Pensions at Risk

To protect against the depletion of pension plan assets and to insulate themselves from litigation risk, plan sponsors and administrators should review their current governance structure—in particular, to determine if the appropriate mechanisms are in place to respond to dramatic changes in financial markets and manage investment risk. Once any limitations or inadequacies in the current governance structure have been identified, sponsors or administrators should implement changes to those structures.

This article provides an overview of pension plan governance for single-employer plans and the adaptation of current governance structures in response to the global financial crisis, including the management of investment risk. While the focus will be on pension plans registered under the Pension Benefits Act (Ontario) (PBA), it is applicable to plans registered in other Canadian jurisdictions as well, due to the similar obligations of sponsors and administrators under the various statutory regimes and well-established cross-jurisdictional guidelines relating to pension plan governance.

The legal framework
Pension plan governance is the process by which a plan administrator and/or sponsor discharges its legal obligations with respect to a pension plan. The sources of those legal obligations include statute and common law concepts such as fiduciary duties and contractual obligations. Good governance will reduce the risk to a sponsor or administrator of being subject to legal liability in connection with the maintenance of a pension plan.

The PBA imposes primary legal responsibility for the administration and operation of employer-sponsored pension plans and their related funds on the employer that maintains them. In the case of a corporate employer, this generally means that ultimate legal responsibility for plan administration rests with the board of directors.

Subsection 22(1) of the PBA requires the pension plan administrator (i.e., the principal employer under the 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.” Subsection 22(2) requires that, in the course of administering a pension plan and investing the assets, the administrator use “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 22(4) states that the administrator of a pension plan cannot “knowingly permit the administrator’s interest to conflict with the administrator’s duties and powers in respect of the pension fund.”

The reference in subsection 22(2) of the PBA to the administrator using all relevant knowledge or skills that it possesses or ought to possess may impose a higher duty on more sophisticated entities that have—or, by reason of their profession or business, ought to have—certain knowledge and skills pertinent to the administration of a pension plan and/or the investment of a pension fund. Also, an argument can be made that simply as a result of being the administrator and being responsible for investing the assets, a person can be presumed to have relevant knowledge and skills that he or she must exercise in connection with the plan and fund.

Over and above the statutory requirements, the plan sponsor or administrator may be subject to general fiduciary duties under the common law with respect to plan administration and pension fund investment. Historically, the relationship between an employer and its employees was viewed by the courts as contractual, and fiduciary duties were not perceived on either side. But more recently, Canadian courts have concluded that it is possible for an employer to have fiduciary obligations to its employees with respect to retirement arrangements. Basic fiduciary duties include the following:

• a duty to act reasonably and prudently;
• a duty of loyalty to those persons whose interests the fiduciary is protecting (a fiduciary cannot take into account considerations other than the best interests of those persons);
• a requirement for the fiduciary not to let personal interest conflict with duty;
• 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 the competing interests of those on whose behalf the fiduciary is acting.

Plan administration and investment matters that typically fall within the fiduciary obligations of the entity responsible for the administration and operation of the plan include investment of the assets (including developing and implementing an appropriate investment policy); correct calculation and payment of benefits; proper remittance of contributions (i.e., the right amounts within the time required); appropriate communications to members; and compliance with applicable laws and the terms of the plan.

The nature of these duties—and the potential risk relating to each duty—will differ depending on the plan type. For example, if the pension plan is a DC plan under which members direct the investment of all amounts contributed to their accounts, then the sponsor or administrator may be more at risk for claims relating to the provision of investment advice that turns out to be inaccurate, incomplete or otherwise inappropriate for the member; failure to inform and educate members about the investment options under the plan and basic investment principles; and imprudent selection of investment options. With a DB plan, members are generally not directly at risk due to the selection of investments, so the sponsor or administrator is less likely to be liable for breach of fiduciary duties relating to plan investment, provided that the investments comply with applicable laws and perform adequately as per the investment policy implemented by the sponsor or administrator and general market conditions. However, the sponsor or administrator may have more legal exposure with respect to the payment of benefits, communications to members and application of surplus assets.

Principles of plan governance