Issue: July/Sept 2010
Editorials

FUND GOVERNANCE

Signs of distress

What they are and how they should be handled. Pensions lawyer Jonathan Mort offers advice.

Jonathan Mort

Mort . . . involve the Registrar

At what point does a crisis encountered by a retirement fund become so chronic that the fund can be considered “distressed”, in need of external intervention to be rehabilitated? I’d suggest that it’s when:

  • There’s a failure to deliver the promised benefits;
  • Those benefits are particularly poor, or exposed to an inappropriate level of risk;
  • Costs to provide for benefits are excessive, or cannot be justified, or
  • The process of delivering benefits is untrustworthy so to stakeholders (members, employer, sponsor or Registrar) as to warrant intervention or involvement by the Registrar.

Basically, a fund is in distress when its viability is under a serious threat likely to materialise over the short term.

Inadequate governance must be at least one cause. It could arise, for instance, from a board being dysfunctional, lacking the necessary skills, not properly exercising its oversight responsibility or discretion, or not communicating adequately with its stakeholders.

But distress might be caused not only by governance failure. It can also be a result of inadequate service rendered by its administrator, investment manager, legal adviser or actuary.

The fund might also have legacy issues, such as poor member data or unreconciled employer contributions, making difficult the delivery of benefits. And environmental factors might play a part too, for example if an umbrella fund cannot ensure employer compliance with s13A of the Pension Funds Act to pay contributions.

A single situation can create a crisis for a fund; for example, a major retrenchment exercise or problems with the sponsor whose business is in difficulty.

There could also be important changes in the regulatory environment, such as a new methodology for actuarial valuations which is so different from previous requirements that there is considerable delay in providing benefits. It happened with the ‘surplus legislation’ where new requirements took so long to be promulgated that some valuations took years to be completed.

From experience, funds in deep distress are characterised by:

  • Invariably being umbrella funds (without a commercial sponsor);
  • Member data has been terribly poor;
  • There is typically poor compliance with s13A;
  • There is a high number of complaints before the Adjudicator:
  • There are high trustee costs;
  • There has often been non-compliance with fund rules;
  • The board has poorly exercised its oversight function and simply made bad decisions;
  • There has been abuse by service providers.

To start rehabilitating a distressed fund, the first step is to acknowledge that there has been a failure either because of external reasons (such as a service provider failing to carry out its function properly), or through inadequate governance by the board itself. At this time it won’t help to apportion blame because it won’t necessarily help in addressing the remedy.

The Registrar must always be involved in managing the return to health. He does not have a governance responsibility; that is squarely the function of the board itself. But he can be asked to advise on whether proposals to the fund constitute irregular or undesirable practice. This is not the same as asking whether an arrangement with a service provider is on acceptable or appropriate commercial terms.

A fund can ask the Registrar to undertake an inspection of the fund and its service providers (which is different from a compliance visit). But whenever the Registrar has become involved in a fund, whether or not at the fund’s request, the board must be completely transparent, co-operative, and report regularly to the Registrar on progress made.

Begin by ensuring that the fund’s governance is sound. This entails proper reporting of the benefit administration and investments, making certain that the rules are properly understood by the board, reviewing the contractual arrangements, communicating regularly with stakeholders, and giving a reasonable timeframe.

The board might also consider appointing an independent trustee, and should certainly put in pace appropriate governance structures (sub-committees with defined mandates, regular board meetings). There must be proper governance policies and processes too (code of conduct, communications, investment policy statement, death-claim processes etc). Trustee training is important.

Where the fund’s data is a problem, the board should embark on a project to restore the data. This will involve experts and will take time as well as resources. There’ll be significant expense.

To what extent should one act against those who’re to blame, if blame can be apportioned? Certainly, if the fund finds itself in crisis as a result of a service provider and suffers loss (say through having to incur an expense which it would not otherwise have had to incur), then that loss must be recovered (even if it means litigation).

But if the loss has been caused by poor governance, the board might need to look at whether it itself is liable; in that event, whether it should remain in office. It’s possible that the Registrar may bear some responsibility.

As always in considering litigation, one must assess the prospects of success and the costs against the benefits. Litigation may be needed to restore the fund’s credibility.

Any fund might become distressed. Regular risk management is vital to avoid it. Far more funds are periodically exposed to serious risk than is usually appreciated. These risks are rarely foreseeable, and are typically of the low-probability high-impact species. When these risks begin to appear, funds must be able to react quickly and flexibly.