Minimizing Risk & Communicating Effectively When Converting to a Defined Contribution Plan

Transcription

1 Minimizing Risk & Communicating Effectively When Converting to a Defined Contribution Plan Canadian Institute s 13 th Annual Advanced Forum on Pension Reform, Litigation and Governance Jana Steele, Mitch Frazer and Andrew Oringer February 24, Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

2 AGENDA 1. The Law Relating to Plan Conversion i. Applicable Statutes ii. Common Law Principles iii. FSCO Policy and CAP Guidelines iv. Case Law 2. Risks Associated with Plan Conversion 3. Minimizing Risk 4. How to Communicate Effectively 5. The U.S. Experience 1

3 The Law Relating to Plan Conversion 2012 Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

4 (i) APPLICABLE STATUTES No direct statutory procedure for a pension plan conversion Key Principles: > Pension standards legislation varies from province to province > Jurisdiction where plurality of members reside governs conversion > If members in other provinces entitled to minimum standards in their own jurisdiction 3

5 Pension Benefits Act (Ontario) S. 22: Plan administrator must exercise care, diligence and skill that a person of ordinary prudence would apply in dealing with the property of another person and use all relevant knowledge and skill that the administrator possesses or, by reason of the administrator s profession, business or calling, ought to possess S. 14: Voids any amendment to a plan if it purports to reduce members accrued entitlement S. 26: Superintendent and plan members must be given adequate notice 4

6 THE ONTARIO HUMAN RIGHTS CODE S. 5: Guarantees every person the right to equal treatment with respect to employment without discrimination based on age S. 11: Allows for discriminatory behavior if it is reasonable and bona fide in the circumstances 5

7 THE EMPLOYMENT STANDARDS ACT, 2000 S. 44(1): No employer shall provide for a benefit plan that treats employees differently because of age, except as prescribed O.Reg. 286/01 (Benefit Plans) regulations permit different treatment in pension-contribution context 6

8 (ii) COMMON LAW PRINCIPLES Administrator = fiduciary at common law vis-à-vis beneficiaries of pension fund > Administrator can be liable for damages, restitution or other equitable relief for breach of duty General fiduciary standard: trustee must take same care in administering trust as ordinary prudent person would take in managing similar affairs of his or her own 7

9 (iii) FSCO POLICY C (July 1, 2004) Policy: sets out means of converting pension plan from DB to DC: Highlights > Members must be given the option of preserving accrued DB, instead of crediting the value to the new DC plan > The commuted value of the accrued benefits must be determined for each member > Where a DB plan is a FAE plan, a projection of salary increases must be taken into account to determine accrued benefits > Plan members must be given adequate notice of conversion > Where a plan is contributory, the amount by which the member s contributions exceed 50% of the commuted value as of the date of conversion must be added to the member s DC account > If the assets of the plan are not sufficient to cover the commuted value of the benefits, the employer must contribute the shortfall of the plan 8

10 CAP GUIDELINES Guidelines for Capital Accumulation Plans (published in May 2004 by the Joint Forum of Financial Market Regulators) > Outline and clarify the rights and responsibilities of CAP sponsors, service providers and members > Ensure that CAP members have the information and assistance they need to make informed investment decisions > Aim for similar regulatory result for all CAP products and services regardless of the regulatory regime that applies to them 9

11 CAP GUIDELINES cont d Guidelines are voluntary and reflect expectations of the regulators May be considered by a court In the U.S., ERISA contains statutory safe harbours to insulate an employer from liability if all the prescribed steps are properly taken (more on that later) In Canada, the CAP Guidelines set out industry best practices but there are no safe harbours to protect employers (except for limited safe harbour in the federal jurisdiction) 10

12 (iv) CASE LAW Nolan v. Kerry (Canada) Inc. (SCC 2009) St. Marys Cement v. United Steelworkers, Local 9235, 194 L.A.C. (4 th ) 72 Dawson v. Tolko Industries Ltd., 2010 BCSC 346 Halliburton Group Canada Inc. v. Alberta, 2010 ABCA

13 Nolan v. Kerry (Canada) Inc. (SCC 2009) Instructive re: structuring a plan Provides a framework for determining legal issues regarding the permissibility of cross-subsidization of an employer s DC obligations 12

14 St. Marys Cement v. United Steelworkers, Local 9235 Key Facts > An employer sponsored a DB plan and sought to unilaterally convert it to a DC plan > The plan text granted the employer the right to unilaterally amend or discontinue the plan Issue The CBA with the union provided that the plan text was part of the CBA, and it had no other provisions limiting this right > Can the employer unilaterally convert to a DC plan? 13

15 St. Marys cont d Ontario Labour Arbitrator > The union s argument that the CBA only incorporated a DB plan was rejected The CBA incorporated the Plan s entire text regardless of the type of plan > The union s only avenue to limit the unilateral right to amend or discontinue the plan is through bargaining The union cannot try in arbitration what it was unsuccessful at achieving through bargaining 14

