The facts

Telent was formerly known as Marconi. In 2006 Telent sold the majority of its business to Ericsson. The scheme remained with Telent. The Regulator cleared the deal on the basis that Telent established an escrow account of £490 million because the employer's covenant had been materially weakened as a result of the sale. The conditions for claiming from the escrow account were:

  • After each IAS19 valuation, funds would be released to the scheme if and to the extent that the scheme was less than 100% funded on IAS19.
  • If and to the extent that the scheme's assets and the escrow account were valued at more than 105% on the buy-out basis, funds would be repaid to Telent.

Under the escrow agreement, until conditions for payment to the scheme were met, the account was an asset of Telent and reflected its accounts. The scheme was mature (62,000 members but only 1,000 actives). It had a value of £2.5 billion and was 100% funded on the IAS19 basis.

On 25 September 2007, Pension Corporation (PC) announced its offer for Telent. The trustees initiated meetings with PC to ascertain its attitude and plans for the scheme. These meetings did not allay the trustees' concerns.

On 18 October 2007 the trustees asked the Regulator to exercise its power to appoint independent trustees to the scheme. On 19 October 2007 the Regulator appointed three independent trustees. On 7 November 2007 the Regulator conducted the compulsory review of its initial decision. The following day the Regulator issued its final notice confirming the appointment of the independent trustees.

Regulator power to appoint trustees: a quick reminder

The Regulator has the power to appoint trustees where:

  • It has removed a trustee or a trustee has been disqualified.
  • On application of the employer, trustees or members, the appointment of a trustee is necessary to secure:
    • The trustees as a whole have, or exercise, the necessary knowledge and skill for the proper administration of the scheme,
    • The number of trustees is sufficient for the proper administration of the scheme, or
    • The proper use or application of the assets of the scheme.

In the Telent case, the trustees applied for the appointment of independent trustees to secure the proper use or application of scheme assets.

Determination Panel procedure: a quick reminder

The initial Telent decision was taken using the Regulator's special procedure. This procedure requires a compulsory review of the decision to be undertaken as soon as reasonably practicable. The review is a re-hearing of the initial determination. This means that the Determination Panel can consider any fresh evidence which has come subsequently to light as if it had been available at the initial hearing. The decision is reached on the balance of probabilities.

On what grounds was regulatory action requested by the trustees?

The trustees were concerned that PC would have the power to appoint trustees to the scheme because it would control Telent. This power to appoint trustees might result in the following conflicts of interest:

  • The risk that the appointees would wish to implement PC's investment strategy regardless of whether it was appropriate for the scheme.
  • The new trustees, if appointed by PC, would have a conflict when deciding whether to exercise their investment powers and when deciding whether to appoint PC as the Scheme's investment manager.
  • If PC was appointed as investment manager or its personnel were involved on investment policy decisions or its application, a conflict could arise every time that PC (or its personnel) provided investment advice.

The trustees' case

The trustees (supported by the independent trustees and the Regulator) argued that the fundamental conflicts meant that regulatory action was required immediately. In particular:

  • PC had referred in the takeover documentation to “gaining control” of previously acquired schemes and to this being the intention behind Telent's acquisition.
  • In previous acquisitions PC had appointed its own executives so that they formed the majority of both the trustee board and the investment committee. In addition PC had been appointed investment adviser to the schemes in one case without a beauty parade.
  • The individuals nominated to the scheme's trustee board or to the proposed liability and investment committee would be PC executives in line with PC's approach to other acquisitions.
  • PC executives and board members are among its investors and are thus personally interested in the success of PC's business strategy.
  • Despite representations that any return to PC would be achieved through investment management performance and that there were no plans to seek money from the escrow account in the near future, an email from a PC executive indicated that PC was contemplating a very significant liability management exercise and as part of this would seek to use £30 million from the escrow account.
  • The level of conflict of interest (and lack of acknowledgement by PC that the conflict existed) created a danger that scheme assets and interests of members would be at risk.
  • To achieve PC's desired investment return, the scheme's investment strategy would need to assume a higher level of risk than at present.

