Commentary / Practical Considerations
- In this case TPR appointed Dalriada as independent trustee
- TPR used the special procedure (i.e. taking immediate effect and without issuing a warning notice) given the immediate risk to members interests arising from the transfers of funds out of the scheme.
- This is a useful case study of the extreme cases, including risks to scheme funds, which can trigger the use by TPR of the special procedure under section 98 of the Pensions Act 2004 to take immediate action.
Key words
trustee knowledge and understanding/skill, appointment of an independent trustee, section 7 of the Pensions Act 1995, governance failures, conflicts of interest, special procedure
DN Date
14 February 2020
DN title
XYZ Pension Scheme:
DN reference
C147218076
PA04 procedure
Special procedure (s 99(4), compulsory review)
Case summary
This case involved a transfer of funds from the pension scheme to the sponsoring employer, triggering a wide range of issues including breach of trust, lack of adequate systems and controls, lack of trustee knowledge and understanding, and investment breaches.
- Between 2015 and 2019, £799,500 of Scheme funds had been transferred out of the Scheme account to the Employer account. At the time of the initial determination on this matter, the balance of the Employer account was £74. It was not known what had happened to the Scheme funds due to a lack documents.
- TPR used the “special procedure” and appointed an independent trustee to the scheme with immediate effect (and without the prior need to issue a warning notice).
- The special procedure may be used where the Panel considers that it may be necessary to act immediately because it believes there is, (or that if a warning notice were to be given there would be), an immediate risk to the interests of members or the assets of a pension scheme.
Analysis
(i) Facts and Background
The issue
- The XYZ Pension Scheme (the “Scheme”) is a defined contribution pension scheme.
- The trustees of the Scheme were a Mr X, a Mr Y and Company Z Limited (together, the “Former Trustees”).
- The Scheme’s principal employer is XYZ Limited (“the Employer”). Mr X also owns 75% or more of the Employer’s shares / voting rights.
- TPR (the “Case Team”) described the events as an “almost wholesale transfer of Scheme funds” by the Former Trustees into the Employer’s bank account.
The Case Team raised concerns relating to breaches of trust, lack of adequate internal systems and controls maintaining a separate bank account, lack of trustee knowledge and understanding and investment breaches.
(ii) Summary of decision
Stage 1 – initial decision
The Panel ordered that an independent trustee should be appointed to the Scheme with exclusive powers.
The Panel was not satisfied that it should use the special procedure to suspend the Former Trustees under section 4(1) PA 95 and declined to exercise that power.
Stage 2 - compulsory review
The Panel confirmed its initial decision to appoint the New Trustee.
The Panel noted the following:
Investment breaches
The limited documentation supplied to the New Trustee showed the Scheme as holding two principal investments, namely certain fixed income bonds (“the Bonds”), with a total par value of £755,000.
The Panel held that there was a concerning lack of detail and audit trail in relation to the Bonds. The Bonds were held in the Employer’s, and not the Scheme’s, name. According to the New Trustee, the Bonds represented an unregulated financial investment. Further, there was no evidence that any, or proper, investment advice was sought. In any event, the investment of a large proportion of the Schemes’ assets in the Bonds appeared to breach the Investment Regulations and the requirement for diversification.
Employer investment
Whilst there was minimal Scheme documentation, the Case Team were able to identify that one of the member’s transfer value had been paid directly into the Employer’s account and that the transfer value would be used to acquire “Bonds, Employer Related Investments and Stocks and Shares options.”
The Panel confirmed that, where a scheme invests in its principal employer, this may amount to an employer-related investment in breach of the Investment Regulations. The Panel also noted the lack of information to evidence that the apparent conflict of interest was recognised and appropriately managed.
Care home loan
There was evidence to suggest that a £100,000 loan had been provided to a care home out of the Scheme’s funds. The Panel agreed that there was cause for concern given the lack of information concerning the use of Scheme funds for this purpose.
