Article by Diana Woodhead , ©2006 Blake, Cassels & Graydon LLP
This article was originally published in Blakes Bulletin on Pension and Employee Benefits - January 2006
The plan sponsor’s role in pension plan governance is a question that sponsors themselves, advisors and even courts struggle with — particularly, corporate plan sponsors who are not only responsible for establishing or maintaining the pension plan, but are often the registered plan administrator. This dual role gives rise to situations where the interests of the sponsor can conflict with those of the plan beneficiaries.
Plan sponsors are subject to general legal obligations at common law, as well as in legislation. The principles and obligations governing plan sponsors apply equally to defined benefit, defined contribution and combined defined benefit/defined contribution pension plans. However, different obligations apply to the plan sponsor depending on whether it is acting in its capacity as "employer" or as "plan administrator" in performing a particular duty.
Common Law Obligations
Often, in the course of administering a pension plan and investing a pension fund (or implementing investment instructions), a plan sponsor may be acting as a fiduciary at common law.
The plan sponsor often has discretionary power to affect the legal and financial interests of members through its management and investment of the pension fund. In a defined benefit plan, for example, members reasonably rely on the administrator to protect the value of the fund and their entitlements under the plan. In a defined contribution context, the administrator may have discretionary power to affect the legal and financial interests of members through its management of the plan, including, for example, its choice of investment options.
The courts have recognized a fiduciary duty in the course of plan administration and investment in a number of cases. Basic fiduciary duties under the common law would include the following:
- A duty to act reasonably and prudently
- A duty of loyalty to those people whose interests the fiduciary is protecting·
- Not allowing the fiduciary’s own interests to conflict with the fiduciary’s duties
- A duty not to profit from the fiduciary’s position and to account for any undisclosed profit, and·
- A duty to hold an "even hand" between competing interests of those on whose behalf the fiduciary is acting.
A plan sponsor who fails in this duty will be found liable for breach of fiduciary duty. In addition, a plan sponsor could be liable for negligent misrepresentation where, acting in its fiduciary capacity, it provided erroneous information or has failed to disclose material information to employees and the employees can establish the requirements for an action based on the tort of negligent misrepresentation.
Legislative Obligations
While the focus is on the Pension Benefits Act (Ontario) (PBA), pension standards legislation in the other provinces and the federal jurisdiction have similar provisions for duties, obligations and standards of care of administrators of pension plans.
The PBA imposes primary legal responsibility for the administration of the pension plan and the pension fund on the "administrator" of the plan which, in the case of a corporate plan sponsor, is normally the corporation. Assuming the corporation administers the plan, ultimate legal responsibility for plan administration rests with its board of directors.
The PBA requires the administrator of a pension plan to 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. By comparison, the common law standard of care is the standard of care that a person of ordinary prudence would use in managing his or her own affairs. On the theory that a person of ordinary prudence would take better care of the property of a third party than of his or her own property, the PBA standard of care is a higher standard of care than the common law fiduciary standard of care.
Furthermore, the PBA provides the administrator must use, in the administration of the pension plan and in the administration and investment of the pension fund, all relevant knowledge and skill the administrator possesses or ought to possess by reason of the administrator’s profession, business or calling. The PBA also provides the administrator must not knowingly permit its own interest to conflict with the administrator’s duties and powers in respect of the pension fund.
Role Of The Plan Sponsor
Historically, there have been two views on the nature of the plan sponsor’s role as employer and administrator. These were discussed by Madame Justice Eileen Gillese, one of the first pension legal experts to analyze the dual and potentially conflicting roles of the plan sponsor.
The first view is based on the theory that once an employer makes a decision to implement a pension plan, all decisions made in relation to the pension plan (including amending or terminating the plan) are made in its fiduciary capacity as plan administrator. This would mean that all functions carried out by the plan sponsor related to the plan would be performed by the plan sponsor in a fiduciary capacity. On this view, the plan sponsor could not act in a self-interested fashion, for example, to amend the plan design prospectively, if this would have a detrimental effect on the benefits of plan members. It is also difficult to see a how a sponsor would be able to wind up the plan.
