Who is looking after the group RRSP?

Enron Corp.’s bankruptcy destroyed employee pensions – don’t make the same mistakes.
By Rick Headrick
|Canadian HR Reporter|Last Updated: 10/18/2002

With the collapse of Enron Corp. virtually wiping out the retirement plans of thousands of its American employees, Canadians are wondering if the same thing could happen here? A report by Canadian financial regulators, to be released this spring, is intended to ensure pension savings invested in the market are safe from similar devastations.

In Enron’s case, the employer portion of company savings plan contributions went exclusively to buy Enron stock, and many employees heavily invested their plan contributions in Enron stock as well. When the company filed the largest bankruptcy in U.S. history — in a scandal that has senior management facing possible criminal charges involving the alleged cover-up of the firm’s dire financial straits — retirement savings were destroyed.

In Canada, it would be unusual for employer contributions to be invested exclusively in the employer’s stock within a group savings plan. However, some employer sponsored savings plans do require employer contributions to be invested in a single mutual fund, often a balanced fund. Employees are allowed to select the investment funds their money can go to but have no say where the employer’s contributions go.

Although a balanced fund is much less risky than a single stock, what happens if that fund performs poorly relative to other balanced funds or even other asset classes? The employer may find itself facing an Enron-type argument from its employees — “You gave me no choice, and now I’ve lost my retirement income. It’s your fault.”

Many employers in Canada offer a group registered retirement savings plan (Group RRSP) whereby employees contribute to investment options through payroll deductions. Often the employer will offer a matching contribution and may even pay the administration fees associated with the plan. However, for a surprising number of employers, this is where their involvement ends. There is little communication made to employees after the initial plan enrolment and rarely will an employer monitor the investment options offered.

The question is, if the employer is not doing it, who exactly is looking after the Group RRSP?

The CAPs Report

On April 27, 2001, the Joint Forum of Financial Market Regulators’ Working Committee on Investment Disclosure in Capital Accumulation Plans presented a discussion paper entitled Proposed Regulatory Principles For Capital Accumulation Plans (the CAPs Report). The CAPs Report focuses on capital accumulation plans, including Group RRSPs and was developed to address the need to provide members of CAPs with regulatory protection and the need of employers to have their duties and responsibilities clearly defined and harmonized across jurisdictions.

The Joint Forum offers the view that employers who sponsor a CAP should have a fiduciary duty to:

a) select investment options for members that offer a reasonable range of options with different risk and return characteristics, each of which is diversified;

b) prudently select, using all relevant knowledge and skill, the investment managers for each investment option; and

c) prudently monitor the performance of the investment managers for each investment option, including setting and monitoring benchmarks for performance according to the type of fund, and taking appropriate action where performance is unsatisfactory.

Things can go wrong

About five years ago, a dispute arose between Bell Canada and its retirees. The facts of the dispute were:

•Bell set up a Group RRSP for its employees;

•Bell made no contributions to the Group RRSP;

•Bell paid the administrative costs and provided for payroll deductions to facilitate employee contributions;

•GICs issued by Confederation Life and Desjardins Life were investment options in the plan; and

•Confederation Life went into liquidation and a number of retirees lost a significant portion of their retirement income though they eventually recouped most of it.

The retirees argued that Bell was liable to them because it chose and promoted the Group RRSP, selected Confederation Life and failed to inform them of the inherent risk involved in participating in the plan. Further, the retirees alleged that Bell was aware of the financial troubles Confederation Life was experiencing and had a duty to communicate this knowledge to them. In fact, the selection of Confederation Life GICs as investment options had been prudent at the time — certainly Bell Canada was not the only employer caught off guard by the company’s quick dissolution. Nevertheless, even though it denied liability and the retirees’ losses proved to be only temporary, Bell allegedly chose to settle the dispute. The Toronto Star claimed the settlement amounted to $21 million, including interest and administrative costs.

In the U.S., in addition to Enron where employees have also filed suit, Lucent Technologies is facing an employee court challenge. In the Lucent case, employees are objecting to the fact that the company continued to offer Lucent stock as one of the 19 investment options. The employees allege that Lucent knew the company was in trouble, but continued to allow them to invest in the stock, breaching its fiduciary responsibilities.

What should you do?

An employer should adhere to the three requirements of selecting and monitoring investment options set out by the Joint Forum in the CAPs Report. It is not enough to prudently select the investment options, carefully select the investment managers for each option and then forget about the plan. An employer must continue to monitor the investment options and take appropriate action when the financial interest of plan members are likely to be adversely affected.

A recent decision from the U.S. provides a good example of how monitoring and communicating to employees can save an employer from liability. Unisys Corporation sponsored a participant-directed defined contribution plan (401(k) plan) that offered six investment fund choices. Some of these funds held GICs as part of their asset mix.

Unisys conducted a competitive bidding process prior to purchasing GICs. A recognized GIC specialist was retained to oversee the process, including determining the creditworthiness and suitability of the insurance companies being considered, and the company ultimately selected had received very high ratings. However, two years after the GICs were purchased, these ratings were downgraded. Unisys became aware of this change and communicated it to employees, together with the risks involved. Approximately one year after this communication, the insurance company was liquidated and the funds offered to plan members lost a significant portion of their value.

Employees sued Unisys for breach of fiduciary duty and sought to recover (US)$73.6 million in losses. They said the plan suffered as a result of the GIC investments. The Court found that Unisys had been “prudent” in its process of selecting the GICs from the liquidated company, had communicated the change in rating of the company and therefore had not breached its fiduciary duty owed to employees.

Monitoring Group RRSPs

Proper monitoring should include:

•performance analysis relative to performance objectives;

•detailed analysis of each investment manager (such as staff turnover or a change in style);

•detailed analysis of each investment manager’s “value-added” against relevant market indices;

•comparative performance of each investment option against a universe of similar funds;

•performance analysis on a risk-adjusted basis;

•summary of factors impacting capital markets;

•detailed breakdown of plan assets by fund;

•review of plan administrator performance; and

•implementation and annual review of an investment policy.

The recent troubles of the financial markets serve as a reminder that prudence requires an employer to regularly monitor its Group RRSP and to take action when needed. Failure to do so may result in the employer explaining that decision to disgruntled members of the Group RRSP — in a courtroom.

Rick Headrick is a consultant with James P. Marshall, Inc., a Hewitt Company. He may be contacted at (416) 361-0225 or rick.headrick@jpm.hewitt.com.

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