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Pensions special: Give and take

Man cannot serve two masters ­ – a concept any finance director considering
whether or not to sit as a trustee on their organisation’s pension scheme board
well knows.

In the good old days it was natural for the FD to be a trustee. They brought
to their fellow trustees a breadth of numeracy and analytical skills that most
trustee boards sorely missed. But that was before the 2003 legislation (which
stopped companies walking away from their pension fund and turned any shortfall
into a statutory debt) and before the 2004 Pensions Act (which strengthened the
powers of trustees).

Even today, with all the pressures on the FD to declare themselves
conflicted-out, there is still a strong feeling that, without the FD, the
trustee board would be considerably weakened.

Rachel Brougham, a principal at benefits consultants Mercer, says there is no
doubt that, despite the relatively widespread awareness today of the conflict
issue, there are still plenty of FTSE FDs retaining their seats on the board of
trustees.

However, David Pollard, a partner at the law firm Freshfields Bruckhaus
Deringer, who has made a careful study of the conflicts that can arise from the
occupational pension scheme, points out that the law is quite categorical in
stating that a senior officer of a company who acts in breach of any duty owed
to the company or to the trustee board, can quite legitimately be held
personally liable for such a breach.

Conflict of interest
That is not a comfortable thought since it may not be possible to honour one
duty without breaching the other, even though a careful FD might argue that a
serious breach giving rise to a significant personal damages claim is unlikely.
However, this is the kind of argument that gives corporate lawyers grey hair.
They take the view that if something negative can happen, it probably will.

“The problem haunting FDs is that, inevitably, they know things that are
highly confidential,” says Pollard. In many instances, these are things that the
trustees would be very keen to know about if there was any way they could get a
glimpse into the mind of their FD trustee board colleague. The problem is that
the FD, sitting as a trustee, can’t pretend they do not know, in a fairly direct
way, that much of what is going round in their head from time to time would be
interesting and useful to their fellow trustees and pertinent to their
deliberations.

Rashpal Bhabra, head of corporate consulting at Watson Wyatt, puts the point
simply. “It is hard to devise a process that deals with this kind of conflict.
FDs know a lot of stuff that is of interest to trustees and it is very difficult
to withhold it while sitting beside them,” he says. In his view, the way
legislation has developed in recent years has sharply increased the number of
times when the FD will be conflicted in their role as trustee.”

“Take scheme funding, for example,” Bhabra adds. “After September 2005 the
trustees have to agree with the company what funds will go into the pension
scheme. This power used to lie solely with the company board. So this is a big
change.” In the old process there was no conflict since, while the trustees
might have had a view on scheme funding, the board alone had the power to do
something about it. Now trustees have both a view and the power to press that
view.

Develop this thought a bit further and the nature of the FD’s conflict
emerges with crystal clarity. From the trustee’s standpoint, their natural
starting point is to look for the maximum security for their members and the
better funded the scheme, the more protected the members.

From the company side, however, Bhabra says there is no point in overfunding
the scheme since the money is effectively lost. “The scheme is a one-way valve
as far as the company is concerned. It can’t get its money back, so the optimal
point that the FD is going to want to fund has to be lower than the optimal
point for the trustees. So every time the talk is about funding, the FD has a
conflict,” he says.

Mercer’s Brougham points out that while corporate transactions, such as the
purchase of a company, may throw up clear instances where the interests of the
trustees and the interests of the company might diverge, companies have the
option of a voluntary clearance process that they can go through with The
Pensions Regulator at the start of any acquisition project.

“The key here is that the trustees need to be brought on board for this
process. The Regulator is not going to give clearance without hearing from the
trustees. So there needs to be an agreement about what information can be shared
with the trustees, and there needs to be some agreement about confidentiality,”
she says. This kind of agreement process can rationalise areas of conflict and
clear the air.

“The point here is that trustees are powerful and they have to take
appropriate advice on how the covenant with the employer is likely to be
affected in any transaction. Our advice at Mercer in these situations will
probably be that, yes, the covenant is, almost by definition, being weakened
slightly since acquisitions hold increased risk. But if the trustees can get
more money into the fund from the employer to compensate, then this will be good
enough,” Broughman says.

This is what the Regulator will generally look for and with a process like
this set out in advance, the FD who also holds a trustee position need not feel
so conflicted.

It is all about putting numbers to the risks, and if the scheme is well
funded, then the risk is probably going to be small. “Trustees like to have the
FD sitting at the trustee board table since they bring expertise and deep
knowledge of the company,” she says, adding that the ICAEW has issued guidance
to members covering the role of the FD on trustee boards.

“One of the options they have recommended is to get independent professional
trustees on the board,” she says. Obviously, the presence of strong,
professional trustees on the board makes it more likely that any conflict the FD
might have in playing a dual role will be understood and dealt with effectively.

Stay on board
Brougham says there are a growing number of trustee boards that don’t want the
FD to be sitting there as a member, but are very keen for the FD to attend
meetings. “That is a great solution and enables the company and the trustees to
forge a proper relationship that need not be adversarial,” she says.

Freshfields’s Pollard agrees. “Sometimes the most practical alternative is
for the FD to stay on the board and to manage the conflict, declaring himself
for the company on some major points, and abstaining from any vote,” he
suggests.

Watson Wyatt’s Bhabra does not agree. “There are too many situations where
real conflict arises. And when you have a problem it is very hard to find an
adequate process that will deal with it,” he says. In his view, any company
setting up a pension trustee board today would almost certainly not choose to
have the FD as a member.

With rising inflation, areas of conflict between trustees and the scheme
sponsor are likely to sharpen. A 1% increase in inflation can mean an impact in
the order of 20% on scheme funding liabilities. This is particularly true where
the pension scheme is inflation-proofed. Any sharp rise in inflation will be
particularly painful for such schemes. This, in turn, puts pressure on the
funding of schemes.

Add to this the pressures coming from increased longevity, volatility in the
equity markets and an environment of low returns generally, and the stage is set
for a more adversarial relationship between boards of trustees and the company.
Clearly, this makes it increasingly difficult for FDs to think they can straddle
this divide, with a foot in each camp.

One can also overplay the adversarial bit, though. “Going the other way, if
you put aside structural points such as the different optimum funding points for
the two sides, there are some grounds for a commonality of interests. We should
not lose sight of the fact that trustees are looking after members’ interests
and the employer is spending a great deal of money aiming to look after
members,” says Bhabra.

Given that commonality of interests, and even accepting the relationship
between the company and trustees has come under a great deal of legislative
pressure, it is obvious that FDs should take a strong interest in the company
pension scheme. “They do need to look at the scheme from both points of view,”
he says.

The trustees, of course, are not that strongly obliged to take both points of
view. Their priority is their members interests, though, of course, their
members will not thank the trustees if, in their zeal to protect pensions, they
tip the company into liquidation and cost the members their jobs. So trustees of
necessity cannot be completely blind to the company interest.

What this amounts to is that where there might be several options which the
trustees will want to explore in detail in a particular set of circumstances ­
all of which will be of interest to the FD as well ­ there will also be two or
three other options that are of no or little interest to the trustees that the
FD will want to explore in detail.

In particular, there are things companies want to examine to offload, or to
partially offload pension liabilities.

Those are not options the trustees will have much interest in initiating and
exploring thoroughly, though they are going to become interested once the
company puts one or more of these action plans on the table for discussion.

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