16 Dawson v. Tolko Industries Ltd. Key Facts > The employer offered to convert employee DB benefits into a DC plan (with help from an actuarial firm) The DC entitlement turned out to be lower than the DB entitlement > The plaintiffs argued breach of fiduciary duty and negligent misrepresentation arising from the information provided to them > Some plaintiffs had signed a release upon their termination Issue Releasing the employer and it agents from any liability > Can the actuarial firm rely on the release? 15

17 Dawson cont d British Columbia Supreme Court > In a pre-trial motion, the Court held the actuarial firm could not take advantage of the releases to avoid litigation The releases were not specific enough to cover the actuaries > The Court reserved its judgment on the effect of the releases if the actuaries are held as joint tortfeasors at trial However, the case was settled before trial 16

18 Halliburton Group Canada Inc. v. Alberta Key Facts > Halliburton converted a DB plan to a DC plan (Jan 1, 2002) There was an earnings freeze for DB calculations as at that date > In 2005, the plan s definition of Best Average Compensation was amended to reflect the 2002 earnings freeze Issue This amendment was rejected by the Alb Superintendent interference with vested rights and retroactive reduction of benefits > Should the 2005 amendment be rejected and the 2002 earnings freeze rescinded? 17

19 Halliburton cont d Alberta Court of Queen s Bench > The Superintendent s decision was reasonable Alberta Court of Appeal upheld > The DB formula required the compensation number to be the highest for 5 of the last 10 years of employment prior to the employee s normal retirement date thus, there was a vested right based on this 5 of 10 year projection > To freeze earnings at an earlier date (i.e., the date of the conversion amendment) would be to retroactively reduce members benefits 18

20 Risks Associated with Plan Conversion 2012 Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

21 COMMON MISCONCEPTION Employers bear investment risk in DB plans and employees bear investment risk in DC plans Employees risks in DB plans include: > Inflation risk > Risk of employer insolvency > Risk that the employer will wind-up plan 20

22 THE REALITY More accurate to state: > Employers & employees share investment risks in DB Plans > Employees bear 100% of investment risks in DC Plans > Employers bear increased legal risks in DC plans 21

23 WHAT TO DO Thesis: In converting from a DB plan to a DC plan, employees increase their overall investment risks and, correspondingly, employers replace their investment risk with a new set of legal risks. Advice: Employers and employees should re-evaluate their assumptions concerning the overall desirability of a DC plan or a DC conversion. A DC plan may be very appropriate for some workplaces, but some employers convert for the wrong reason. 22

24 RISK HOTSPOTS Circumstances where plan administrators may attract liability in a plan conversion: > Cross-subsidization > Investments > Delegation > Conflicts of interest > Human rights claims > Constructive Dismissal 23

25 Minimizing Risk 2012 Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

26 CROSS-SUBSIDIZATION Employers may want to convert the plan for many reasons, including: > Reduce their financial risk > Use surplus in the DB plan to take contribution holidays in the DC plan (called cross-subsidization ) Avoid wind-up in DB plan (which crystallizes surplus) May amend the plan to close the DB plan to new members and convert the plan to DC on a go-forward basis But cross-subsidization may contravene trust agreement New asset transfer rules in Ontario (not yet in force) will require that DB plan assets be used to provide DB benefits DB & DC components must be part of the same plan 25

27 INVESTMENTS DB plan administrator must invest the assets in a reasonable and prudent manner DC plan sponsor may have fiduciary duties when making plan design decisions CAP Guidelines puts the responsibility on the employer to design the plan s investment options > The CAP sponsor should ensure a range of investment options is made available taking into consideration the purpose of the CAP Consider: number of funds offered (taking into account the diversity and demographics of plan members, etc.) 26

28 EDUCATION v. ADVICE Plan members may rely on discretionary investment advice provided by the employer > If the participant detrimentally relies on the advice, the participant may bring a claim for damages Investment education vs. investment advice > Plan sponsor should provide investment information to assist members in making investment decisions > Plan sponsor may retain a third party to provide investment advice 27

29 DELEGATION Administrator must: > personally select the agent and be satisfied that the agent is qualified to perform the tasks > supervise agents as is prudent and reasonable DB plan > typical agents = HR department, the actuary, the investment manager, the custodian, legal counsel DC plan has most of these agents and more > wide range of potential service providers (including investment advisors) 28

30 DELEGATION cont d Factors to consider in selecting a service provider: 1. Professional training and experience 2. Cost 3. Specialization 4. Understanding of pension legislation and other rules 5. Quality, level and continuity of services 6. Consistency of service offered in all geographical areas in which members reside (see CAP Guidelines) 29

31 DELEGATION cont d DC plan service providers directly communicate with and possibly give advice to plan members throughout membership This almost never happens in DB plans Increased opportunity for misunderstandings and misrepresentations 30

