Sheer Prudence

A pension plan administrator has a legal obligation to invest plan assets prudently and in compliance with the quantitative limits on pension investments. Until recently, however, the content of the legal duty to make prudent pension investments had not received significant judicial consideration.

Following a regulatory investigation, the board of trustees and investment committee of the Canadian Commercial Workers Industry Pension Plan (CCWIPP) were charged with breaching the Ontario Pension Benefits Act (PBA) in connection with plan investments made between 2002 and 2003.

In a recent decision, the Ontario Court of Justice convicted CCWIPP’s investment committee for breaching the 10% investment limit under the PBA and the trustees for failing to supervise the committee in respect of those investments. While all defendants were acquitted of charges that the investments (in real estate and other business ventures) were imprudent, their success should be viewed with caution, since the Court did not find that the trustees had acted prudently in relation to these investments. Rather, the Court held that the Crown had not proven its case, since it had not introduced expert evidence to assist the Court in determining what would have constituted prudent investment practices.

From a pension industry perspective, the Court’s reasoning in this case is instructive. In terms of the diligence expected from pension fiduciaries, the Crown alleged that the defendants did not undertake thorough, complete and independent investigations before making particular investment decisions and argued that this violated the prudent person standard. (Section 22(1) of the PBA states that in the investment of a pension fund, the administrator shall exercise the care, diligence and skill of a person of ordinary prudence.)

The Court accepted that consideration of the prudent person standard should be judged based on the process by which individual investment decisions are made—not by the results. The Court also indicated that industry standards on what diligence is required in making investment decisions would be relevant in determining which processes were prudent for a pension plan. This suggests that prudence is to be judged for each investment within the context of the overall portfolio.

According to the Court, prudent investment means capital should not be placed at an undue risk of loss but invested so that it is capable of generating a suitable rate of return (and an element of risk may be necessary to generate such return). The Court also noted the following:

• investment committee members without specialized expertise should obtain advice from experts to supplement their knowledge and perform at the level of a fiduciary; and

• fiduciaries need to ensure that they are getting expert advice from an objective source (i.e., not the party seeking funding).

In order to limit a pension plan’s exposure to risk, the PBA prohibits more than 10% of the value of pension plan assets to be invested in any one person. In considering the plan’s investments, the Court found that the total exceeded the 10% threshold, thus violating the PBA. The Court held that the investment committee acted as the “administrator” in making the investment decisions and, as such, its members were found guilty of breaching the rule.

The Court also held that while delegation of investment decisions is permitted under the PBA, the administrator is obligated to supervise fund investment in a prudent manner. However, the Court found that the trustees failed to prudently supervise the investment committee relating to the quantitative limits and thus convicted the trustees of breaching Section 22(7) of the PBA.

There is good reason to think that these principles would apply equally to defined contribution (DC) plans. The Court found that CCWIPP was essentially a DC plan, since the employers had no obligation to top up any unfunded liability.

This decision is an important reminder of the need to focus on the process by which investment decisions are made in order to meet legal duties to invest prudently. Developing proper processes, taking expert advice when necessary and having proper documentation to support investment decisions are essential now that pension regulators are more actively regulating the prudence of pension investments. BC

Paul Litner is a partner in the pension and benefits department at Osler, Hoskin & Harcourt LLP.
plitner@osler.com

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