Do Pension Governance And Financial Reporting Meet?
By: Chris D’Iorio
At the same time as Canadian companies are being asked to meet new financial reporting requirements, the Canadian pension industry is awaiting a set of guidelines from the Canadian Association of Pension Supervisory Authorities (CAPSA) for pension governance best practices. Chris D’Iorio, of PricewaterhouseCoopers LLP, looks at the intersection between these two initiatives and how plan sponsors can best respond to the challenges posed by these overlapping governance regimes.
The Supreme Court of Canada recently refused leave to appeal in the case of ING Canada Inc. v. Aegon Canada Inc., et al, now commonly known as the Transamerica case. The allegation in the Transamerica case was that warranties given with respect to the adequacy of pension contributions and the accuracy of financial statements in respect of pension costs were breached. Liability was imposed on the basis that the warranties with respect to the pension plan were untrue because the plan sponsor had taken an illegitimate contribution holiday (the Ontario Court of Appeal found that the language of one of the merged plan trusts did not permit the contribution holiday that the vendor had taken). Transamerica is an object lesson in how misconstrued plan liabilities can affect the veracity of financial reporting.
Effective March 30, 2004, chief executive officers and chief financial officers of Canadian publicly- traded companies are required to certify the information contained in their annual and interim financial reporting and to certify that they have designed and implemented disclosure and internal controls for financial reporting purposes. These new requirements mirror, in many respects, the certification regime that now exists in the United States under the Sarbanes- Oxley Act. In fact, the Canadian rules include an exemption for companies that are in compliance with the requirements of the Sarbanes-Oxley Act. These certification requirements impact human resource business processes, including pensions.
At the same time that these new financial reporting requirements have been introduced, the Canadian pension industry has been scrutinizing a draft set of guidelines from the Canadian Association of Pension Supervisory Authorities (CAPSA) which will articulate a set of pension governance best practice and internal control expectations. This article explores the intersection between these two initiatives and how plan sponsors can best respond to the challenges posed by these overlapping governance regimes.
Financial Reporting Requirements
On January 16, 2004, the Canadian Securities Administrators (CSA) released Multilateral Instrument 52-109. It requires CEOs and CFOs of all reporting issuers to personally certify, four times a year, that they have reviewed their filings and that based on their knowledge:
- their annual and interim filings do not contain any untrue statements of material fact or omit to state a material fact required to be stated or that is necessary to make a statement not misleading.
- that the financial statements and other financial information included in the filings taken together fairly present, in all material respects, the financial condition, results of operations, and cash flows as of the date and for the periods presented.
MI 52-109 also requires that the CEO and CFO personally certify quarterly (including at year end) that he or she is responsible for establishing and maintaining disclosure controls and internal controls for the company and that such controls were designed by them or under their supervision. The disclosure controls must be certified to provide reasonable assurances that material information about the company and its subsidiaries is made known to the CEO and CFO within required timeframes. The internal controls must be certified to provide reasonable assurances that the financial statements are fairly presented in accordance with generally accepted accounting principles.
MI 52-109 does not define ‘internal and disclosure controls,’ nor does it prescribe their degree of complexity or any specific policies or procedures. According to its Companion Policy 52-109CP, this is intentional. Securities regulators believe that these considerations are best left to management’s judgment based on their particular circumstances, including the size and the nature of their business.
These new certification requirements impact human resource business cycles. Internal controls for a host of processes need to be reviewed and confirmed or redesigned to support the CEO and CFO certification. Table 1 indicates the HR cycles that are affected by these new certification requirements, along with a listing of accounting standards that govern financial reporting in these cycles.
Pension Plan Governance
The pension industry is no stranger to the concept of governance, nor is this the first it has heard of internal controls. The draft Pension Plan Governance Guidelines published by the Canadian Association of Pension Supervisory Authorities (the CAPSA Guidelines) require plan sponsors to establish internal controls in a number of areas crucial to proper plan governance, as well as set out fundamental principles upon which to found a functioning governance system.
The CAPSA Guidelines do not prescribe any particular system or framework of internal control. Like the certification requirements, the specifics are left to management’s judgment. The flexibility of this approach, is, however, constrained and informed by the legal requirements and regulatory objectives of each regime.
Intersection: Internal Controls
Both the pension governance and financial reporting regimes impose very high standards of accountability. Under the certification requirements, CEOs and CFOs must personally certify their companies’ financial information. As a matter of pension law, plan sponsors operate under a fiduciary duty to plan members.
