In large part, the current move by many plan sponsors to a DC pension plan has been fuelled by a desire to escape the inherent risks (and costs) associated with sponsoring and administering a DB plan.
But offering employees a DC plan also carries risks for employers. These risks are likely to become more apparent in the near future, since recent regulatory developments and pension reform efforts in Canada are increasingly focused on DC plans and the legal obligations of employers and others that administer such plans.
A capital accumulation plan (CAP) is a type of DC plan in which members direct the investment of assets in their individual accounts. CAPs can include registered pension plans (RPPs), savings plans and group RRSPs. Historically, CAPs have not been the subject of litigation in Canada. However, the legal risks and obligations faced by sponsors and administrators of these plans are arguably greater than those under DB plans, since employees’ retirement income or savings is dependent upon the investment decisions those members make based on the information they receive from their plan administrators.
It’s important to remember that an administrator of a CAP (whether an RPP that is subject to pension standards legislation or not) and its delegates are fiduciaries and thus will be held to a fiduciary standard. Among other things, fiduciaries have a duty of loyalty, a duty to act prudently and reasonably in the selection and monitoring of its delegates, and a duty to provide information to members. While there has been minimal case law dealing with the administration of CAPs, administrators can find some guidance in Canadian court decisions dealing with DB pension plans to ascertain the legal principles that apply to CAPs.
Fiduciary duties
In 2011, the Ontario Court of Appeal confirmed in Indalex Limited (Re) 2011 ONCA 265 that a plan administrator’s fiduciary obligations arise at common law, where it could be reasonably expected that one person in the relationship would act in the best interest of the other person in the relationship, and by virtue of pension standards legislation. The court also confirmed that administrators owe a fiduciary duty to plan members to act in their best interests, notwithstanding any conflicting duties. This means, when an employer is both plan administrator and sponsor, it must put the conflicting duties of these roles aside and act in the members’ best interests.
Member communication
Recently, in Ault v. Canada (Attorney General) (2011), the Ontario Court of Appeal recognized the importance of disclosing information to plan members and confirmed its previous decision in Hembruff v. Ontario Municipal Employees Retirement Board (2005), where the court determined that there is a duty to communicate information that is “highly relevant” to beneficiaries of a pension plan. Although the facts of these two cases do not involve CAPs, the principles articulated by the courts can be readily applied to the CAP model where information relating to investment options and plan terms are important, since plan members’ retirement income is dependent solely on their investment decisions.
Selecting and monitoring of delegates
The courts have also considered an administrator’s responsibility to select and monitor its delegates. In R. v. Christophe (2009), the Ontario Court of Justice was faced with the criminal prosecution of the trustees and investment committee of a multi-employer pension plan in connection with the (allegedly imprudent) investment of plan funds. The court viewed the multi-employer pension plan as a DC plan and acknowledged that there is an increased need to protect the interest of the DC plan members, due to their vulnerability to the outcome of investment decisions. The court also noted the administrator’s fiduciary duty to prudently select and supervise its delegates—which gives legal responsibilities to the plan administrator to select and monitor investment options and managers.
Applying this principle to the CAP model, the administrator has a duty to prudently select the investment options available to plan members—including the default option—and to monitor such investment options. Arguably, this duty could also extend to non-traditional CAPs, where members’ options are essentially unlimited (i.e., they are not offered a selection of funds in which to invest but, instead, are able to invest the funds in their accounts in any publicly available investment), and give rise to an obligation on the administrator to select and monitor investment advisors and brokers made available to the members.
Stateside trends
DC plan litigation has become an emerging issue in the United States. Plan members are bringing claims against their employers for excessive fees and failure to adequately disclose such fees and expenses. Recently, in Tussey v. ABB, Inc., et al., a district court found that the employer breached its fiduciary duties by failing to monitor recordkeeping costs, failing to negotiate lower recordkeeping costs, agreeing to pay recordkeeping costs that exceeded market costs and replacing an investment fund with an inferior fund offered by an affiliate of the recordkeeper.
Another emerging trend has been for increasing regulatory involvement in the way in which CAPs are managed. The class of advisors considered to be fiduciaries has been expanded, and the U.S. Department of Labor recently required service providers of 401(k) and other pension and profit-sharing plans that allow participants to direct investment of their accounts to provide new fee disclosure. The new requirement applies to all mutual fund families that provide recordkeeping or brokerage services, in addition to investment platforms for 401(k) plans, as well as investment managers, advisors, recordkeepers and administrators, and even to the managers of investment funds that are treated as holding plan assets. Third-party fiduciaries and vendors to U.S. pension and profit-sharing plans were required to provide mandatory fee disclosure to the plan fiduciaries responsible for hiring them by July 1 this year. Retaining a service provider that has not provided the disclosure is a prohibited transaction under U.S. pension law (i.e., Employee Retirement Income Security Act).
Even more recently, the U.S. Department of Labor has issued regulations requiring administrators to inform plan members of how much their plan participation costs (i.e., administrators must disclose direct and indirect fees to members). This includes full disclosure of any charges or penalties resulting from switching from one fund to another, basic information (e.g., fees, transaction costs) associated with any brokerage windows available to participants and fund expenses as a dollar amount.
To date, while there has been little litigation relating to CAPs in Canada, a trend relating to regulatory involvement is beginning to take root. Consider the following:
- In 2004, the Joint Forum of Financial Market Regulators released the Guidelines for Capital Accumulation Plans (CAP Guidelines), which reflect what Canadian regulators consider to be best practices. Although these guidelines do not have the direct force of law, regulators have stated that they expect all CAPs to be administered in accordance with the guidelines.
- CAPSA recently released draft guidelines entitled Defined Contribution Pension Plans Guideline. These are intended to supplement the existing CAP Guidelines to provide further guidance on the legal responsibilities of plan administrators, sponsors and other parties in relation to DC plans, and to elaborate on the information to be provided to plan members.
- Amendments to the Pension Benefits Standards Act (Canada), which are not yet in force, attempt to address DC RPPs and investment options relating to such plans. Specifically, the amend-ments state that administrators must offer members investment options of varying degrees of risk and expected returns that would allow a reasonable and prudent person to create a portfolio suited to his or her retirement needs.
- The draft regulations and legislation relating to pooled registered pension plans (PRPPs) require such plans to be provided at “low cost” (and attempt to define what low cost means), require enhanced fee disclosure to members and prescribe conditions relating to investment options made available to members.
Since there is increasing evidence of regulatory focus on the legal obligations of plan administrators in relation to CAPs—a trend expected to grow here in Canada based on the U.S. experience—plan administrators will need to focus more closely on their role in relation to such plans and in particular their governance practices, due diligence on investments and communications in order to manage risks. Those employers that aren’t willing to take steps to mitigate legal risk should consider the PRPP instead (once the provinces enact legislation that allows this plan to be offered), as it appears to require much more limited employer responsibility.
Paul W. Litner is the chair of the pension and benefits department, and James Fera is a pension associate with Osler, Hoskin & Harcourt LLP. plitner@osler; jfera@osler.com