The second theory is based on the assumption an employer retains certain rights and powers to act in the capacity as employer at the same time as being the administrator of the plan. This view is based on the fact that the initial decision to create a pension plan is made by the employer acting in its own interests in a non-fiduciary capacity and that, once the pension plan is established, there are times when the employer continues to retain the right to act in its own interest. This view recognizes that members of boards of directors of corporations who sponsor pension plans have separate duties to the corporation and to the plan and that, when acting as "employer," the members of boards of directors may act in a non-fiduciary capacity in the interests of the corporation, even while they continue to hold the role of plan administrator.
There have been several recent court decisions that have considered the issue of whether the plan sponsor is bound by a fiduciary obligation when amending a pension plan. One recent decision was Association provinciale des retraites d’Hydro-Québec v. Hydro-Québec. In that case, a group of retirees alleged the use of surplus that was agreed upon by Hydro-Québec and the employees through their union was detrimental to their interests. According to the retirees, they were not consulted or treated in an equitable fashion when the decision was made to use the accumulated surplus to increase certain benefits for active employees (including early retirement benefits) and to reduce the contributions to be paid by Hydro-Québec and the employees.
The Court of Appeal held the retirees were not entitled to increased benefits and that neither the Civil Code of Québec nor the Supplemental Pension Plans Act requires they consent to modifications to the pension plan. The Court of Appeal also concluded that a union and employer can agree to use plan surplus to reduce pension plan contributions without the retirees’ consent. The appellant retirees argued Hydro-Québec breached its fiduciary obligations to them when it implemented the amendment. The court ruled the employer was not acting as a plan fiduciary but as a plan sponsor when it amended the pension plan and, in these circumstances, it was entitled to do so. The application for leave to appeal this decision to the Supreme Court of Canada in this case was denied; therefore, the decision of the Québec Court of Appeal stands.
This follows the general pattern of the cases to date, which suggest that an employer is not a fiduciary in the design, amendment or termination of a plan. However, it should be noted that in limited circumstances, the employer’s ability to amend a plan may be subject to a contractual duty of good faith or may be constrained by a collective bargaining agreement or regulatory requirements relating to minimum or maximum benefits.
While it is still unclear, the prevailing view would appear to be the plan sponsor has the ability to wear "two hats." This is certainly recognized under the PBA and other similar pension standards legislation and has been recognized by the courts. Assuming this view holds true, how does one determine whether a plan sponsor, in performing any given act in respect of a pension plan or fund, is acting in its capacity as "employer" or "administrator"?
Avoiding "Role Confusion"
Once the decision has been made to establish the plan, pension legislation (including, where applicable, the Income Tax Act (Canada), imposes a number of specific duties on the plan sponsor in its capacity as administrator, including filing documents that create and support the plan, ensuring legislative and regulatory compliance, and various other specific duties. These acts are clearly performed by a plan sponsor, acting as administrator. There are also acts it is hard to imagine could be carried out by the plan sponsor acting as administrator because they could not be exercised in the best interests of plan beneficiaries, such as the use of actuarial surplus to offset employer contributions, an amendment to reduce future benefits, or a decision to terminate the plan.
There may be other situations, however, where it is not clear in which capacity the plan sponsor is acting. For example, consider a situation in which the pension committee of an organization has been delegated the authority to approve compliance amendments, as these are considered to be "administrative" in nature because they do not affect overall plan design. The Canada Revenue Agency requests an amendment to clarify which forms of incentive pay are included in the definition of "pensionable earnings," for compliance with the requirement that pension adjustments (which are based on such earnings) are determinable. While there has been an administrative practice of including certain types of incentive pay in pensionable earnings, this has never been stated in the plan text.