32 CONFLICTS OF INTEREST Legislation > Administrators cannot knowingly permit their interests to conflict with duties and powers regarding the pension fund Common law > Fiduciaries have an absolute obligation to ensure that their personal interests do not conflict with the performance of their duties > Avoid both actual and apparent conflicts of interest 31

33 CONFLICTS OF INTEREST cont d A plan participant may have a claim for breach of fiduciary duty in the conversion process if: > The employer selects service providers or investment managers with whom it has a previous relationship > Insufficient requirements are established for investments that would constitute conflicts of interest 32

34 HUMAN RIGHTS/ CONSTRUCTIVE DISMISSAL To avoid potential human rights claims, it may be preferable to allow existing employees the option of converting to the new DC plan Ensure that there are systems in place to preserve the current value of members entitlements 33

35 A FEW THOUGHTS Trend toward DC plans is a reaction to employeefriendly court decisions Employers should be cautious of different risks and responsibilities on a DB-DC conversion Employers should ensure that the DC plan fits their needs (eg. - cross-subsidization) 34

36 How to Communicate Effectively 2012 Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

37 COMMUNICATION In DB plans, there is little ongoing communication between the plan administrator and the plan members > ex - annual statements, termination statements, portability options, joint and survivor options, certain plan amendments In DC plans, there is regular communication between the parties > ex - investment making decision tools, investment and transfer options, and ongoing communications (see CAP Guidelines) More communication + more opportunity for plan members to make decisions = more likely to have a miscommunication or misrepresentation 36

38 HELPFUL COMMUNICATION TIPS Provide reasonable notice in an open and clear forum to inform affected employees Create accurate, clear and understandable information memos for employees Implement an investment education program for employees Use creative educational campaign materials Use focus groups and meetings as well as written information 37

39 The U.S. Experience 2012 Torys LLP, Goodmans LLP and Ropes & Gray LLP. All rights reserved.

40 UNITED STATES - BACKGROUND ERISA (Employee Retirement Income Security Act of 1974) > Reactive, like employee-benefits legislation generally > Remedial > Comprehensive and fully reticulated Plan design Fiduciary activity > A reinvented area > Law vs. lore 39

41 UNITED STATES FIDUCIARY RULES IN GENERAL Prudence > Investing with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims > Modern portfolio theory (investments not viewed in isolation) > Some refer to a prudent expert standard and to procedural prudence > Leaving us with - deference to nonconflicted, expert, educated fiduciary decisionmaking that takes into account all relevant considerations Certain other general fiduciary rules > Diversification (to minimize the risk of large losses) Exception for employer stock > Compliance with governing documents - insofar as... consistent with Titles I and IV of ERISA Prohibited Transactions > Per se > Self-dealing Contrast (i) general investment discretion with (ii) selection and monitoring of available investment alternatives under a participant-directed plan 40

42 UNITED STATES FROM WHENCE WE CAME Traditional plan defined benefit plan > Promised benefit > Required funding > Benefit formulas Cost and complexity > Changing funding rules > PBGC rules, oversight and premiums > Large liabilities (including to affiliates) > Evolving formulas 41

43 UNITED STATES TOWARDS DEFINED CONTRIBUTION PLANS The emergence of defined contribution plans, in general > Administrative costs > Simplicity Section 401(k) As compared with DBs M&P plans, volume submitter plans > Fundamental exception to tax principles governing timing of inclusion > Shared cost with the employee (and with the U.S. Treasury) > Safe harbor plans, SIMPLE plans > Automatic enrollment Section 404(c) of ERISA > Participant control > Required range of choices > Daily valuations, technologically advanced platforms > Allows fiduciaries to avoid responsibility for losses resulting from participant elections - although selection and monitoring obligations will continue to apply 42

44 UNITED STATES WITHER DEFINED BENEFIT PLANS? Together with a once-rising market... a perfect storm in favor of 401(k) plans? Advance notice of adverse changes to goingforward benefit formulas So is this the end of defined benefit plans? > Legacy defined benefit plans > Small-employer and professional plans > Attention from policymakers 43

45 UNITED STATES BE CAREFUL FOR WHAT YOU WISH Market downturns > The internet bubble bursts > Enron/WorldCom (leading to Sarbanes-Oxley) > The subprime crisis (leading to the TARP legislation) Emerged and emerging litigation > Types of cases Stock-drop cases Indirect-fee cases Subprime cases Next? > Addressing certain risks Attention to process, generally Committees Outsiders Fee transparency a multi-pronged approach > For fiduciaries 5500 reporting Disclosure under the 408(b)(2) exemption > Disclosure to participants 44

46 UNITED STATES WE ARE WHERE WE ARE Maybe the most important investment assets (retirement assets) are in the hands of those (participants) who may be inexperienced investors, with no guarantees > Investment-advice rules and exemptions Contrast with investment education > Examination of the definition of fiduciary and who should be liable for what But, whatever the pros and cons may be, the 401(k) plan has arguably become - and will remain - the centerpiece of U.S. retirement policy 45

47 Questions? 46

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