DC on the defence

Others argue that this risk is overstated; that we won’t see this rush to litigate.

But what worries employers is that the Guidelines for Capital Accumulation Plans do not offer the ‘safe harbour’ provided by ERISA in the U.S. So, the big question for plan sponsors is: “If I comply with the CAP Guidelines, am I still vulnerable to litigation?”

There is also the advice component. If plan sponsors make financial advice available to their plan members, could they be sued if the advice is bad?

Unfortunately, no Canadian court has answered these questions, so there’s no legal precedent. But that changed on Feb. 2 and 3 in Quebec. A precedent-setting mock trial unfolded at our 2006 DC Plan Summit and the hypothetical ABC Company had to face the charges of a an unhappy employee with pension assets far short of his target.

THE PLAINTIFF
Jim Smith is a 55-year-old manager of purchasing services in the procurement department of ABC Company. He and his wife have a simple dream of opening a bed and breakfast when they retire.

Shortly after joining the company in 1991, Smith enrolled in the pension plan. He transferred the commuted value of $86,000 from his previous pension plan into his DC plan at ABC. He invested the entire amount in the Balanced Segregated Fund. Upon enrollment, Smith was provided with the standard enrollment package given to all plan members. At the time, he planned to retire at 60.

Seven years later when ABC Company included additional investment options in its plan, Smith’s pension had grown to $180,000. It was then that he decided to retire at 55 instead of 60. Using the retirement savings worksheet and calculator provided by ABC, Smith determined the assets in his plan would have to total $335,000 to have an adequate retirement income. His calculations also revealed he would need to realize an annual rate of return of 9% over his remaining eight years in the plan to meet this target.

With this in mind, Smith assessed the new fund options. Changes were needed to reach his target. One fund in particular caught his eye—the Canadian Technology Segregated Fund. It had realized 1-, 3- and 5-year annualized returns of 12%, 17% and 11% respectively as at Dec. 31, 1997. After consulting with a close friend, Smith allocated all of his plan assets into the tech fund. At first, it appeared he had made a wise and profitable investment decision. The value of his plan climbed to $225,000 in just two years. That was the peak. But the technology sector began its downward slide in 2001 and Smith’s investments took a hit. By 2002, as the tech sector continued to plummet, he returned what was left of his plan assets to the Balanced Segregated Fund. At the time of the lawsuit, Smith’s pension assets totaled $200,000, far short of the amount he needed to retire.

THE CASE AGAINST ABC COMPANY
Disgruntled with the situation Smith found himself in, he decided the best course of action was to take ABC to court. Thanks to inadequate investment knowledge, Smith’s plans to retire at 55 were a mess. After reviewing Smith’s case, Hugh O’Reilly agreed to take it on. On behalf of Smith, O’Reilly alleged the following:

1)ABC improperly delegated investment responsibility to Smith.
2)ABC breached its fiduciary duties to Smith(and plan members) by failing to provide a qualified investment advisor.
3)ABC breached its fiduciary duties, not warning Smith of the consequences of poor investment decisions.
4)ABC breached its fiduciary duties by providing Smith with improper investment options. Since it did not provide an advisor, the company was responsible for investigating Smith’s circumstances and ensuring individually tailored options were provided to him.
5)ABC breached its fiduciary duties to Smith by failing to monitor his investment decisions to ensure that they were appropriate for him.
6)Although the CAP Guidelines have only recently been adopted, they represent “best practices” that ought to have been followed by the ABC from the time the plan was established. ABC has only recently begun to follow the guidelines and this is evidence of the sponsor’s failure to meet its standard of care.
7)A failure to explain the risks associated with a DC plan and to ensure that the member receives advice constitutes a pattern of negligence that amounts to a negligent misrepresentation.
8)ABC failed to ensure that Smith was, at all times, provided with full disclosure of investment options as well as education about investment options and decisions.

THE PLAINTIFF’S CASE
Smith’s lack of investment knowledge became apparent during his cross-examination conducted by David Stamp of Osler, Hoskin & Harcourt LLP. Smith freely admitted to reading only the instructions in his enrollment package and being overwhelmed by all the information provided. “I did not get a chance to read it all,” he said. “I’m a very busy person. My job is very demanding.” Smith never attended any of the lunch-hour seminars held by the fund manager except for the mandatory one-hour session held in 1998. He never called HR with any questions either. He did not deny knowing it was his responsibility to make investment decisions, but did assert he had no idea of the scope of such an undertaking.