Would an amendment to the plan to clarify the definition be merely a "compliance" amendment that can be approved by the pension committee in its fiduciary capacity as "administrator" or are there plan design elements that mean the amendment ought to be approved by the "employer" acting in its own interest?
The result of this "role confusion" can be to increase the plan sponsor’s exposure to fiduciary liability. If the plan sponsor undertakes a task in its capacity as administrator the task will attract unnecessary (and undesirable) fiduciary obligations.
How can a plan sponsor strive to avoid "role confusion"? Madame Justice Gillese (when still a professor of law) suggested that if the task in question is a "functional" one that must be performed to ensure the plan operates as it is required to under the terms of the plan and relevant law, then it is administrative in nature and is performed by the plan sponsor acting in its fiduciary capacity as plan administrator. The PBA specifically identifies a number of these "functional" tasks that are the responsibility of the administrator.
She proposed that all tasks that do not fall into the category of "functional" tasks can be performed by the plan sponsor acting as employer in its own capacity and interest. This would typically include:
- Establishing, amending and terminating the plan
- Determining funding policy for the plan
- Determining accounting and actuarial assumptions and policies for the plan
- Approving the audit for the plan and
- Other tasks specifically identified under the PBA as being the employer’s (versus the administrator’s) responsibility.
In this regard, the PBA identifies certain tasks as being the responsibility of the employer. For example, the PBA makes it clear that it is the obligation of the employer to make the contributions required to fund the benefits provided under the plan (even though it is the responsibility of the administrator to file the actuarial valuation, where required and to ensure the employer’s required contributions are made when due).
The PBA also provides it is the employer who has the right to apply for consent to payment of surplus out of the pension fund. Moreover, the regulations to the Act permit the employer to use actuarial gains (i.e., surplus) in an ongoing plan to reduce its contribution obligations. The idea the employer may be acting in a self-interested way in taking contribution holidays is reinforced in the Schmidt decision, which established that an employer may take contribution holidays even where the employees are entitled to surplus funds on plan termination.
These are specific instances where the PBA provides the plan sponsor may take action in its capacity as employer, as opposed to plan "administrator." If the PBA required the plan sponsor to take these actions in its capacity as plan "administrator," it would, of course, be undertaking such action in its fiduciary capacity, where it would be bound to act in the best interests of the plan beneficiaries.
Putting Theory into Practice
The principles that apply to managing business assets also apply to the management of pension assets. The intention of corporate governance is to put in place a sound decision-making system to ensure the board of directors acts in the best interests of the corporation, with a goal of meeting its obligations to shareholders.Pension governance is really a subset of corporate governance. It refers to the structure and processes for overseeing, managing and administering a pension plan to ensure the fiduciary and other obligations of the plan are met. The objective of a good pension plan governance system is to establish processes that encourage sound decision-making, in the management, administration and oversight of a pension plan.
A good pension governance system will:
- Establish a framework for defining the duties, associated responsibilities and accountabilities for all participants in the governance process
- Cover all facets of pension plan management, including communication, funding, investments, and benefit administration, and
- Provide careful oversight while enhancing protection for plan members and beneficiaries.
While regulatory authorities and various "experts" have issued regulatory rules and guidelines for corporate and pension plan governance, there is little case law to date explaining how those rules and guidelines should be applied. However, it would appear that the key corporate governance responsibilities of the board of directors, relevant to pension plans, are risk management and approval of strategic policy initiatives for the corporation.
Regarding risk management, pension plans are a source of potential legal and financial risks for the corporations that sponsor them, in view of the significant assets they may hold that need to be invested, the employer funding obligations, complex regulatory requirements and evolving jurisprudence relating to pension plans. There may be other risks, such as high turnover or lack of employee commitment to the business resulting from employee dissatisfaction with their compensation/benefit arrangements, including their pension plan, if the plan is not properly structured, managed and communicated.
As a result, corporate governance responsibilities ought to include a periodic review of risks relating to the pension plan and assuring systems are in place to manage the risks. Boards would likely establish levels of materiality to determine their level of involvement with these issues and which require approval by the board, as opposed to approvals by authorized officers.
