Employers’ duties to pension plan members

(July 2008) The financial services industry is familiar with the decline in the number of defined benefit pension plans in the private sector and the growth in the number of defined contribution plans.

In many cases employers are abandoning defined benefit plans, primarily to place a cap on their contributions and reduce funding liabilities. Employees are also seen to benefit as they often have the opportunity to select from various investment options that are better aligned with their individual financial goals and risk tolerance.

There seems, however, to be little or no discussion of the potential risks faced by employers who offer defined contribution plans arising from their obligations to employees.

When an employer selects a plan provider, his or her employees are relying on the employer’s choice. While employees are generally not obligated to participate in a pension plan, when the employer also contributes to the plan, the incentive to participate is great.

Typically, the “hands on” delivery of plan details to members includes an explanation by representatives of the financial institution to a group, or groups, of employees on how the plan works and which investment choices are available. The initial explanation also gives employees instruction on how to complete the required investment experience, time horizon and risk tolerance documentation.

While the representatives are available to answer any questions, these are often not raised. Often the group has not been given sufficient time to review the materials provided. They may also fear asking, in the presence of their colleagues, questions that may seem stupid.

Employees rightly or wrongly assume that the employer will choose a provider who will provide at least an adequate level of service. As the dollar amounts of contributions from individual employees tend to be small, and the employers are tempted to minimize their cost of sponsoring the plan and the cost of time spent with employees, the “DIY” approach is often favoured. Unfortunately, many employees are not able to complete these forms in a satisfactory manner — they have no qualifications and little to no experience in financial matters.

How does this lead to potential liability for employers?

A review of the literature on cases involving the Employment Retirement Income Savings Act (ERISA) shows that the common, and often successful, claims made against American employers for failing to meet their obligations to employees are similar in substance. It is alleged that employer sponsors

a) entered into agreements with service provides (plan administrators) that charged unreasonable and excessive fees,

b) failed to inform themselves and understand how plan administrators and their affiliates earned income from the plans,

c) failed to monitor plan fees and expenses, and

d) failed to monitor the performance of investments available in the plan.

For employers in the U.S., there are “safe harbour” provisions in ERISA that, if complied with, protect them from liability for failing to meet their obligations. There are no similar provisions in Canada with regard to defined contribution plans.

While employers often require plan administrators to comply with Capital Accumulation Plan (CAP) Guidelines that satisfy regulatory requirements, there is no assurance that this alone will protect employers from civil liability related to claims based on any of the four allegations listed above, or their breach of fiduciary duty.

Further, recent publications by regulators would suggest that the obligation to “know your client” requires plan sponsors to collect more extensive minimum information about clients than was the industry standard for many years. It is not clear whether or not compliance with CAP Guidelines is enough to protect mutual fund dealers or advisors providing support for defined benefit plans.

Perhaps it is early to expect to find many court judgments related to cases alleging wrongdoing on the part of employers. A complaint, however, was settled several years ago where the guaranteed investments available to members of a self-directed RRSP were limited to those of a single issuer. When the single issuer failed, the union representing members successfully argued that the employer had a responsibility to those members whose guaranteed holdings exceeded the deposit insurance coverage, which should have made the investment whole — the employer should have either made other guaranteed investments available or specifically cautioned members when their investments exceeded deposit coverage limits.

Defined contribution plans may provide employers with a number of benefits, but employers cannot shirk their responsibilities to their employees without negative repercussions.

Richard E. Austin is counsel with Borden Ladner Gervais LLP in Toronto, and specializes in financial services, with a particular emphasis on registration and compliance matters. RAustin@blgcanada.com

(07/22/08)