Dear prudence…

A recent consultation paper issued by the Canadian Association of Pension Supervisory Authorities (CAPSA), entitled The Prudence Standard and the Roles of the Plan Sponsor and Plan Administrator in Pension Plan Funding and Investment, offers some insight into what the regulators want.

“They could have shortened the title down to Process, Process, Process, because that’s what this paper is primarily about,” says Nancy Chaplick, partner with Osler Hoskin Harcourt’s pensions and benefits department. “It is a very good education piece, and I would recommend it to everybody who practices in this area.”

She points out that the paper is not law, but that it is “always good to know the regulator’s views.”

“They want you to make sure you have a documented process; they want to make sure that you follow your process; and they want to make sure you have evidence that you followed your process.”

• Read the consultation paper

Developing such a process forces the fiduciary to consider issues which might otherwise have been taken for granted. It is also useful to have a document that explains the process, as it ensures continuity, and can be used as defense evidence in the event of a legal or regulatory action.

On the downside, developing a process document requires a substantial time commitment and perhaps the engagement of external advisors. Implementation could also add costs.

“Prudence is process,” she explained. “That means what the regulator is going to look at is not the result, it’s the process that you’ve got to get you to that result. As long as your process is good, your result can be crummy and that’s OK, you didn’t breach your fiduciary standard according to this principal.”

This makes sense, she says, because a fiduciary is not a guarantor or insurer. Circumstances beyond the fiduciary’s control can have an impact on results that should have been better, based on the process followed.

In theory, and Chaplick stressed theory, the reverse could result in regulatory action: consistently good investment returns, absent a written process, could be deemed a breach of fiduciary duty.

“They could come in and look at your file, not see the process and not care that you did just fine. They might consider that you breached your fiduciary duty,” she says.

The process documentation cannot simply be off-the-shelf, boilerplate copy, she points out. It must be tailored to the peculiarities of a given plan.

Among the issues that the process documentation should cover are:

• the role of the plan sponsor and the plan administrator;
• monitoring statutory requirements;
• governance program;
• how you delegate to agents;
• monitoring and supervision of agents;
• conflict of interest;
• funding;
• selecting and monitoring service providers;
• documenting all decisions made, including keeping minutes of meetings;
• member communications; and
• a review policy;

The process must be detailed enough to reflect the nuances of the specific plan and how it best serves its members, but at the same time, excessive complexity may render the plan unworkable for the investment manager.

Too much detail in the investment process may slow transaction execution to the point that the investment manager misses out on opportunities that require quicker decisions.

In the recently decided Canadian Commercial Workers Industry Pension Plan case, FSCO charged the board of trustees with making imprudent investments, with an inordinate portion of the portfolio allocated to investments in Caribbean resorts.

(The case was commonly known as the “defrocked priest case” because the investments were operated by one such ex-clergyman, turned real estate mogul.)

The trustees claimed that they had no special skills which would have prevented them from approving the investments, but Justice Beverly Brown of the Ontario Court of Justice rapped their knuckles, saying they could not hide behind a defence of “ordinary prudence.”

FSCO won only part of the case, according to Chiplick, and it was the easy part at that. The investment clearly violated the quantitative rules of the fund, exceeding the 10% limit for any one investment.

But where FSCO failed, Chaplick said, was in proving that the board of trustees or its investment committee—a subset of the board itself—had breached its fiduciary duty in regards to prudence.

FSCO had essentially said that the investment was prima facie imprudent, and that no reasonable person could have thought it was a prudent investment.

Justice Brown, however, pointed out that this approach was the equivalent of reverse-onus, placing the burden of proof on the defendants. The burden of proof, she ruled, remained on FSCO, and the regulator must supply experts testimony that the investment was imprudent, which it failed to do.

To comment on this story, contact us.