Regulators are steering directors away from holding pensions trustee positions, says Matthew Craig
According to some, the conflicts of interest are now too great for a finance director to act as a trustee of a defined benefit (DB) pension scheme. However, an FD’s resignation from a trustee position may not be in the best interest of the company.
A recent paper, The pension liability: managing corporate risk, by the Chartered Institute of Management Accountants (Cima) bluntly stated: “Cima’s view is that no director of a company should be a trustee of a sponsored scheme as the risk of potential conflicts of interest is just too high”. Charles Cowling, managing director of Pension Capital Strategies and a member of Cima’s pensions advisory board, said a key reason for Cima’s stance is that The Pensions Regulator (TPR) now requires trustees to negotiate with the sponsoring employer over a scheme deficit in the same way that a bank would do over an unsecured loan. “Cima’s view is that it is very difficult to see how an FD could negotiate a commercial loan with the company,” says Cowling.
Further evidence of the potential for conflict was found in a survey carried out by Hewitt Associates last December. While over half of 70 schemes surveyed still had a company director on the trustee board, a director had stepped down within 15% of the schemes, specifically due to conflicts of interest. Hewitt scheme actuary Lynda Whitney says: “Trustees have to negotiate robustly with the sponsoring company and that puts directors into a very difficult position.”
Paul McGlone, principal at Aon Consulting, adds that FDs can also face conflicts over the employer covenant. “On the basis [that] the stronger the covenant, the more optimistic the investment and funding assumptions can be, the FD has a vested interest in talking up the strength of the business. Then when it comes to affordability, the FD switches into ‘we can’t afford these contributions’,” McGlone says.
Other conflicts of interest may arise. Cowling cites the disclosure of financial information that an FD may be privy to: “If you know as FD that the company has real problems, do you tell yourself as a trustee and use that information to make life even harder for the company?” Investment strategy is another area where the interests of the trustees and the FD could diverge. Whitney comments: “Most trustees would like to be more prudent than the FD would like”, pointing to an FD’s preference for a more aggressive investment policy. However, she adds that such investment decisions are often dealt with as part of the agreement of an overall package. “Trustees don’t often go head-to-head with the FD – they will find ways to manage these conflicts. The FD may be willing to say ‘if I give you extra money, I would like you to invest it in this way’. The FD can influence investment strategy like this.”
FDs may also face a conflict between their financial responsibilities, or their role as a shareholder, and their interests as a DB scheme member. As a scheme member, an FD may want a generous DB scheme to stay open, whereas shareholders may see it as too expensive and risky for the company to continue to run.
Until relatively recently, it was widely accepted that conflicts such as this existed at pension schemes and the issues raised were considered manageable. Pinsent Masons partner Robin Ellison, comments: “Most grown-ups know there are conflicts of interest and it is a problem if they are unmanageable, but that hardly ever happens.” Ellison says that other trustees would know that the FD was conflicted and would take this into account. And FDs who resign as trustees may well regret their decision. “If you are a director of a company, you should be involved in running the pension scheme, because it’s an important part of the firm,” he says.
For FDs seeking to manage these conflicts, one option is to step outside the room on particular issues. Another option is for the FD to sit on the trustee board in a guest capacity, able to offer expertise but not be formally involved.
Another solution for companies that are part of a larger group, is for an outside FD to negotiate on behalf of the company, enabling the ‘home’ FD to remain on the trustee board. McGlone comments: “It means the trustees continue to benefit from the FD’s financial knowledge and it helps create a sensible dialogue, as the two FDs don’t want to hide anything from each other.”
In terms of best practice, Whitney comments: “We are seeing more trustees keep a formal register of [interest conflicts], putting policies in place when it is not appropriate for a trustee to serve on a working party, [in short when a person needs] to step back from a decision.”
Despite these measures, it seems likely that trustee boards will continue to lose the benefits of having the FD as a member. As Cowling points out, the perceptions of the conflicts of the interest to the outside world are also a factor; shareholders and scheme members may question the FD’s position.
Rightly or wrongly, the Pensions Regulator and other factors have created a situation where it is increasingly problematic for an FD to also serve as a scheme trustee.
The Pensions Regulator’s consultation document on conflicts of interest
The Pensions Regulator issued a consultation paper on conflicts of interest in February 2008, with consultation until 30 May 2008. On the issue of directors, it commented:
“Trustees who are also directors of the employer will also need to consider, and seek legal advice on, the requirements of the Companies Act 2006 and the obligation on directors of a company to avoid a situation in which they have, or can have a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company where such a situation arises. It is beyond the scope of this guidance to consider this in detail and the trustees should discuss this with their legal advisers.
“Having senior staff of the employer on the trustee board may also bring some benefit to the effectiveness of the trustee board, particularly in terms of their knowledge and expertise. Against this however, it needs to be recognised that such trustees may face conflicts of interest both as members of the scheme and servants of the scheme.”