The Pensions Regulator has published draft guidance on conflicts of interest.
It states that:
- Trustees must act in the best interests of scheme beneficiaries.
- They must not place themselves in a position where their interests could conflict with the schemes.
The draft guidance includes several principles that should apply to most schemes, but solutions should be individually tailored. Consultation on the draft guidance closes on 30 May 2008.
Ensuring good governance: New pensions draft guidance
One of the Regulator's statutory objectives is to promote good governance. Management of conflicts of interest is integral to good scheme governance. To this end, the Regulator has published draft guidance on conflicts of interest. Consultation on the draft guidance closes on 30 May 2008.
The guidance aims to provide practical assistance to trustees in relation to the management of conflicts of interest. It has the following summary of the key principles which underpin sound conflict management and governance:
- Understanding the importance of conflicts of interest.
- Conflicts of interest policy.
- Identifying conflicts of interest.
- Evaluation, management or avoidance of conflicts.
- Managing adviser conflicts
The draft guidance emphasises that there cannot be a single approach to conflicts and that trustees are best able to assess their needs with appropriate independent advice (legal or otherwise).
What are conflicts of interest?
The draft guidance states that:
- Trustees have a legal obligation to act, as the draft guidance terms it, in the best interests of scheme beneficiaries. They also have a duty not to place themselves in a position where their own interests conflict, or could possibly conflict, with the scheme's.
- The rule prohibiting conflicts exists because of the possibility that, if a conflict arises, it may lead to a breach of the duty to act in the members' best interests, or otherwise result in a trustee failing to properly consider a decision.
The above is the Regulator's view but we consider that this is an oversimplification of the law. Please see our comments in the closing paragraphs.
What is the focus of the draft guidelines?
The draft guidance is intended to assist trustees improve their governance arrangements by:
- Assessing the adequacy of their current conflict arrangements.
- Addressing any identified gaps.
- Understanding the Regulator's expectations in respect of sound conflict management arrangements.
The draft guidance is not intended to provide exhaustive guidance on what trustees need to do to comply with relevant legal requirements. Instead it is designed to promote and improve understanding of good governance.
The principles of sound conflict management
Principle 1: understanding the importance of conflicts of interest
The draft guidance comments that it is vital for trustees to understand their duties in relation to the scheme and its beneficiaries. In particular the chair of trustees can play a pivotal role in the effective operation of the board as well as in establishing robust conflict management arrangements.
The draft guidance states that conflicts are likely to be of two main types:
- Conflicts of personal interest between trustee, a director or staff member and those of the fund (eg personal financial gain)
- Conflicts of duty owed to the fund and to another party (eg the duty to act in the best interests of the members may conflict with the duty of directors to act in the best interests of the sponsoring employer/shareholder).
Examples of conflict situations given are:
- Where a trustee is a director or senior employee of the sponsoring employer.
- Where the trustees is also a union representative or employee representative.
- Funding decisions which are unduly influenced by a trustee who holds a senior role within the employer.
- Employer-nominated trustees may also become privy to sensitive information relating to the employer which could have an impact or a potential impact on the scheme.
The only conflict which is clearly authorised is that of a trustee by virtue of his or her membership of the scheme. Beyond this it is unclear whether or not provision in governing documentation which purport to authorise conflicts can be taken at face value.
The draft guidance makes it clear that induction training for newly appointed trustees should include identification and management of conflicts.
Principle 2: conflicts of interest policy
Trustees should document their policy (or procedure) for identifying, monitoring and managing conflicts. The policy may be a stand alone document, part of a governance policy or code of trustee conduct. It should be formulated and approved by the board with legal advice. The draft guidance states that it would be usual for it to include details relating to the secretary to trustees and the pensions manager. The conflicts policy will help trustees to comply with the internal controls requirements and risk management policies.
The policy must be tailored to the needs of the trustees and should be a clear and concise working document. Larger schemes may need more detailed policies. The types of details which should be included are:
- Trustees' fiduciary and statutory obligations in respect of acting independently and in members' best interests.
- Processes for indentifying conflicts including a description of the types of conflict that may arise in acting as a trustee.
- Processes in place to avoid conflicts.
- Options available for managing conflicts (this will need legal input).
- Monitoring compliance with and review of the policy itself.
It is important that compliance with the policy is monitored and that the policy itself is reviewed.
Principle 3: identifying conflicts of interest
The draft guidance makes it clear that before conflicts can be identified, trustees must be aware of any other interests or obligations owed by individual trustees to another party which may conflict. Trustee appointment procedures should require trustees to disclose any conflicts and the draft guidance contains a sample declaration form. This enables existing and future potential conflicts to be managed. The initial declaration of interests should be updated at least annually as well as when any changes to circumstances occur. The draft guidance suggests that conflicts should be a standing agenda item at each meeting and any declarations should always be recorded in the minutes.
Principle 4: evaluation, management or avoidance of conflicts
The draft guidance states that where a conflict has been identified it is essential that it is assessed and appropriate action (if any) is taken. Where a conflict is to be actively managed the trustees need to determine how to do this, bearing in mind the circumstances of the decision and the impact it might have on scheme members.
