© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the September 2005 edition of BENEFITS CANADA magazine.
Coming to terms with fee disclosure
Fee disclosure is a key component of the Joint Forum’s Guidelines for Capital Accumulation Plans. Plan sponsors should manage and disclose their fees as part of their fiduciary obligations.
By Joan Johannson

With the impending Dec. 31, 2005 deadline for compliance stipulated in the Guidelines for Capital
Accumulation Plans
(CAPs), there has been increasing focus on section 4.4, which outlines requirements relative to fee disclosure. This is clearly a principle of good governance. It states that plan members and plan sponsors should know what investments they are purchasing, their associated costs and the investment product’s performance.

“Employers negotiate fees which members pay, often in the form of lower investment returns,” explains Colin Ripsman, Mercer Investment Consulting’s national coordinator of defined contribution(DC)consulting in Toronto. “As a result, a key fiduciary responsibility of the plan sponsor is to ensure the fees paid by members under the plan are reasonable.

“In a bundled recordkeeping environment, the investment fees and recordkeeping fees are normally combined in an aggregated asset-based fee. The objectives of the fee disclosure provisions of the CAP Guidelines are two-fold:
1. To provide the members with an understanding of the level of fees that they are paying and an appreciation for the services that these fees are supporting;
2. To provide plan sponsors with an understanding of what members are paying in order to ensure members are receiving value for their fees. In order to accomplish this objective, a plan sponsor must be able to break down the fees for the services they are receiving.”

The CAP Guidelines, finalized in May of last year also specify that “where appropriate, these fees, expenses and penalties may be disclosed on an aggregate basis…(provided their nature is identified).” However, those fees incurred by members by virtue of member choice should not be aggregated.

What types of charges against their investment options should sponsors look for that might currently be passed on to the member in fund-of-fund or segregated fund arrangements? This is a question sponsors should pose to their DC service providers. There are numerous possibilities which may be represented by a variety of names, often varying by plan. A quick checklist of possible costs should include: administrative fees for plan management; supplementary fees for educational programs; third-party fees for financial advice or guidance; third-party fees for brokerage or investment structuring and monitoring; administrative backdating for reconciliation purposes or to cover for timing discrepancies in placing trade orders, etc.

While in some cases these fees were agreed when the plan was originally established and have been disclosed due to changes in sponsor management, consultant support or a lack of documentation, it is possible that knowledge of these arrangements has been lost.

Additionally, while disclosure to the sponsor may be in place, disclosure to the member has generally been overlooked, especially since there is no specific requirement for such disclosure unless a change were to be considered “material” under the Insurance Act. It is therefore particularly notable that this principle has been included in the CAP Guidelines to cover this possible gap in governance.

For those plans administered under securities law, compliance with existing regulations requires disclosure of all fees and charges to investors which are, in the case of DC plans, the plan’s members. However, securities-based service providers represent only one segment of this industry of DC recordkeepers and hence many sponsors and their members are not covered under these laws and regulations.

Compliance for most plan sponsors will require a review with their consultant to ensure they have appropriately disclosed costs to their members both for compliance with the CAP Guidelines and from the perspective of good governance.

The duty is clearly with the sponsor to be aware of all costs to the member and ensure that they are appropriate. One might then argue that it is also a fiduciary duty to ensure that the member is aware of these costs, which are actually charged against their holdings, and their possible impact on reported performance.

“It seems to me that the CAP Guidelines start from the implicit assumption that the underlying investment funds meet modern-day standards with respect to how they are structured, operated and governed,” says Glorianne Stromberg, a former commissioner of the Ontario Securities Commission in Toronto. “This would include a mechanism for objective, independent oversight by a board of directors, trustees or other fiduciaries and would include provision for the fund to be audited by independent auditors. There is also the implicit assumption that management will have consistently complied with clearly defined rules for calculating net asset value, forward pricing for the issue and redemption of units and stringent procedures for error corrections or fund adjustments.”

In response to comments that these principles may not be reflected in some segregated and other investment funds, Stromberg cautions sponsors against selecting any investment option that does not reflect these basic principles. She adds that sponsors should also ensure the fund clearly discloses all management fees and operating costs that are charged to it and should insist that all performance information be shown net of such fees, costs and expenses. She also states that sponsors have a duty to members to insist on these standards being followed.

