Performing A Governance Audit
By: Peter Gorham
Finding out if a plan has good governance probably requires that an audit be carried out of the current structure. Peter Gorham, of Morneau Sobeco, discusses some of the areas that an audit should review.
Pension Governance. So many people in the industry are not sure of just what we mean by good governance. In many ways, good governance is just good common sense. But unfortunately, as Voltaire said, “Common sense is not so common.” And so we are left with the question of how to identify good governance. To be able to properly assess the quality of an organization’s pension governance, one needs to engage in a review or audit. Anything less could lead to missing key issues or not recognizing potential opportunities.
An audit can serve to identify and document a governance structure (to the extent that it has not been fully documented in the past), assess the processes and structures in place, identify and assess risks, and make recommendations for change. In making these assessments, we are looking for things like completeness, efficiency, accuracy, consistency, reasonableness, accountability, responsibility, and so on.
There is no one single perfect governance system. What is good for one organization may be poor for another. So the assessment of a system must take into account how the organization is structured and how it works in its core business. Within that context, an overall opinion can be given. The pension industry has for years been focused on ‘good governance.’ While laudable, we believe that for many organizations this establishes a target which appears to be unattainable at a reasonable cost. That will probably lead to inaction – either through inertia or a lack of budget. Most of the benefits of good governance are intangible and most of the risks are only potential risks. Why spend all of the time and money focused on something not clearly aligned with the organization’s core business?
Perhaps, our focus should instead be on ‘better governance.’ We start with a governance audit. This establishes the base and identifies the most significant areas for improvement. The issues can then be prioritized and changes made in an orderly and controlled fashion. Improvement will happen and be noticeable, but in a series of small steps. Rather than being overwhelmed by the sheer magnitude of the problem, focus is given to smaller issues which can be resolved with a reasonable investment of time and cost. So our governance gets better and we gradually work our way towards good governance.
Focus Of A Governance
Audit Agovernance audit can focus on various areas. It is important to identify the scope and the depth of an audit before starting. The more common types of audit include:
High level overview – where the focus is on the policy-making, its mplementation, and the structure of the governance system.
Administration audit – where day-to-day administration is examined in detail for processes, accuracy, completeness, consistency, efficiency, compliance, and risks.
Financial audit – where financial issues are reviewed and risks assessed. This looks at the investment process including manager selection and review as well as other financial issues such as contributions, corporate reporting, and the plan’s financial position
The scope of any audit can be defined to suit the needs of the organization. In general, one starts with a high level overview. From that result, specific areas for which more detail is desired are identified and reviewed.
The CAPSA self-assessment questionnaire can assist in performing a review. However, by its nature, the questions are general and open-ended. Unless one understands the possible details behind the 22 questions, it is easy to think you are in better compliance than you really are. While a governance audit can use the CAPSA questions as a basis for the review, it is likely that a more in-depth audit will provide more useful information and a better foundation on which to base future improvements.
Conducting An Audit
Should a governance audit be conducted by an external consultant? This is not always necessary. It depends upon the purpose of the audit, the expertise of the personnel available to do the work, and the budget available. Some situations where a knowledgeable internal person could effectively perform an audit include:
- Documenting existing structures and the roles of the people and committees involved
- Checking calculations and communications for accuracy and completeness
- Where the people involved have experience with different processes and systems and can evaluate and recommend in an independent fashion
- Identifying plan risks, their potential impact, and control processes
An external consultant with governance experience is probably better for situations such as:
- Review of current structure and preparation of recommendations for improvements
- Reviewing processes and benchmarking them against best practices and/or industry averages
- Satisfying a board of directors or the senior pension committee that a thorough and independent review has been conducted
- Whenever there is any doubt as to the knowledge and ability of oneself or other internal personnel to impartially assess processes and practices
A third-party consultant can add significant value through their experience with different systems and impartial judgment. While many internal people are knowledgeable about good governance, it can often be with limited experience of alternative structures and processes. As a result, the current system may get great marks for completeness, but it may be inefficient or ineffective for the organization.
Where do you find a governance consultant to assist with, or conduct, your audit? Most of the large firms of pension consultants, lawyers, and accountants will have governance experts. Each of these types of consultants will bring a different perspective to the task based upon their training and focus of the rest of their activities. The nature of any anticipated or known problem may influence the type of consultant to be hired. Lawyers can offer solicitor/client privilege, useful if there is a chance of a lawsuit. Accountants are wellversed in business processes and controls as well as sampling data for review. Actuaries and pension consultants bring a broad range of experience and training focused on pensions.
Even with a consultant, you must be careful. As with any decision to use an outside party, there is the need to assure oneself that the consultant possesses the knowledge and experience for the situation. In addition, conducting a governance review is a task that will make few friends. The consultant will almost certainly experience a number of conflicts of interest during the review and in preparing the report.
Governance reviews are often initiated by the board or a senior committee. Since it is highly unlikely your governance system is perfect, the review will undoubtedly find a number of areas where a change is recommended. Senior and middle management involved in the system will likely see this as criticism and may feel threatened. There will be attempts to influence the results and possibly refocus the review. How will the consultant react if the person feeling threatened is a key decisionmaker in hiring the consultant for other work? Will they cave in or stay true?
A governance mandate is fraught with dangers for both consultants and those involved in the system. This potential problem can be mitigated in two ways.
- Keep the focus on better governance. I t is far more effective to focus on recommendations for improvement than to report that something is ineffective.
- Consider the possible conflict when setting the scope of the review. Make sure those involved in the system understand and buy into the review as a positive for both them and the plan.
Frequency Of An Audit
In general, a governance audit should be conducted when there is suspicion that all is not as it should or could be. Probably this will be about every five to 10 years. Another time to consider an audit is following a significant change in structure or personnel.
If the recommendations of an audit report have largely been implemented, the benefits should continue for years. But inefficiencies will gradually creep in. At the same time, the concept of good governance will change. After some time (likely the aforementioned five to 10 years), even the best system will probably be ready for changes.
In our view, a written report is an essential product of an audit. It serves to document the base from which you are starting, as well as the fact that you have recognized your obligation (whether fiduciary or not) to recognize good governance.
Once a report has been prepared, the next step should be an evaluation of the recommendations in terms of importance and cost. They can be prioritized and an orderly process established for implementation. It is not always necessary to implement all recommendations. Some may have a very high cost with a low benefit. In our opinion, good governance includes recognizing when being proactive is not worth the risk. This is no different from good governance of an enterprise.
A pension governance audit is an opportunity to assess the past and plan for future successes. If i t is planned so that all parties look at it as an opportunity for improvement which will be beneficial for all, the audit will almost certainly be a success and provide a great blueprint for your future developments.
Peter Gorham is a partner in the Ontario pension practice of Morneau Sobeco.
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