PC's case

PC argued that:

  • The conditions which need to be satisfied for independent trustees to be appointed had not been met. In particular, the trigger referring to any risk to scheme assets required there to be an immediate risk rather than a prospective one and PC did not consider there to be an inherent conflict of interest.
  • The initial determination had been based on incorrect facts.
  • In any event PC put forward a solution which would entrench in the scheme's rules the position of independent trustees. It proposed that the trustees appointed by the Regulator would remain in place until April 2008 (with a further term for a single independent trustee). PC argued that this solution meant that it was unnecessary for the Regulator to exercise its power. It would work with the trustees to achieve this solution.

Determination Panel reasons

The Determination Panel decided that the independent trustees the Regulator had appointed should remain in place for the following reasons:

The Regulator's power to appoint trustees did not depend upon an immediate risk but should only be used when there is a threat which is sufficiently proximate to justify its use: this is a question of fact and degree.

There was a reasonable prospect of the trustees' concerns in relation to irreconcilable conflicts of interest coming to fruition. This was as a result of PC's business model and strategy, which suggest that it is not interested in the commercial activities of the employer. Instead, its business is the management of pension schemes.

The use of the terms “control” and “own” used by PC in its documentation in relation to the scheme were not meant superficially. PC's intention was to manage the scheme's assets to generate a return for investors with the result that the relationship between Telent/PC and the scheme would be fundamentally different from a typical employer/scheme relationship.

It would not be possible for PC to achieve its aim of managing the scheme to 105% of buy-out in five years (so that it could satisfy in its favour the escrow conditions) without taking greater investment strategy risk with the consequential reduction to members' security.

PC's proposed solution was not sufficient because considerable work would be required to reach a binding and satisfactory agreement and this would need to be in place before the take-over. In addition, the fact that the solution had undergone a number of changes during the hearing itself suggested that reaching a satisfactory agreement would not be easy.

Comments

PC is one of the new breed of players in the pensions buy-out market. One arm of its business insures pension schemes directly, either insuring all or part of pension scheme risk in a relatively traditional way. Another, the one involved in Telent, acquires employers with schemes, the intention being (among other things) to use its investment expertise to manage the assets and liabilities of pension schemes to generate profit for its investors. It is not PC's intention to control various business enterprises.

In June 2007 PC assumed control of the Thorn and Threshers pension schemes. These acquisitions mean that currently PC has around £1.3 billion of pension assets under management. Although the fact that these deals have occurred is in the public domain, the detail is unknown. However, as in the Telent case, it would appear that an escrow account has been created for both the Thorn and Threshers schemes. Again PC's intention for both scheme is to invest the assets in order to release the escrow funds for the benefit of its investors. PC's website comments that the asset value of both schemes has increased since the acquisitions.

The interesting contrast between the Thorn/Threshers deals and Telent is that in the earlier cases the Regulator was not asked to get involved. It is also worth noting that even if the Regulator had a concern about the appointments to the Thorn/Threshers schemes, it would not have been able to appoint trustees without removing some of those in place. Unless the Regulator has removed or disqualified trustees, it can only take action on application by the employer, trustees or members.

A particular feature of the Telent case is the speed with which the Regulator was able to act. The case was drawn to its attention on 18 October 2007 and, by 8 November, the original decision had been made and an appeal decided. This is in stark contrast to the protracted (and ongoing) Sea Containers hearings in relation to the imposition of a financial support direction under the Pensions Act 2004. Regulator involvement in Sea Containers started in June 2006. The hearing of Sea Container's appeal against the imposition of a financial support direction is not due to be heard until early 2008.

This differing response time is because the regulatory action taken in the Telent and Sea Containers cases are subject to different procedures. The appointment of independent trustees is subject to the special procedure under the Pensions Act 2004 whereas the imposition of a financial support direction is subject to the standard procedure. In both Telent and Sea Containers the Regulator took action to protect the assets of the schemes. It is odd that they are subject to differing regulatory formalities which has meant that Telent has been resolved whereas Sea Containers drags on. The anomaly might result from the likely financial consequences of a financial support direction when compared to what is essentially a governance issue in the appointment of trustees.

Finally, the main reason why the Regulator in Telent decided to appoint independent trustees was because there were unresolved conflicts of interest. The Regulator is due to issue guidance on conflicts of interest soon but no publication date has been released yet. It is, however, very clear that proper management of such conflicts is on of the top items on the Regulator's agenda.

This briefing note is based on the reasons of the Regulator's Determination Panel dated 14 November 2007.