This article by Fiona Thornton was published in Irish Pensions Magazine, 4(3), Autumn 2002.

As markets plummet and pension funds see the value of their assets significantly drop it is understandable if employers, trustees and members wonder 'does redress arise?'

Employers know that they have been told that they bear the investment risk in a defined benefit arrangement whereas members bear the risk in a defined contribution arrangement.

However, what exactly are the issues? How relevant is the recently reported settlement of a claim by the Sainsbury Group in the UK against Merrill Lynch Investment Managers, formerly known as Mercury Asset Management, (MAM)? Last December a Stg. £130 million (€208 million) claim against them by the Unilever Pension Fund was settled at a reported figure of Stg. £70 million (€112 million).

In big picture terms, in a defined benefit arrangement the trustees will have a responsibility to invest assets, appoint investment managers and supervise them to ensure that they are doing their job. An investment management agreement ought to be in place between the trustees and the manager explaining the investment objectives and strategy, reporting obligations, administration issues, terms of the mandate and so on.

Modern trust documents usually exonerate trustees from investment downturn. Where professional trustees are involved they may have liability, if negligent. It is conceivable that an employer, in a defined benefit scenario, might assert a negligence claim against professional trustees where investment downturn arises and there is a well founded suspicion that the manager has not been appropriately supervised or the benchmarks agreed between the trustees and the manager appear inappropriate. In those circumstances ought the trustees first consider making a claim against the manager?

In the defined contribution scenario similar principles apply. A new development is that, increasingly, members are given access to data to enable them to make their own investment choices. The trust deed will provide that in those circumstances the trustees are exonerated from liability for poor investment returns. This regime is reflected in the Pensions (Amendment) Act 2002 although it is not yet operative.

The Unilever case went to hearing last autumn. It was of considerable interest to pension advisors because the trustees sought to prove the investment manager was negligent in its investment strategy. It is unusual for this type of litigation to arise and the case has set a precedent, in spite of being settled.

It is instructive to look at some of the key facts that were reported in the newspapers.

A less experienced 27-year-old individual, who increased the level of risk apparently without telling the fund, had replaced the top manager. MAM did not tell the Unilever pension fund of the change in personnel for almost two years. It appears that the new appointee may have been inadequately supervised, as he appeared to have ignored MAM's stated agreed sector divergence guidelines. The new mandate terms (agreed it seems, between MAM and the fund) enabled a lower limit of equity holdings to be reduced from 50 holdings to 30, thus heavily increasing the investment risk. Was this appropriate?

When the fund became seriously concerned with the poor returns during the period it appears that the lead manager within MAM would not discuss what had gone wrong. The trustees' chief investment officer admitted that she could have noticed that the pension fund was going awry earlier, but had not done so because she had not supervised the results carefully during a short period of two months prior to the downturn.

The investment downturn had occurred during a fifteen month period between 1997 and 1999 when the returns of the fund were less than 10.5% below the industry benchmark. This arose three years after the new manager took charge of the Stg£600M Unilever pension fund portfolio. A key issue was the degree to which fund managers should ignore prevailing market sentiment.

The recommendation of the UK High Court, by the time the proceedings were discontinued, was that it ought never have to have come to litigation and should have been settled at an earlier stage. Perhaps this is indicative of why the Sainsbury claim settled.

The lessons to be learned appear to be, as far as investment managers are concerned, include the following: the client (trustees) must be kept informed; think twice about an aggressive investment strategy and make sure that more junior managers are adequately supervised and operate within the overall policy guidelines set within the investment manager chain of command. As far as trustees are concerned, they must be vigilant and carefully review results. Obviously, trustees are not expected to be investment gurus and they would need to take professional advice in carrying out this review. All the foregoing appears to demonstrate common sense.

In conclusion, trustees should not be afraid to ask questions and need to be mindful of their obligations to carry out duties appropriately i.e. to monitor and supervise.

Autumn 2002.

For further information please contact Fiona Thornton.