Governance concerns
In particular, the Panel noted the failure to keep appropriate Scheme records demonstrating where Scheme funds have been placed posed a grave risk to the Scheme’s assets and therefore, the interests of its members. The Panel accepted that Mr X was able to deploy Scheme funds without the apparent knowledge or agreement of the other trustees. The Panel also noted the failure of Company Z Limited, who also served as the Scheme’s administrator, to ensure it was fully conversant with the Scheme’s administration.
The Panel also agreed that in relation to the investment in the Employer, there was a potential conflict of interest given the ownership of the Employer (i.e. the majority shareholder being Mr X, a trustee). On the evidence, this had not been recognised or properly managed.
Trustee knowledge and understanding
In light of the above, the Panel agreed that the Former Trustees appeared not to have the required trustee knowledge and understanding. In particular:
- the Former Trustees allowed Scheme assets to be deployed in a manner contrary to the requirements under the Investment Regulations;
- the Former Trustees failed to manage the conflict of interest issue in relation to the apparent employer related investments;
- the Former Trustees failed to adhere to the requirements of the Scheme Administration Regulations; and
- the Former Trustees failed to put in place an effective system of scheme governance.
Key legal principles
Breach of trust
Trustees are under a legal duty to conduct the business of the trust in the same manner that an “ordinary prudent person of business would conduct their own business, on behalf of those for whom they felt morally bound to provide.” As regards Scheme funds, they must ensure they are protected by being held in a scheme account or alternatively being properly invested. In this case, Mr X was the sole signatory to the Scheme account. This had not been properly challenged by the other trustees (nor had Mr X’s decision or instruction to transfer Scheme funds into the Employer account). Given that Mr X was both a director and the owner of the Employer, there was a clear conflict of interest. Payments of Scheme funds to the Employer therefore amounted to a breach of trust.
Lack of adequate internal systems and controls and maintaining a separate bank account
- Trustees are required to ensure that the Scheme has effective “internal controls” including, amongst other things, “arrangements and procedures to be followed for the safe custody and security of the assets of the Scheme”.
- Trustees are also required to keep scheme funds in a separate bank account to that of the employer.
- The Former Trustees in this case had failed to implement any, or adequate, arrangements for the safe custody and security of Scheme funds.
- In fact, significant amounts of Scheme funds have been transferred to the Employer’s account.
- In addition, the Former Trustees did not ensure that there were systems in place to identify and appropriately manage conflicts of interest in relation to Mr X.
Investment breaches
Trustees are under a legal duty to act in the best interests of members when making investment decisions. Trustees must additionally take proper written investment advice, from a person qualified to do so, when making investment decisions. In this case, the Case Team had very little information as to what investments may have been made with the Scheme funds and no evidence to suggest that any advice had been sought or obtained. The only investment documentation available related to the Bonds (which were deemed an unregulated investment) and the employer related investments, which are broadly prohibited under pensions law.
Knowledge and understanding
Trustees are required to have appropriate knowledge and understanding of the law relating to pensions and trusts. This includes knowledge of core fiduciary obligations, implementing adequate internal systems and controls for the safe custody and security of scheme assets, keeping scheme funds in a separate account, and not acting contrary to, or placing themselves in a position where trustees’ interests (whether actual or potential) are in conflict with that of the scheme. In this case, the Former Trustees had demonstrated a lack of trustee knowledge and understanding by acting in breach of all of these requirements by failing to protect the assets of the Scheme and failing to address or manage the apparent conflicts referred to above.
Practical considerations
This decision highlights the importance of trustees maintaining good scheme governance, obtaining proper and written investment advice and ensuring that adequate internal controls are implemented for the security of scheme assets. It also demonstrates the implications of not identifying and managing conflicts as and when they arise.
The decision serves as a useful example of when the Regulator will invoke the special procedure. The special procedure was appropriate in this case given the immediate need to prevent any further inappropriate transfers out of the Scheme account and secure member’s benefits.