While both regimes require the establishment of a system of internal controls, they each respond to different imperatives. Management certification of financial reporting is a matter of corporate governance, subject to securities regulation, whereas pension fiduciaries are charged with conducting plan affairs in the best interests of members because of duties imposed by both the common law and pension standards legislation. While management certification acts to protect the shareholders’ interest in transparent financial disclosure and accuracy, pension governance seeks ultimately to protect members’ benefits.
The potential for conflicts of interest between these two constituencies is hardly surprising and note is taken of it in the CAPSA Guidelines:
The guidelines recommend principles for effective pension plan governance. They discuss the appropriate roles and responsibilities of the plan sponsor only when the plan sponsor is acting as plan administrator. They do not discuss the roles and responsibilities of the plan sponsor under general corporate governance principles. Many individuals who have pension plan governance responsibilities also have responsibilities to the plan sponsor. Consequently, they must clearly understand the different roles and responsibilities for each. Further, when taking actions that affect the pension plan, they must carefully document the actions for both sets of responsibilities. (Pension Plan Governance Guidelines and Self-Assessment Questionnaire, July 2003, p.2)
There is always the potential for conflict between the role of plan sponsor and plan administrator. For instance, a plan fiduciary might insist on never taking a contribution holiday when there is reason to believe the plan has a solvency deficit, while the plan sponsor might insist that there is nothing in the funding rules that preclude it from taking a contribution holiday based on the last filed valuation. These types of conflicts of interest might call for additional procedural controls. As noted above, the regulators’ expectation is that the individual performing in these dual roles will document actions taken pursuant to both sets of responsibilities.
It is likely that in most organizations a single control will exist to respond to both regulatory regimes. It is also likely, in many organizations, that the control will not have been designed with both regimes in mind. Since the CAPSA Guidelines are strictly voluntary, they will not receive the same level of attention from senior management as the certification requirements. However, if the effort must now be expended to comply with the certification requirements, it would make sense to take the opportunity to design internal controls in the pension cycle that meet both sets of objectives. The efficiency of only having to review the set of applicable internal controls once would justify the marginal increase in effort needed to consider pension governance objectives at the point of design.
Similarity Of Risks
In an ideally risk-managed world, an internal control is designed to meet a control objective which, in its turn, is defined in relation to some specific risk. An assessment of the risks facing one’s business objectives should give rise to the articulation of a set of control objectives, which can, in turn, be managed through appropriate internal controls.
While securities regulators have offered no prescription for the types of internal controls that should be implemented in the HR cycles, the CAPSAGuidelines, without specifying their content or complexity, identify a minimum set of policies and internal controls (see the first column in Table 2).
In a heavily regulated sphere like pensions, a partial assessment of the risks facing pension plans is already inherent in the legislation and policies under which plan sponsors operate. In effect, regulators are saying, through a document like the CAPSA Guidelines, that a baseline set of risks have been identified and that these risks, at a minimum, should be managed through the identified set of minimum internal controls. In the context of the discussion here, however, the question to be asked is whether this set of pension governance internal controls is also sufficient for achieving the objectives of disclosure and control for management certification purposes.
As noted in Table 2, it is possible to identify examples of financial reporting risks for each item in the set of pension governance cycles identified by the CAPSA Guidelines. From the perspective then of both efficiency and compliance with all applicable regulatory regimes, it would make sense to use the identified pension governance cycles to begin the task of developing internal controls in the overall pension sphere.
Since the content and extent of internal controls for certification purposes is left to management’s discernment, one cannot definitively answer the question of whether pension governance controls alone would satisfy management certification requirements. However, given the common risks addressed by both regimes, it would appear that, for the pension cycle, the implementation of pension governance internal controls would be an efficient first step in fulfilling the internal control objectives now required by Canadian securities regulators.
What Should Sponsors Do?
The Transamerica case has given some indication of the willingness of the courts to review management’s representations concerning pensions. The disclosure mechanisms and internal controls that are implemented for the purposes of MI 52-109 should take into account a plan sponsor’s fiduciary duties in respect of pension governance. Persons responsible for, and familiar with, pension issues inside the organization can and should be providing input into the design of internal controls for managing pension risks. If the exercise is undertaken from the outset with the intention of satisfying both sets of objectives, plan sponsors who are labouring under the requirements imposed on them by securities administrators could, in fact, achieve economies of scale in design and implementation and become better plan fiduciaries in the process.
Chris D’Iorio is a manager with PricewaterhouseCoopers LLP’s human resource services practice in Toronto.
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