Litigation may well represent one of the more dramatic and unwelcome challenges for a pension fund, its trustees and or its sponsoring employer, but being sued by members for failing to deliver on performance or poor administration is not out of the question.
But how high is litigation risk for the UK’s auto-enrolled workplace pension system with its default funds, qualifying criteria and the supervision by two regulators, one of which includes a detailed authorisation process? Any look at the global situation shows that in some circumstances, DC scheme members can be litigious when faced with poorly performing plans though, of course, they always come with local characteristics and each case is usually different.
In the US, no less a name than Goldman Sachs is facing legal action from one of its 401k members over its alleged use of underperforming proprietary mutual funds with the accompanying assertion that outside investors could obtain lower charges on the funds concerned and that where the scheme did invest in non-Goldman Sachs funds, it obtained a lower level of charges.
Meanwhile, the investment adviser to New York University’s scheme, Cammack LaRhette Advisors, has found itself the target of litigation from NYU employees over the advice it gave to the employer in constructing the workplace pensions options available to them. This case is yet to be concluded.
In Australia, Commonwealth Bank of Australia’s pension arm is facing two class actions from members of its First Choice superannuation fund, respectively for charging too much in order to pay financial advisers’ commissions and for failing to move members into lower charging funds from a high charging default as required by regulation.
Much of this is continuing fallout from the Royal Commission which was highly critical of financial services provision by Australia’s banks across a range of services, not just pensions. So perhaps we should be wary of direct comparisons.
Meanwhile, in the US, the Pension Protection Act of 2006 (PPA) created a safe harbour for “qualified default investment options” (QDIAs) that allows scheme sponsors to default members into a default fund. This safe harbour legislation has led to a significant uptake of target date funds as DC investment options amongst US employers.
Adviser commission is no longer an issue for UK pension schemes, though the default fund is an important component of the UK system.
Looking at the UK, experts acknowledge that there are legal risks, but also suggest that the characteristics of the UK pension system post auto-enrolment and with other subsequent reforms provide significant protections as well.
PTL managing director Richard Butcher says: “There is no direct legal liability through to an employer, but there is an implied duty of care to their employees. Certainly, in the US, there are starting to emerge class actions against employers where they have failed to exercise their duty of care properly.
“There are some litigation lawyers trying to come over from the States, who argue that the same set of principles could apply here. So, if an employer doesn’t offer a good workplace pension scheme then the employees or a group of employees could litigate against them. That said, we are not very class action- orientated in this country.”
Pinsent Masons pensions partner Tom Barton says: “The lesson from overseas, particularly the US is that you need to take fiduciary or fiduciary-like duties very seriously in DC pensions and understand how fiduciary duties apply to DC.
Looking after other people’s money can never be risk free, but good governance and careful communication are the best ways to manage down that risk.” Sackers partner and head of DC Helen Ball says: “There is nothing at the moment in the law around pension schemes that says there is a direct line from a member to an employer.
“There is no case law where an employer has been challenged by an employee saying ‘why on earth have you put in that scheme, that is a rubbish choice’. However, there is always a potential for there to be a case in the future. So, the question an employer should ask is how can I future proof my decision? Have I got reasons to explain how I made this choice, or have I good advice from an investment expert or benefits consultant which I can pull out of the drawer and explain in future why I made this choice?”
Barton says that much of the architecture of pension regulation around master trusts does give some comfort.
“Authorisation provides a very comforting message to employers using master trusts. It means that the regulator is satisfied that those involved in the running of the master trust are fit and proper, the systems are in good order and that a plan, backed by capital, exists to protect members from what should now be an unlikely failure.
“However not all master trusts are the same. They offer a range of solutions for different types of employers and different kinds of work forces, so an employer still has an important role to play in selecting the right fit,” he says.
“Whether a given master trust is fit for purpose depends on the purpose. Not all employers want the same thing. Authorisation is a real positive and the master trust market as it stands should be really proud to have come through such a rigorous process. But it doesn’t leave a completely homogeneous master trust market. There are all shapes and sizes and employers need to figure out what suits.”
Ball adds: “As a legal adviser we would usually focus on ensuring the decisions the employer had made are reasonable. They had not simply picked the cheapest, or a sc heme t ha t had poor communications or admin, but they had had advice that said this is a reasonable performance from this provider. It is also important they keep this under review.
“In the past, employers might have set up a scheme in the early 2000s, chosen an investment strategy and then never looked at it again. I think the world has moved on from that. Most people who are active members are in DC, and they expect some degree of oversight and corporate governance committee or trustee board to ask: ‘Is this still appropriate?’ I would say make sure what you choose now is kept under review and you are satisfied it is performing as expected.”
Master trusts, says Butcher, do not give employers a safe harbour in law. “There isn’t a statement saying if you have an authorised master trust you are protected against this liability, but you would expect it to be a good defence against legal action.”
He adds: “The employer could argue this is a master trust authorised by The Pensions Regulator. Of course, the regulator is really concerned with systems and processes – so is this thing going to be well run? They are not that concerned with value for money. It could well be that you have an authorised master trust that provides awful value for money. But, of course, you have a board of trustees whose duty it is to report on that value for money. “So, I don’t think it gets you off the hook entirely. You have an obligation as an employer to do some due diligence. The regulator is confirming that a master trust is fit for purpose.
“What they have tested for is the known knowns, what they can’t test for the unknown unknowns, a systemic failing. They can’t anticipate the unknown unknowns, so it is not entirely a get out of jail free card.”
Barton says that in terms of constructing default funds and managing associated risks is that ‘the rule of thumb is that taking ownership and doing things well is a good way to manage down risk”. “The construction of default funds should be no different. That means clear lines of responsibility and good quality advice,” he adds. One recent challenge that did make the headlines involved Jordi Casamitjana, a former employee of the League against Cruel Sports, who was sacked for misconduct but who argued it was due to his veganism. An employee tribunal has now confirmed veganism is a philosophical belief protected in law, a finding which garnered global headlines. Yet at the crux of the case is whether Casamitjana was sacked for his beliefs or for justifiable misconduct. Among other things, he had complained to management and then fellow employees claiming the pension on offer invested in firms which used animal testing.
Butcher says: “The recent vegan case has a bearing on the investment question but The Pensions Regulator, for example, wouldn’t opine on the master trust investment strategy. All they will judge is the systems and processes, they have to deliver a default investment strategy. They won’t opine on the quality. On the default, when you are trustee, there is always a chance of litigation but on the default, as long as we go down the right decision funnel, it is difficult to challenge us legitimately.”
Ball adds: “There are some arrangements where the employer takes on responsibility for setting up the scheme. Others are off the peg. If you go with master trust A, you may get this default. Master trust B may have a range. If you are choosing from a range, you should keep it under review. There is no guarantee that someone might not come back and say it is a terrible choice. I am going to complain. As long as you have done everything reasonable it will be hard for that complaint to work.”
What about the differences between contract based and master trusts? Ball says: “If you go with an authorised master trust, you know you have the approval of the regulator. With a GPP you are making a choice to have something without that, but you instead have the Independent Governance Committee that looks over the shoulder of the GPP provider. With both sets you can have a corporate governance committee, a group of people at the employer that looks at member experience and the service levels of either the master trust or the GPP, to hold them to account.
As an employer, it is good practice to have some kind of accountability mechanism within your organisation or contact points within an IGC or master trust. The latter do have their own employer forums. You want to have an environment where can you hold the service provided to account.”