Defined contribution plan sponsors are facing challenges that will shape the nature of their legal obligations to employees.
Member communication is a key challenge, said Jon Marin, an associate in pension and benefits at Osler, Hoskin & Harcourt LLP, during Benefits Canada’s 2019 Defined Contribution Investment Forum in Toronto on Sept. 27.
“In the vast majority of DC plans, investments are member directed,” he said. “And these members are being asked to make complex financial decisions that they often don’t have the requisite expertise to make.”
As well, when it comes to the outcome of investments and their related fees, DC plan members are the sole bearers of risk. “From a legal perspective, this creates the potential to place a microscope on the prudent selection and effective oversight of investment options and managers.”
Canada’s current legal framework for DC plans is designed primarily to deal with the accumulation stage, noted Marin. “Ironically though, the retirement period can — in many cases — have a greater overall impact on DC value than the initial accumulation phase. And this gives rise to complex questions, including who bears the responsibility for preparing members for the decumulation stage and how to improve upon retirement outcomes.”
Since defined benefit pensions have a much longer history in Canada, there’s little to no jurisprudence on DC investment specifics, he said, noting large cohorts of DC plan members are now nearing retirement. “It’s possible that concerns relating to retirement security are going to drive the same sorts of litigation we’ve seen in the U.S. And to me this points to the need to be proactive in managing legal risk under these plans.”
Notably, plan sponsors should be aware of the differences between case law and what’s occurred in common law scenarios, said Marin. He noted the case law in Canada is clear that a pension plan administrator is going to be considered to be acting in a fiduciary capacity for plan beneficiaries.
“I can say there’s certainly been a discussion as to whether this case law is stale, whether it would be appropriate in some contexts to consider non-financial interests. One of the biggest motivators of this debate is the increasing focus on environmental, social and governance factors in a plan’s investment policies and procedures. The duty to act reasonably and prudently is similar under the prudence standard under pension standard legislation.”
Marin highlighted a case that demonstrates where DC plan sponsors could hit some friction, specifically with regard to a plan administrator’s responsibility to invest assets in accordance with pension standards requirements, and its obligation to prudently monitor external delegates.
“At issue here were investments made by an investment committee in Caribbean hotel and resort properties, and it caused the plan to lose a significant amount of money,” he said. “Charges were brought by the Crown against members of the plan’s investment committee who authorized the investments, as well as the against the board of trustees who were the plan administrator for its failure to properly supervise the investment committee.
“In this case, the court found that the defendants were not guilty of breaching the prudence standard, but I will say that was largely due to evidentiary issues; they didn’t put forward a good case as to what the prudence standard meant, so the judge felt he couldn’t find them to have breached it, but a better presented argument almost certainly would have resulted in a different conclusion.”
However, the investment committee members were convicted of breaching the 10 per cent diversification rule, referring to a federal investment rule that stipulates that no more than 10 per cent of plan assets can be invested in any one person or affiliated person, noted Marin. “So there was breach of that rule. And also the trustees were convicted of failing to supervise the committee. So what are the key things that can distilled from this case from a legal perspective about the duty of prudence?
“First, when considering what the duty of prudence meant, the court accepted that prudently investing pension plan assets is a bit of a balancing act. While prudence means that capital shouldn’t be unduly placed at risk of loss, it also means that capital should be invested to generate a suitable rate of return and that entails taking some risk. In this regard, the court said that an analysis of prudence should not be focused on the outcome, but must instead be focused on the investment process that was followed. So was there due diligence in selecting the investment funds or managers? Was there effective oversight?”
Further, the court made it clear that it was incumbent on the board of trustees and the investment committee to obtain expert advice if they were unable to prudently monitor the investments themselves, he added. “This reinforces the point that in today’s environment, there was an expectation that, where there is isn’t internal expertise, external support will be obtained to assist with the process.”
The case becomes even more eye-opening when one considers the plan was a multi-employer pension plan, which meant the employer contributions were fixed, said Marin. “So in some ways it’s a lot like a DC environment because retirement outcome depended in large measure on investment performance. The court said, given the vulnerability of members, the prudence standard was actually higher in this scenario than it might even be in a defined benefit scenario. And I think that suggests a similar approach could be adopted in a DC environment.”
Finally, the case shed further light on how a court might view the administrator’s duty to prudently select and supervise delegates as a separate and distinct part of the duty of prudence, he said.
“One of the things I’ve alluded to is that one grey area under the law is whether external third-party providers will be subject to fiduciary obligations, under either pension standards legislation or the common, There have been a few places where claims have been made against external providers, including investment consultants, actuaries, with allegations that they’ve breached their fiduciary obligations. However, these cases have all been settled, so we don’t have clear sense of how a court would deal with these issues.”
Read more coverage from the 2019 Defined Contribution Investment Forum.