Trustees may need to renegotiate contracts with fund managers

Trustees of pension schemes who have entered into stock lending arrangements which make short selling possible could be in breach of their duty as trustees, potentially triggering claims against them, warns Wedlake Bell, the leading commercial law firm.*

Wedlake Bell says that if any payment for lending shares to hedge funds does not adequately compensate for the loss a pensions fund could suffer on the falling value of its assets due to short selling, the trustees may be in breach of their responsibility to manage the scheme in the best interests of members.  

According to Wedlake Bell, trustees need to urgently review their practices with regard to stock lending, particularly as many schemes who have delegated investment decisions to fund managers may not even be aware that they are lending stock. Trustees may be protected from claims by having delegated investment decisions to a fund manager, but can only rely on this if they have taken reasonable steps to satisfy themselves that the manager is complying with the rules on the exercise of trustees’ investment powers.

Jane Wolstenholme, Partner, Wedlake Bell, comments: “The losses suffered by pension funds in the financial turmoil could have some scheme members looking for scapegoats, particularly if employers are unable to make up funding shortfalls, or in a defined contribution scheme where losses directly affect members.”

“Trustees have a duty to exercise their powers of investment prudently and predominantly by investments in traded securities, and it could be argued that trustees who have lent stock without adequate safeguards are in breach of these principles, which could expose them to claims.”

“A few of the larger schemes are taking action to limit stock lending, but many trustees will have delegated investment decisions to fund managers, and could be unaware of scheme assets being lent to hedge funds for shorting. This lack of awareness may not provide a defence.”

She adds: “Trustees should take urgent steps to review stock lending practices. These arrangements often lack transparency and they can be structured in such a way that the benefits to the scheme are unclear.”

Wedlake Bell points out that stock lending can take the form not of an actual loan but a derivative instrument (i.e. a commitment to transfer shares on certain events occurring). Schemes, however, are forbidden by investment regulations from investing in derivative instruments unless it contributes to a reduction of risk or efficient portfolio management.