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Litigation Risks For DC Plan Sponsors

By: Warren Laing

Will the combination of an aging workforce, unreasonable pension expectations, low investment returns, and the CAP Guidelines lead to a rush of legal action? Warren Laing, of Open Access, offers his thoughts.

The legal vultures are sharpening their claws at the class action lawsuit opportunities about to present themselves in the Canadian pension industry!

The combination of an aging workforce, unrealistic employee pension expectations, low investment returns, and the new CAP Guidelines has created a once-in-a-lifetime opportunity for a litigation lawyer, not a pleasant prospect for plan sponsors.

As a workforce ages, they become more focused on retirement planning and the prospect of being able to financially maintain their standard of living during retirement. For many Canadians this exercise is a chilling wake-up call. They find their personal savings are inadequate because they didn’t save enough or start early enough. They find the level of government old age support is minimal.

Then they find that the retirement benefits under their Defined Contribution pension plan are much less than they expected. Some thought they would have a pension approximately equal to the benefits under their old Defined Benefit plan, say 50 per cent of their best five years. However, the low investment returns in recent years, perhaps coupled with poor investment decisions (such as investing in GICs), has resulted in a pool of capital that is insufficient to purchase an annuity equal to the employee’s expected pension.

When all these factors are combined, the employee faces the stark reality of a significant reduction in their standard of living during retirement. Some wag suggested that people in this position should take up smoking immediately!

When faced with this grim reality, some employees will look for a scapegoat, someone with deep pockets, someone who can be blamed for the financial predicament they find themselves in. Who better than their plan sponsor?

Who are these former employees seeking compensation? They are the employees who became proactively involved in their retirement investment plans. Employees who were passive in managing their plans, but who also now experience this chilling dose of reality will join them. Both will become an easy mark for a litigation lawyer. In a class action lawsuit, there is no downside for them. They either win a settlement or life goes on as before.

The CAP Guidelines are a litigation lawyer’s ‘dream come true,’ for they impose a higher level of fiduciary responsibility on the plan sponsor, and outline the role the sponsor must fulfill and the information that must be provided to the plan participant. The guidelines are quite specific and require a major change in how sponsors have acted in the past. Few of them, however, have woken up to what they are now required to do.

According to our legal counsel, class action lawsuits will become more prevalent when investment results have been mediocre or bad.

Nobody Cares

In good times, nobody cares. In bad times everybody will be looking for someone to blame.

In building a class action lawsuit against a plan sponsor, a litigation lawyer will likely focus on four areas:

The objective is to prove that the sponsor was negligent in fulfilling his fiduciary duties, which resulted in the claimants suffering damages for which they should be reimbursed. It may sound difficult, yet initially it will be amazingly easy for a good lawyer to do.

The litigation lawyer is going to review the investment options offered to ensure that a sufficient number of appropriate options were offered to enable the participant to design a portfolio with adequate diversification by asset class, by investment management style, and by investment manager.

Offering only the funds of the plan recordkeeper exposes the sponsor. So does offering only one or two funds per asset class, as it does not enable a participant to build a diversified portfolio. Next, the quality of each of the options will be compared with similar funds in terms such as riskadjusted investment returns and investment management fees. This review would include the qualifications of those who selected the investment options. Were they experienced in investment matters? Were they licensed as investment advisors? Did they monitor the options continuously, or did they provide just a one-time list of recommendations?

If the sponsor does not have the appropriate talent internally, it is his responsibility to retain unbiased professional investment expertise to select the options offered to plan participants. Furthermore, it is the sponsor’s responsibility to replace a fund that consistently under-performs. Failure to do so can constitute negligence.

The litigation lawyer is probably going to review all the fees charged to the plan participant to verify that they are both reasonable and fully disclosed. This includes investment management fees paid to the fund manager, administration or recordkeeping fees paid to the recordkeeper, and any commissions, service, or referral fees paid to a broker.

The guidelines require that the sponsor verify the reasonableness of all fees charged to the plan participant. The sponsor is advised to do so on an annual basis and to document this research.


Investment information and decision-making tools are often a weak point for the plan sponsor. The guidelines specifically list the information and tools that must be provided. That’s the easy part, because it is specific.

The litigation lawyer, however, will likely review the appropriateness of the investments held in individual participant accounts to determine if the information and tools provided enabled the participants to make sensible investment decisions. This is the gray area. For example, if the workforce is young and all invested in short-term GICs, one might assume that the information and tools are not adequate and the result is participants making inappropriate long-term investment decisions.

There have been numerous studies indicating that, despite being given both good investment information and all the decisionmaking tools commonly available, only a small percentage of participants feel equipped to make investment decisions on their own. An alternative that reduces the sponsor’s potential fiduciary liability in this area is to retain a properly registered investment counsel/portfolio manager to provide investment advice to plan participants.

Since the investment counsel is responsible for the selection of all the investment options on a continuous basis and is providing investment advice to the participants, the issue of adequate investment information and decision-making tools becomes irrelevant.

In fact, the investment counsel becomes a co-fiduciary with the sponsor and, therefore, is going to be careful not to recommend risky or inappropriate investments.

The lawyer is going to look for conflicts of interest. Examples would be investment options created, owned, and promoted by the recordkeeper. These could be GICs, the recordkeeper’s own funds, or the funds of an associated company.

In offering these products to the participants, the recordkeeper is acting as a principal. He is biased to encourage the participants to invest in these products. The sponsor, therefore, has a higher level of responsibility to ensure that these investment options are appropriate.

Another example of a conflict of interest is the bonus commissions some recordkeepers pay to brokers depending on the amount of business the broker has sent to that recordkeeper.

Conflicts of interest do not necessarily mean that the sponsor or service provider has acted inappropriately, or that the participant has been adversely treated. However, they will raise concerns in a court of law and they put the sponsor on the defensive, as it is his responsibility to prove that, despite the conflict, the participant did not suffer damages. A good litigation lawyer will have a field day here.

Significant Change

With the introduction of the CAP Guidelines, we have entered a period of significant change in the DC plan business. These guidelines provide much needed protection to plan participants, protection they have lacked in the past, not because of any malicious intent by sponsors, but because the sponsors had no vested interest in policing the service providers. Now this has changed; the sponsor does have a vested interest in plan participant protection. Those sponsors who adjust to this new reality will have a better plan, with participants that have a more secure future. Those that do not may experience a class action lawsuit with all the costs and employer/employee tensions that are associated with such an action.

A forward thinking sponsor will ensure that there are no conflicts of interest internally or with any service providers, that all fees are reasonable and fully disclosed, and that licensed, professional investment experts have been retained to select and continuously monitor the investment options. The sponsor should do this now, before it is too late and the vultures start circling.

But then this forward thinking sponsor still faces the dilemma of whether to provide investment advice or investment information and tools. If the decision is investment information and tools, how does the sponsor ensure that participants make the right investment decisions so that they have sufficient capital to retire comfortably?

An important issue that deserves more thought and discussion…

Warren LaingWarren Laing is chairman and chief executive officer of Open Access Ltd..

litigation risks

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