Typically, if the relevant documents are organized in advance, the onsite review of a medium-sized plan should only take a few days. Assuming the auditor will have discussions with the sponsor and individuals responsible for administration of the plan and that there will be a written audit report prepared, the entire process should only take a few weeks to complete. Depending on the complexity of the plan, the cost of the audit could vary greatly (for example, anywhere from CAD 15,000 for a basic audit of a small plan to CAD 75,000 or more for an audit of a large, complex plan). Audits of only part of a plan’s operation would, of course, cost less.
Assuming plan documents allow administrative expenses to be paid from plan assets, the cost of the audit should be a legitimate cost of the administration of the plan and, therefore, an appropriate expense to be paid from plan assets. As noted, however, it is generally recommended the audit be paid directly by the sponsor to help ensure the audit report does not become property of the plan.
Pension plan governance audits are an important tool to enable plan sponsors and administrators to monitor a plan’s compliance with the requirements of minimum standards legislation, as well as helping to identify and correct any administrative problems that may exist. In doing so, the plan administrator helps fulfil its fiduciary duties to the plan beneficiaries, while hopefully discovering new and more efficient ways of administering the plan.
Pension governance audits can also help ensure sponsors and their officers and directors fulfil their duties to corporate stakeholders – at least as far as pension disclosure and reporting is concerned.
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.