Mike Still, a consultant with Aon Consulting in Toronto, provides an example of where such standards were requested. According to Still, “Aon was recently hired to help a firm address its compliance concerns as a result of the release of the CAP Guidelines. A natural first step was to create a comprehensive governance document including monitoring criteria, which, in part, required that we determine the actual fees the plan sponsor was being charged. During the course of the fee investigation, it became apparent that fees had not been reviewed for 10 years. The sponsor very quickly ran into resistance and was told repeatedly by the service provider that an actual fee dollar value was not available.”

Still says that, in addition to this poor level of customer service that came to light, the difficulty the provider actually had in producing the fee data was alarming to the sponsor. The ultimate result was a new provider search and the subsequent firing of the service provider. He says service providers, whether insurance companies, consultants or agents, should recognize that the new focus on monitoring and disclosure is becoming a much larger issue.

In order to prevent the above scenario from occurring, it is important that fee information be made available to consultants for their review and analysis. Software programs have been developed as an analytical tool which can serve also as an audit on behalf of the plan sponsor, comparing gross and net unit values. The discrepancy, aside from the odd temporary cash flow implication, should be the agreed and expected costs and fees.

This does additionally require, however, that both gross and net unit value records have been retained by the service provider for an extended period of time—say five years—at the plan and even member levels. In the event of a court case, usually the issue at hand will involve an analysis of financial data in the favour of one party or the other. Should costs be at issue, detailed and reliable records should be available to support the sponsor and clearly demonstrate good governance.

Still says sponsors may be horrified when the fees they are paying are ultimately disclosed. And this element of surprise may be due to previous sales agents portraying these plans as having no cost. “The new Guidelines are achieving their intended purposes, which is to force plan sponsors to sit up and take notice of the fees they are paying and the plan members will ultimately benefit from the increased disclosure.”

This disclosure will not only ensure that sponsors can fairly evaluate the cost of the plan versus its benefits(levels of service, accuracy of recordkeeping, effectiveness of education and communications, access to financial guidance, etc.)but will also permit them and their members to better understand the performance of members’ investment selections.

Another aspect of disclosure is the need to communicate what may appear as new fees to members. It is essential, in such situations, that the appearance of these charges against the fund does not detract from the overall benefit enjoyed by the plan members. This has been a challenge for the group health benefits industry for years, as companies have struggled to continue to provide coverage for essential medical costs and, in many cases, have shared these costs with their employees in order to continue with the plan.

Again, the overall value of this benefit is a primary focus of such communications and should include, where appropriate, the need to share some costs in order to properly support the plan.

Disclosure of fees without communications may create a negative reaction when properly executed communication can create peace of mind for both member and employer alike. “Helping our staff prepare for their future retirement needs is very important,” says Diane Low, director of corporate human resources at Canon Canada Inc. in Toronto. “For employees to realize the value of the plan they must be well informed and make good decisions.” To this end, Low says Canon has selected securities-based funds that provide full disclosure of associated costs. She adds disclosure alone is not pivotal to a positive feeling about any retirement program. “But our openness helps to create trust and goes a long way in letting our employees know we are seriously committed to helping them.”

The compliance deadline set by the Joint Forum of Financial Regulators of Dec. 31, 2005 was intended to provide time for plan sponsors and service providers alike to achieve compliance with any new stipulations in the Guidelines. It is not a due date after which an axe will fall upon the unprepared.

It is, however, a marker for the courts as to what the industry considers a reasonable period for achieving compliance. For all of us, it serves as a useful reminder of the steps we need to take to ensure we are prepared to meet the requirements of these Guidelines and the standards for governance which they represent.

DC plans provide a much-needed assist to employees who hope to save for a comfortable retirement. And perhaps Low from Canon says it best: that a properly governed plan with full disclosure “creates trust and goes a long way in letting our employees know we are seriously committed to helping them.”

Joan Johannson is managing director and senior vice-president, Integra Group Retirement Services in Toronto. JJohannson@INTEGRA.com