Keeping CAPs out of the courts

But what will happen when employees who have spent the bulk of their working lives participating in a CAP, or a combination defined benefit plan and CAP, begin retiring? Will this ultimately result in court challenges against plan sponsors?

The best defence to any such litigation is for CAP sponsors to conduct due diligence and ensure proper governance. These plans need to be effectively operated so plan members will see an appropriate appreciation of their investment capital when terminating from the plan or retiring.

Possible Litigation Areas
There are a number of areas identified as risk concerns for plan sponsors:
• insufficient information provided, which prohibits plan members from knowledgeably selecting options and managing their accounts;
• poor investment returns resulting in inadequate retirement income;
• plan sponsors’ failure to adequately supervise service providers and select the options available under the CAP;
• inadequate contributions;
• inadequate fee disclosure;
• appropriateness of the default option under the plan; and
• lack of information and advice provided when the member ultimately retires.

Mitigating the Risks
CAP sponsors can begin their due diligence by asking the following questions:

What communications are being provided? Are they effective? Are they provided in a format that members will use? Are there areas where members would like (or should have) more information? The best way to answer such questions is to frequently survey plan members.

Are you actively monitoring the CAP? Are you adequately supervising your service provider and investment options? Are you following member behaviour, such as trading patterns and asset movements following market corrections and over time? Have you implemented any needed corrective action based on such monitoring, and has it been communicated to plan members?

Do you track the level of contributions being made to the plan? Are members taking full advantage of any matching offered by the plan sponsor? Have you benchmarked your contribution rates against others in the industry? Have you determined what income replacement ratio a member could expect at retirement and communicated this to members?

Do you provide adequate information or advice to members at appropriate times? Have you reviewed the materials provided to members or survivors at termination or retirement from the plan? Are the materials adequate? What biases are built in? Do your members understand their investment and transfer options and understand that, once made, they may be irreversible?

While some CAP sponsors are very involved in the administration of their plans, others can be described as “hands off.” South of the border, CAPs are now being more actively administered and are designed so that members can elect out of automatic features. In Canada, however, there are potential legal issues with certain automatic features.

We have seen the industry focus change at different points as the CAP market has matured. Whether a plan is built on a foundation of automatic features or not, it is necessary in all cases to ensure that proper records are kept of what information was provided to plan members and when it was provided.

CAP Guidelines
For any CAP sponsor, the CAP Guidelines, which have now been around for a few years, provide a road map for various governance issues facing CAPs. The guidelines apply to all tax-assisted investment or savings plans that allow plan members to make investment decisions among two or more investment options and cover the following issues:

• establishing a CAP (including details regarding whether to employ service providers and the selection of service providers);
• investment options (including selection of investment options for the CAP, transfers among investment options, maintenance of records and the need for a policy regarding the failure of a member to make investment choices);
• investment information and decision-making tools for CAP members (including the nature of investment information to provide CAP members, the need for investment decision-making tools and consideration of selection of a service provider to give investment advice);
• introducing a CAP to potential members (including providing information on investment options, how to transfer among investment options and disclosure of fees, expenses and penalties);
• ongoing communications (including the need to provide member statements at least annually and their content, other information that should be made available upon request to CAP members or should be reported to CAP members, such as changes to investment options, and performance reports for investments);
• maintaining a CAP (including a review of service providers, investment options, decision-making tools and maintenance of records); and
• termination of a CAP.

But remember, although the CAP Guidelines are touted as a best practices model, they do not establish a “safe harbour,” in which a plan sponsor is protected from liability for making financial decisions in good faith. However, from a legal perspective, if a plan sponsor can show compliance with the guidelines in the event of litigation, this may assist in buttressing a due diligence defence to any allegations of plan sponsor negligence or wrongdoing.

U.S. Litigation
In the U.S., there have been cases regarding the adequacy of fee disclosure. In one case, Hecker v. Deere & Co., the court determined that the fees contained in the CAP were reasonable, as there was no evidence that the fees charged to the members differed from the fees charged to the public. It appears that plaintiff’s counsel in the U.S. is also broadening its assertions to cover other grounds. For example, there is an ongoing class action in the U.S. in which the plaintiffs allege a breach of fiduciary duty because the options offered by the plan were limited to high-fee investments.

 Canadian Law
In Canada, while there has yet to be any court cases relating directly to CAPs, there have been other pension and benefits law cases that are certainly relevant for CAP administration. For instance, there are numerous cases regarding employee communications in the pension and benefits context that would be directly relevant to CAPs. These cases have highlighted the need for adequate, accurate, timely and understandable communications to plan members. The cases dealing with communication have also found that employers are potentially liable for not only written communications but also oral communications with their employees regarding benefits matters. In addition, there have been instances where the CAP administrator may have been found liable if the matter proceeded to court, but a settlement was reached with the employees without court proceedings.

So What Is the Hype?
As the CAP population begins to retire and more jurisprudence develops in other jurisdictions, there will be CAP litigation here. In terms of a legal cause of action, the claim may be brought on different bases, depending on the case, including breach of fiduciary duty, negligent misrepresentation or breach of contract.

To help minimize risk, plan sponsors need to adhere to the various applicable governance guidelines, including the CAP Guidelines, and pay very close attention to all employee ommunications—including providing accurate and timely information and ensuring that such information is understood by CAP participants.

A well-run CAP not only minimizes the possibility of litigation but also builds employee loyalty to the plan sponsor and empowers employees to take responsibility for their retirement goals. BC

Janice Holman is a principal with Eckler Ltd., and Jana Steele is a partner with Goodmans LLP. jholman@eckler.ca, jsteele@goodmans.ca

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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the September 2010 edition of BENEFITS CANADA magazine.