Fiduciary Liability – A Survey of Recent Events

When we think of fiduciary liability exposures on pension plans, we tend to think more of situations involving significant funding deficit situations. Situations that can lead to an inability of the pension plan members to collect the benefits promised them. Perhaps less obvious an exposure is the situation involving pension plan surpluses and the use of those surpluses.

A recent case on this topic concerned Monsanto Canada (Monsanto Canada Inc. vs. the Superintendent of Financial Services). The issue at hand was whether Ontario’s Pension Benefits Act requires surplus be distributed from a pension plan if a partial wind-up of the plan is declared at a time when the plan is in surplus. The court upheld the position that the Pension Benefits Act imposes an obligation to distribute surplus attributable to members of the plan affected by the partial wind-up. Watson Wyatt suggests this Supreme Court of Canada decision will cause many plan sponsors to make changes to the design of their pension plans, as well as funding and investment policies. Such changes may be geared to ensuring the plan “under-performs” and does not build up a surplus, thereby avoiding the liability exposure altogether. In sum, there appears to be no safe median for plan performance. Plan fiduciaries face liability exposures for both deficits and surpluses.

PRUDENT ACTIONS

Plan administrators are insureds under fiduciary liability policies. As such, the actions of the administrator create an additional exposure for fiduciary liability insurance. In several recent Canadian cases (documented in Canadian Legal & Legislative Benefits Reporter v22 no4 pp 3-4 Aug 2004), the Ontario Superior Court of Justice ruled that a pension plan administrator failed to advise plan members of upcoming plan amendments. The court found that the administrators had a duty to inform members about the changes and therefore they had breached their fiduciary duties. The court also found that the plan’s communications policy was inadequate.

Another case (documented in Canadian Legal & Legislative Benefits Reporter v22 no4 pp 5-6 Aug 2004) illustrates the importance of taking corrective action once mistakes are discovered. The New Brunswick Court of Queen’s Bench found the administrator liable for his inaccurate statements. It turned out the inaccurate statements were an honest mistake, however, the court found the administrator liable because he was negligent (by not taking appropriate corrective action) after he realized his mistake. In addition, there was no evidence that the plan members should have known the differences in plans on their own, so the company was found liable for their damages suffered.

Also of note in this case is the position of the court in allowing the plan members to, in essence, plead ignorance with respect to understanding differences between plan options offered by the administrator. This is a key point that creates an additional exposure for defined contribution (DC) plans (compared to defined benefit (DB) plans). Traditionally, DC plans are seen as lower fiduciary risk since they do not “promise” a future benefit. However, there is now concern in the pension fund industry that DC plans can attract liability risk from not only failing to offer enough information to plan participants, but also overwhelming plan participants with information. As with pension surpluses, here again we see that there appears to be no happy median – plan fiduciaries must ensure participants are provided with adequate information and at the same time must be careful not to overwhelm participants with too much information and choice.

FEE ISSUES

Lack of participant knowledge about fees coupled with the fact that fees are often hard to isolate has created a “perfect storm” for fiduciary liability exposure. The fee issue is much more prevalent in the U.S. right now with recent action taken by Eliot Spitzer (New York’s Attorney General) who recently launched a series of investigations into commission and other fees charged by financial services firms. The mutual fund industry in both Canada and the U.S. is no stranger to the fee issue. Management fee expense ratios (MERs) and contingent commissions have a significant impact on investors’ ultimate return (as documented in the June 24, 2004 Globe and Mail article “The fee crunch: Not all investors get value for money” by Janet McFarland and Rob Carrick).

In the world of pensions, billions of dollars are paid annually in fees to fund managers by DC plan participants. These fees are for the management of their investments and may include other fees related to costs associated with their participation in the plans. Knowledge about investment fees is important to pension participants because of the wide range in fees that are charged and because of the negative effect of fees on net rates of return. Fiduciaries are exposed to liability because fees charged to the pension plan have the effect of reducing the ultimate return to the pension participants. Part of the fiduciary role is to ensure fees charged are reasonable and clearly disclosed to participants.

Surveys conducted in November and December 2003 by the American Association of Retired Persons (AARP) found participants generally do not know how much they are paying in fees on their pension plans. While this survey sampled Americans only, I would anticipate similar results for Canadian pension participants. A key role for the pension plan fiduciary is to control the fees and expenses that are charged to plan participants and to ensure that such fees and expenses are clearly disclosed to, and understood by, all plan participants. The Employee Retirement Income Security Act of 1974, known as ERISA, is the U.S. federal law that governs how company officials, or “plan fiduciaries” as they are called under ERISA, manage and administer corporate retirement plans. In Canada the relevant regulations are found in the Pension Benefits Standards Act (PBSA) administered by The Office of the Superintendent of Financial Institutions (OSFI). These regulations impose numerous duties on plan fiduciaries, one of which is to control the fees and expenses charged to plan participants. If fiduciaries violate this duty, they may be held personally liable for the losses that plan participants suffer as a result. Fiduciaries should assess whether fees are reasonable in light of available investment and other alternatives.

Following and documenting the appropriate due diligence will not only help establish that the plan fiduciaries have met their fiduciary responsibilities under the relevant regulatory requirements, but will also help to improve the plan for the benefit of plan participants.

LEARNING OPPORTUNITY

“Knowledge is of two kinds. We know a subject ourselves, or we know where we can find information on it,” comments Samuel Johnson, as quoted in Boswell’s “Life of Johnson – English author, critic, & lexicographer (1709 – 1784)”. This survey of some recent events in the fiduciary liability insurance world underscores the importance of knowledge in all aspects of this coverage.

Insurers, brokers, plan administrators/consultants and fiduciaries themselves all stand to learn a great deal from each other. This learning opportunity is even more important to leverage today. This in light of the fact that fiduciary liability insurance is not widely understood by brokers and the fact that the market for fiduciary liability insurance is facing a great deal of uncertainty (claims, increasingly restrictive wordings, etc).

Industry participants should leverage each other’s strengths and knowledge. Insurers should take every opportunity to meet with pension administrators and consultants to obtain more in-depth knowledge on the fiduciaries and the plan being considered. This advanced knowledge is found in the pension administrators’ familiarity with the plan participation agreements, trust documents, history, and background on the contributing employers, e
tc. Increasing the knowledge level amongst all industry players will contribute to more accurate and consistent underwriting of the fiduciary risk for insurance and will result in a better end product for the consumer (the insured fiduciary) and, ultimately, the plan participants.