Defined Contribution Pension Plans: Uncovering the Wolf in Sheep’s Clothing?
In my last post, I briefly canvassed the differences between defined benefit (DB) and defined contribution (DC) pension plans. I cautioned that, due to their perceived financial predictability and apparent straightforward nature, DC plans don’t always get the attention that they deserve from buyers undergoing the due diligence review of a target.
While DB plans give rise to greater financial risk, most practitioners agree that DC plans give rise to greater legal risk. For all their complexity, the rules governing DB plans are at least predictable (even if not necessarily “employer-friendly”). The rules governing DC plans in each Canadian jurisdiction are vaguer, and there are more potential avenues for employer error. In fact, a slew of recent, high-profile U.S. litigation involving DC plans (with some employee groups winning millions or even tens of millions from their employers) suggests that buyers ignore DC plans at their peril.
As with DB plans, due diligence by the buyer remains the strongest defence against inadvertently assuming many of these liabilities. Scratching below the surface of a target’s DC plans should not wait until the deal is done.
The following is a sampling of potentially significant liability for the buyer that careful due diligence of a target’s DC plans can uncover in advance:
- History Matters. Plans that the seller represents as “DC” may actually have once been “DB” plans that converted their benefit structure at some point in the past. Any restrictions affecting the employer under the old DB structure could, as a matter of trust law, carry through to the DC structure. In fact, there could still be legacy DB funding and benefit obligations.
- Member Communications Count. Incomplete member communications, including booklets and retirement income projections, may lead members to expect rich benefits from their DC plans based on unrealistic assumed investment returns. Members could have strong claims for the difference between what the brochures promised and what they actually receive when they retire with benefits that are less than expected.
- Fees Can Lead to Trouble. Uncompetitive fees (including, in some cases, “retail” rates) charged to plan members’ DC accounts could lead to class actions down the road. The U.S. has seen a number of successful class actions against employers for excessive fees charged by service providers. There is no reason these claims could not also be brought in Canada.
Despite their straightforward reputation and appearance, many DC plans raise their own legal issues. Always remember: At a distance, a wolf in sheep’s clothing looks like a sheep.