The release of the final version of the Joint Forum of Financial Market Regulators Guidelines for capital accumulation plans is as exciting to the pension industry as Christmas morning is to a child.
The anticipation had created a nervous anxiety amongst plan sponsors and service providers alike. What onerous liability would the guidelines impose? How must they be carried out? What sort of implementation time frame would be required? What would it cost? And, most importantly, what would be the impact of non-compliance on a plan sponsor’s ultimate liability?
The final guidelines are not as onerous as the initial proposed guidelines released in April of 2001 nor the follow-up revised draft guidelines proposed in January 2003. The underlying message, however, is the same: plan sponsors must ensure that, as fiduciaries, they are taking an active role in the operation and oversight of their plan and in the information communicated and provided to members.
A respectable alternative to a “Cadillac” version
A Cadillac version of the guidelines would have gone so far as to incorporate some form of safe-harbour rules for plan sponsors who adopt and follow the guidelines in the operation of their plan. A Cadillac would have given details and numbers as to the minimum number of funds to offer members. A Cadillac would have explained what “a periodic review” entails. Capital accumulation plan sponsors, however, can let out a collective sigh of relief. The guidelines are no Cadillac – but they are certainly a respectable alternative.
It is important to remember the guidelines reflect the regulators’ expectations for the operation of capital accumulation plans. They are voluntary best practices, not law. In that regard the joint forum did not have the framework of legislation under which to develop an equivalent to the U.S. Safe Harbor Rules. The guidelines seem to reflect current best practices that, on the whole, plan sponsors are already applying.
Good plan governance: The core of the guidelines
At the core of the guidelines is the idea of good plan governance. Documentation of the plan operations, including all major policies, decision-making criteria, delineation of roles and responsibilities and oversight requirements of the parties involved are the key messages of the guidelines. There will be a cost to plan sponsors in having this type of structure and documentation developed, and there will likely be an increased cost, measured in resources and time, in managing these plans. Ultimately, however, the goals of the guidelines are meant to set up an orderly, documented, decision-making process that will potentially help plan sponsors avoid legal repercussions down the road.
Guidelines can help in worst-case scenario
In the worst-case scenario, where litigation is not avoided, by following the guidelines, the paper trail can show that due process was followed, decisions taken by the plan sponsor were rational based on the best information available at the time the decision was made, and every effort was made to ensure that an assessment process was put in place and followed.
In addition, the guidelines require a minimum level of information, communication, disclosure and investment tools be made available to members to assist in making informed investment decisions. These are the plan sponsor’s first line of defense in a litigious situation.
The following is a high level summary of the main provisions of the Guidelines.
Roles and responsibilities
One of the objectives of the guidelines has always been to provide some clarity around the roles and responsibilities of the plan sponsors and service providers as well as to harmonize the fragmented treatment of members due to the different regulations that govern the pension, insurance and security products available to them. The new guidelines provide a simple harmonization without undue strain on the existing framework of these industries.
In addition the new guidelines also put some of the onus on participants by setting out their responsibilities as plan members.
The plan sponsor requirements under the guidelines are:
• to set up, maintain, and monitor the plan;
• to provide investment information and decision-making tools to members; and
• to introduce the plan to new members and continue to provide ongoing information to all members.
One responsibility that is different from actual practice is the requirement to have all decisions and information supporting those decisions properly documented and retained. While many plan sponsors have decision-making processes in place, often these are informal and certainly not documented. The guidelines will change that by placing a more formal structure on these processes and by ensuring there is a paper trail.
Plan sponsors can delegate some of their responsibilities to service providers. Service providers are expected to follow the guidelines as well. It will be interesting to see how the division of responsibilities will play out and just how much potential liability the service providers will be willing to assume.
Plan members are responsible for using the investment information and tools made available to them to make informed investment decisions and for seeking out investment advice when doing so.
An important point to note is that the guidelines do not require plan sponsors to provide investment advice to members. But they do state that where a third party is enlisted by the plan sponsor to provide advice to members, the plan sponsor is responsible for setting criteria for the selection of the service provider and for monitoring that provider’s performance.
As expected, quite a number of the plan sponsor’s duties relate to the investment funds offered to members, how they will be offered and how they will be monitored. In particular the guidelines require the plan sponsor to choose and monitor the funds, the number and types of which should be consistent with the purpose of the plan.
Also as expected, the plan sponsor is required to review the options periodically. The criteria for choosing each fund should include the following:
• the purpose of the plan;
• the number of funds to be offered and the ability to diversify amongst them;
• the sponsor’s resources to review performance;
• the diversity and demographics of the work force;
• liquidity of the funds;
• risk and return profile of the funds; and
• other attributes of the funds including investment strategy and past performance.
The funds offered must comply with the investment rules under the appropriate pension legislation where the plan is a registered pension plan. Mutual fund products and insurance products are required to follow the security laws or the appropriate insurance rules respectively.
The guidelines state a default fund should be set up and disclosed in the event a member does not make an investment election. The plan sponsor will need to decide what fund is best suited as the default and document the criteria used in making this decision. Extra effort will be required in properly disclosing this information so plan members cannot later say they were not aware of the default fund. The guidelines require disclosure be made prior to putting any of the member’s money into the default fund.
As is already standard practice, essential investment information must be provided to members so that they can make informed decisions. Tools are to be made available as well. The guidelines provide examples of the types of investment information and tools to consider but no hard and fast list of requirements is included.
Initial and ongoing communication
The guidelines require that a plan sponsor provide new members with information on how the plan works, including the contribution amounts, the default fund, and names of the service providers and other contacts as well as details on how to access their account and make changes to it.
Members’ rights regarding disclosure of information should be explained as well as their responsibility to make informed investment choices based on the information and tools available. In addition a recommendation from the plan sponsor for the member to seek advice from a qualified investment advisor is included.
Ongoing communication requirements do not differ significantly from initial communication requirements. Essentially the following information should be provided to all members:
• identification of the funds and the fund managers;
• the investment objective of each fund;
• a description of the risk profile of the fund and the types of securities the fund may hold;
• a description of fees, expenses and penalties;
• a summary of the transactions and investment activity;
• where more information can be obtained;
• whether the fund is considered foreign content and the implication of that for the member; and
• performance reports for each fund at least annually.
Specific additional information is required where options other than investment funds are offered.
Details on how to make transfers amongst the options should be made available as well as disclosure regarding under what circumstances activity would be suspended. The guidelines give certain examples such as when a fund is being changed or a service provider is being replaced. The guidelines also require that advance notice be given prior to any significant changes in investment options.
In order to comply with the guidelines, plan sponsors will need to put in place a review policy, a practice often forgotten once the plan is underway. The guidelines require a review of service providers, investment options, records and investment tools be undertaken periodically.
Criteria for these reviews should be set in advance and actions to be taken where the criteria are not being met should be established. No mention is made of what constitutes a reasonable timeframe for these reviews to take place, other than to say investment options must be reviewed at least annually.
While a Cadillac version of the guidelines would have been nice, it seems the guidelines as released, while not law, have set out the benchmark against which capital accumulation plan sponsors, service providers and, to a lesser extent, members will likely be measured. The new guidelines will still get plan sponsors from the status quo to a more structured state with greater clarity around responsibilities, but perhaps the ride will be somewhat less luxurious.
Lori Satov is an actuary and defined contribution pension plan consultant in Watson Wyatt's Vancouver office. She can be reached at firstname.lastname@example.org.