Where a conflict has been identified the trustees should seek legal advice on how to manage it. Independent legal advice should assist trustees identify where their decisions are being or could be perceived to be coloured by conflicts. Advice will further help trustees find ways of managing a conflict or whether this could lead to a decision being invalidated at a later date. Advice from other independent advisers may be required.
The best way to manage a conflict will depend on the conflict, the scheme and the circumstances of the case. The draft guidance gives examples of ways to manage conflicts including:
- Withdrawal from the decision-making process: legal advice is needed as to whether the conflict can be managed in this way. Trustees should bear in mind the quorum requirements.
- Appointing an independent trustee: such a trustee does not necessarily have to be a professional trustee but he or she should be suitably qualified.
- Resignation/non-appointment of trustees: trustees should themselves if it is appropriate to appoint a trustee likely to face a conflict. Where any conflict is acute or pervasive then resignation might be the most appropriate response.
- Establishing a sub-committee: trustees should seek legal advice as there are many scheme specific and legal factors to be considered on whether delegation is possible or desirable. Trustees must act prudently when choosing sub-committee members.
Principle 5: managing adviser conflicts
Trustees should actively manage their relations with advisers to ensure that the advisers are able to provide independent advice.
The draft guidance states that as part of the adviser selection process, trustees should ascertain whether there are any conflicts or potential for conflicts. In particular trustees should seek confirmation of the following:
- Whether the adviser is engaged to provide services for any party related to the scheme.
- How the adviser deals with conflicts and whether this would prevent the trustees getting objective advice.
- Whether the adviser is required to comply with a professional code or standards.
- Whether the adviser has measures in place to managed conflicts.
- What procedures and controls the adviser has in place to prevent confidential information being disclosed.
Conflicts are a particularly important issue where advisers are shared with the employer. The draft guidance comments that it is difficult to provide guidance in this area. However, as a general rule, trustees should give careful consideration to situations where the same firm/individual provides advice to both employers and trustees. It is likely that there will be situations where the practice is unacceptable.
The draft guidance comments that conflicts can arise where there is an in-house pensions manager who will be employed by the employer. In this case, the trustees need to be sure in what capacity the pensions manager is responding to any trustee query: his trustee hat or his employer hat.
Pension schemes are an unusual form of commercial trust where the employer (as settlor) has powers and duties during the lifetime of the scheme. Traditionally this has meant that employers and trustees have worked together to ensure that the scheme is appropriately funded and administered. Into this rather specialist trust arena, strict conflicts of interest requirements developed in other trust arenas, are being brought to bear. The inherent danger in this is that it will blow apart the usual pension scheme trustee structure and force employers and trustees poles apart. The central issue for trustees and employers is to ensure that all parties are aware of conflicts generally and that "decisions" are not subject to undue influence.
The draft guidance is the first time that the Regulator has attempted to provide detailed guidance on trustees' conflicts of interest. Until now the Regulator has made passing reference to conflict management in other guidance, for example, the clearance guidance. However, the draft guidance is not a summary of the law relating to conflicts and it steers away from giving a legal view on conflicts issues. Instead, it sets out the actions the Regulator considers trustees should be taking, as part of good scheme governance, to identify potential conflicts of interest. In addition, it sets out various courses of action that might be used to manage conflicts. Finally, the draft guidance underlines the importance of legal advice in relation to conflicts generally as well as in specific circumstances.
Trustees need to understand what conflicts of interest are, when they may arise and ways in which to deal with them. Whilst the draft guidance is a useful start, it would be improved if it were much punchier, shorter and clearer. In addition, the draft guidance glosses over confidentiality issues which often occur in practice and tend to be difficult to manage. Specific guidance on this issue would have been helpful.
The draft guidance may be seen to be encouraging schemes to have independent trustees because of the stress it places on the role that independent trustees may play in the management of conflicts of interest. The term "independent trustee" generally refers to a paid professional trustee rather than merely a trustee who does not have a conflict. Instead of talking about independent trustees it would be preferable if the guidance referred to "non-conflicted" trustees. At the same time, the existence of independent or non-conflicted trustees does not eliminate the conflict affecting the conflicted trustee.
It is interesting that the draft guidance focuses on the role of pensions managers and the secretary to the trustees and their potential conflicts. Trustees tend to focus on issues relating to their own conflicts and well as their advisers. Pensions managers, especially those who are in-house and employed by the employer, need to have clearly defined roles and be alive to the fact that they have potential conflicts of interest.
The key to conflicts of interest is that trustees can identify when they arise and can deal with them. There are no hard and fast rules for trustees to be guided by. The appropriate response depends on the circumstances of the case. Trustees need to be aware of the different conflict management techniques (the draft guidance sets out the main ones) and to take legal or other professional advice where necessary. They should develop a conflicts policy in addition to any register of interests.
This analysis is based on the Regulator's conflicts of interest consultation document published on 22 February 2008. Consultation closes on 30 May 2008.