When asked why he decided in 1998 to put all of his fund assets into the Canadian technology fund, Smith explained he wanted to retire at 55 instead of 60 to start the bed and breakfast early. The retirement tools he was provided revealed he needed to earn at least 9% a year on $180,000. “So when I saw how much the technology fund was earning— like 12% or something like that—I figured it would help me reach my goal.”

Smith believed his move was a good one. In 2001, his plan assets had thus far increased by 25%. Then the market began to wane and Smith pulled out his money in 2002. “When I realized that the technology sector was going down the tubes, I figured I’d better get out soon or lose everything,” Smith recalled. Stamp pressed him to acknowledge no one guaranteed a high—or even specific— rate of return with his fund choices. He ended his cross-examination by pointing out that Smith can keep working and paying into his pension until the target is reached. “That’ll ruin our plans for the bed and breakfast though,” Smith lamented.“My wife and I really had our hearts set on that.”

THE DEFENDANT’S WITNESS
Rita Jones is the vice-president of human resources for ABC. Jones oversees the company’s DC Plan. According to her testimony, the plan is provided as a way of helping employees save for their retirement needs and is intended to act as a supplement to other sources of retirement income such as RRSPs and the Canada Pension Plan. “We never said that the plan was intended to provide for all their retirement needs,” she said, adding, “I think that’s pretty obvious.”

Throughout her testimony, Jones was steadfast in her opinion that the investment decisions for each plan member are their own responsibility. At each stage of the plan’s development, HR ensured all of the plan’s members were provided with the necessary information packages(see information provided, page 43)to aid in their decision-making. While no aggressive efforts were made to ensure members read the materials, the envelopes in which the information was delivered indicated it was important information about their pension plan. Seminars were not mandatory but were offered at the office during lunch hours. Plus, members were instructed to contact HR if they had questions.

“Is there anyone [in the HR department] who’s qualified to provide financial advice or further explain concepts about investment risk or retirement savings?” asked O’Reilly during the cross-examination.

“We don’t have any financial experts in HR,” said Jones, “but we certainly could have answered some of their questions.” In fact, Jones’ HR department fielded numerous questions about enrollment forms.

But O’Reilly recapped that ABC provided the information but did not ensure all members understood the materials and assumed all members were making appropriate investment decisions.

“We assumed that if they did not ask questions, they had enough information,” snapped Jones.

ABC felt no obligation to investigate the individual circumstances of its plan members to determine if the investment options provided by XYZ Financial were the ideal fit. “The time, resources and expense required to do that would be immense,” Jones said, adding it is impossible to know individual spending habits, risk tolerance and investment goals of each member. “We’re not in the business of telling people how to run their lives.”

ABC has ensured compliance with all pension legislation and tax regulations throughout the plan’s maturation. Most recently, it has complied with the CAP Guidelines as of the Dec. 31, 2005 deadline. Jones reminded the jury that back in 2000, with the increasing complexity of both the global investing market and the options provided, annual reports encouraged plan members to seek independent financial advice for their investment decisions.

THE VERDICT
The jury found in favour of ABC Company. It felt it was not improper to delegate investment responsibility to Smith and there was no fiduciary duty to provide education for members. The jury also felt ABC had no responsibility to provide a qualified investment advisor to its members.

It was clear in the nature of the plan design that choices were to be made by members. Smith made several decisions throughout his time in the plan, which demonstrates he was aware of this responsibility.

The jury felt ABC was also not at fault for failing to provide investment advice or for not advising Smith that his particular investment decisions were not the right ones for him. Given privacy legislation, the jury felt that the company could not investigate Smith’s individual financial situation to ensure it was offering the right options for him. Under the CAP guidelines, ABC has a responsibility to offer a variety of options to plan members— which it did—even if some of those choices are not ideal for all members.

Throughout the years, ABC made a diligent effort to maintain best practices with respect to its pension plan. The jury felt it acted in good faith. In fact, the jury believed Smith contributed to his predicament by not attending seminars, not reading materials, and not seeking independent investment advice when planning his retirement strategy.

Though the outcome for sponsors was positive in this case, the message is clear: employers need to cover all bases when communicating with employees about the investment choices they make. ABC ensured that it was compliant with all legislation. Nevertheless, Jim Smith’s pension fell through the cracks, paving the way for a lawsuit. So the best way sponsors can prepare is by complying with the CAP Guidelines, communicating frequently with plan members and ensuring they understand the choices they are making. Showing such diligence will no doubt be beneficial if they ever find themselves facing a judge and jury in a court of law.

Leigh Doyle is assistant editor of BENEFITS CANADA. leigh.doyle@rci.rogers.com