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© Copyright 2000 Rogers Media. The following article first appeared in the February 2000 edition of
BENEFITS CANADA magazine.
The 10% rule
At the end of 1999, Nortel represented roughly 16% of the Toronto Stock Exchange 300 composite
index. Does that put your actively managed portfolio offside?
By Paul Litner
While prudence is currently the predominant means of regulating pension fund investment, one can never lose
sight of the quantitative limits contained in pension standards legislation. A prime example of how these
quantitative limits can present pitfalls for the unwary is in the application of the 10% rule.
The purpose behind the 10% rule is to prescribe a minimum level of diversification in pension fund
investment, beyond that otherwise required under prudent investment standards. While the language may
differ slightly and the exceptions to the rule are somewhat different from jurisdiction to jurisdiction,
the restriction on investment is the same--no more than 10% of the total book value of a pension fund's
assets may be loaned to or invested in any one person or group of related persons (e.g., Regulation 909
under the Pension Benefits Act (Ontario), s. 70).
Exceptions to the rule include: fully insured investments and deposits with a bank, loan or trust
corporation; issues, bonds or debentures of, or guaranteed by, a federal or provincial government; and
investments in segregated, mutual or pooled funds that themselves comply with applicable pension fund
investment requirements.
This last exception can give rise to interesting monitoring issues. Consider this common example: the
sponsor of a defined contribution plan permits members to direct the investment of their individual
accounts and, to facilitate this, enters into a contract with an insurance company. To ensure a broad menu
of investment options, members invest in different segregated funds of the insurer. However, some of these
segregated funds are simply flow-through vehicles, and any member contributions to them are fully invested
in separate third-party managed mutual and pooled funds.
WHAT TO DO?
Does the sponsor have to restrict members to investing no more than 10% of the book value of their accounts
in any one segregated fund? Prima facie the exception provided for investments in mutual, pooled and
segregated funds, that comply with the pension investment regulations, solves this problem. If the insurer
can secure assurances from the third party fund managers that such funds also adhere to pension fund
investment rules, then there should be little risk involved. Unfortunately, it is not always possible to
obtain these assurances.
Many mutual/pooled funds in the past complied only with the investment rules and limits in National Policy
(NP) No. 39. For the record, NP 39 of the Canadian Securities Administrators was replaced by National
Instrument (NI) 81-102 effective Feb. 1.
But managing a fund in compliance with NP 39 (or NI 81-102) does not mean compliance with pension
legislation. One key difference is that NP 39 requires a fund to measure the diversity of its assets on a
market value basis (as opposed to the book value basis required under pension legislation).
If a plan sponsor invests (or permits members to invest) more than 10% of the book value of the pension
fund in one or more pooled/mutual/segregated funds, and one of those funds does not comply with the 10%
rule, the administrator could be in breach of pension standards regulations. This problem is more
widespread than one might think and often creates structural problems where pension funds invest in
mutual/pooled/segregated funds.
If the fund manager is not prepared to monitor its fund on a book value basis, the underlying fund and
ultimately the pension fund will breach the 10% pension rule in the event that the mutual/pooled/segregated
fund holds more than 10% of the book value of its assets in any one investment.
At that point, the only solution is to ensure that no more than 10% of the book value of the pension fund
is invested in any one mutual/pooled/segregated fund. In our example, practically speaking, that means
limiting each member to 10% of the book value of his account in any one investment option.
Unfortunately this means more complexity, added cost and responsibility in monitoring investments for plan
administrators. However, it is a necessary step to ensure that pension fund investment limits are
respected.
Paul Litner is a partner in the pension and benefits department at Osler, Hoskin & Harcourt in Toronto.
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