When actions are taken or decisions made by the plan sponsor in its capacity as "employer", they are really based on corporate governance principles. When taking actions and making decisions in its capacity as administrator, the plan sponsor does so based on fiduciary principles. To deal with the issue of role confusion, the plan sponsor must carefully identify the capacity in which each task in the management and administration of the plan must be undertaken and develop a governance process to ensure the tasks are carried out by the plan sponsor in the appropriate capacity.
So, how can plan sponsors establish this governance structure?
Establishing a Pension Plan Governance Structure
In view of the general nature of the plan governance guidelines across Canada and the lack of jurisprudence directly relevant to plan governance, there are no hard and fast rules as to which plan governance functions should be performed by any particular individual or committee within a particular corporate structure.That said, it would be expected that risk management relating to retirement plans (with a focus on potential financial and legal risks to the corporation), significant retirement plan policy initiatives and significant plan design decisions would occur at the level of the board or a board committee for both defined benefit and defined contribution plans, where the plan sponsor is acting in its capacity as "employer."
This approach would be consistent with the plan governance guidelines issued by the Canadian regulators to date and, at least for registered pension plans, the statutory regime applicable to those plans which generally require the plan sponsor to retain ultimate responsibility for their operation.
Consideration should be given to CAPSA’s Guideline No. 3 - The "Pension Plan Governance Guidelines." Where the plan in question is a defined contribution plan or has a defined contribution component, the plan sponsors should consider the "Guidelines on Capital Accumulation Plans," issued by the Joint Forum of Financial Market Regulators and adopted by CAPSA. Both provide guidance to plan sponsors for meeting fiduciary obligations as "administrators," but do not deal with the sponsor as "employer."
Next to consider is delegation. Just as it is impractical for a board of directors to be involved with all aspects of the management of the corporation’s business, it is impractical and inappropriate for boards to be involved with all aspects of managing and administering the plan and fund.
The PBA recognizes this and provides for delegation by the "administrator" to agents of any task required in the administration and investment of the fund. In most cases, it is prudent for the plan sponsor to delegate some of its responsibilities to agents, employees and service providers, such as determining an appropriate investment portfolio for the plan. Where delegation occurs, the administrator of the pension plan is not relieved of ultimate responsibility for the operation and administration of the pension plan and the related pension fund. Therefore, it is important for plan sponsors to ensure that there is a process in place to provide for supervision and monitoring of its agents and delegates.
In addition, authority will typically be delegated to one or more people or one or more pension committees composed of employees of the plan sponsor responsible for undertaking certain tasks in relation to the management or administration of the plan. The delegation of authority to the pension committee would typically be set out in a board resolution and in terms of reference, which would identify the mandate of the committee, detail the specific responsibilities that are delegated and, if applicable, set out the authority of the committee to further delegate its responsibilities to others.
To address the dual role issues, board resolutions implementing the governance structure should clearly specify which responsibilities are to be undertaken by the plan sponsor and its delegates acting in its capacity as employer, and which are to be undertaken by the plan sponsor acting in its capacity as administrator.
Likewise, the terms of reference and mandates of the pension committees and of other delegates should reflect this role splitting with respect to the tasks for which they are responsible. The reporting structure should also clearly indicate the capacity in which decisions affecting the plan were made. This is particularly important if there is one committee that is acting in a dual capacity.
Conclusion
There is no single correct governance structure and there are probably as many as there are corporate plan sponsors. In each case, however, the importance of clearly distinguishing between the role of the plan sponsor as "employer" and as "administrator" can not be over-emphasized. This is fundamentally important since there are certain situations in which it is desirable and appropriate (duties owed to the corporation and its shareholders, for example) for plan sponsors to retain the authority to act in their own capacity and interest, without the restrictions that would be imposed by the fiduciary obligation to act in the best interests of plan beneficiaries.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.