It is an honour and privilege to present on this topic of “Governance Reimagined: The Future of Retirement Fund Governance”; especially to follow the illustrious Prof King who has contributed so much to the thought leadership of governance generally, both in South Africa but globally. I am grateful to having acted as a trustee in almost every type of fund for almost thirty years, and this paper is informed not by that experience but also my practice as a pensions lawyer.

As this is a conference about pensions law, I thought it would be helpful to look at the duty or obligation in law that underlies the requirement for good fund governance. The nature of the governance arrangements – how trustees manage themselves, the business of the fund and their relationships with stakeholders – should therefore support the fulfilment of this legal obligation. And understanding that legal duty should indicate to us where fund governance should go in the future.

Before I look at this, it is necessary for us to be reminded that we have a sorry history of retirement fund governance failures which include: the surplus stripping schemes to benefit employers ; board dysfunctionality resulting in a trustee unsuccessfully lodging a complaint against his fellow trustees with the Adjudicator ; the FSCA having to appoint curators to funds because of the governance inadequacy of the board ; the successful complaint against a board for failing properly to conduct a death benefit investigation ; a board acting ultra vires its powers in reducing interim interest rate bonuses ; the failure to communicate properly to a member with information to which that member is entitled ; the failure of a fund for no valid reason to pay a death benefit more than eight years after the member’s death (section 37C requires this to be paid within 12 months of the death) ; the irregular appointment of a benefit administrator and deputy principal officer ; the failure of a retirement fund to ensure that a member was moved to his appropriate life stage portfolio ; the discrimination by a board against some members to the advantage of the other members in respect of surplus for no justifiable reason ; the loss of between R1,3 billion – R1, 879 billion through speculative positions in maize derivatives ; the bulking scandal whereby hundreds of millions of Rands were taken in secret profits at the expense of retirement funds . All these were avoidable had the governance been better. Understandably, regulators everywhere will invariably say their biggest worry is on this issue of fund governance. So, what can we imagine that good governance of a fund should look like in the future?

It seems to me that we should start any discussion on this with what the soundest legal basis is for the obligation to ensure the good governance of retirement funds. For me, this flows from the fiduciary duty or obligation of trustees.

As background, our law of fiduciary obligations is found in many areas of law, including but not limited to agency, trusts, companies, administration of estates, curatorship and employment. In these situations, apart from the duty of good faith and the duty to give an accounting, there are two well defined negative duties: not to make a secret profit and not to allow a conflict of interest. The fiduciary obligation was summarised as follows in the leading English case of Bristol and West Building Society v Mothew:

A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of the fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of the fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal…They are the defining characteristics of the fiduciary.

We have seen in our law these two negative obligations expressed in Robinson v Randfontein Estates (in respect of conflict of interest) and Phillips v Fieldstone Africa (Pty) Ltd (in respect of secret profits). Many of the fiduciary law discussions by our courts have had to with examining in what circumstances a fiduciary obligation arises so as to determine whether there has been a breach of one or other of these negative duties.

One basis for asserting that a fiduciary obligation exists was set out in Phillips, citing with approval the threefold vulnerability test stated in the Canadian case of Frame v Smith : (a) the existence of scope for the exercise of a discretion or power by someone; (b) which can be used to affect the beneficiary’s legal or practical interests; and (c) the beneficiary is accordingly vulnerable to the exercise of that discretion or power. This, the vulnerability test, points to a protective obligation by the fiduciary, and has its origins in Roman law. Importantly, this protective obligation implies that it is a function of the vulnerability of the beneficiary; in other words, the greater the vulnerability the more protective and onerous must be the fiduciary duty.

But in our retirement fund environment, there is no need to enquire whether a fiduciary obligation exists because our courts have readily asserted that it does, and the Pension Funds Act expressly says it does. The question to be asked is therefore not whether there is a fiduciary obligation owed by a fund trustee, but what the content is of that obligation.

There are important pointers in both the legislation relating to retirement funds and case law which indicate that the fiduciary duty is also a positive obligation and is not limited to the two negative obligations of no conflict and no secret profit: section 7C(2)(f) of the Act requires that the duty in relation to the fund is to ensure its financial soundness, and in relation to the members and beneficiaries is in respect of their accrued benefits payable. In the preamble to Regulation 28 this positive fiduciary duty is stated as requiring the fund to act in the best interests of members, and specifically in relation to the fund’s investments. The Adjudicator has stated in a number of determinations that the fiduciary obligation is a positive one: such as to make a disclosure to a member about a restrictive provision and to provide benefit statements ; as have the courts in respect of the oversight of investments and when faced with a request by an employer to make a deduction in terms of s 37D.

How would the fiduciary duty manifest itself in the governance arrangements of a fund? It seems to me that the obvious primary fiduciary obligation is to provide the benefits promised in terms of the rules. From this should flow a number of subsidiary obligations: (a) to ensure that these benefits are optimal within an appropriate risk framework; (b) that the costs of administration are transparent and can be justified; (c) that the trustees act with the expertise and care appropriate to their responsibilities; (d) that they exercise an independent discretion except on issues of law; and (e) that they able to demonstrate that the process of providing the benefits is credible and able to be trusted by the fund’s stakeholders who are its members and beneficiaries, the employer if an occupational fund, and the regulator. This last responsibility also flows from the legal duty to give an accounting in the legal sense, which is to explain the administration of the fund, what the trustees have in furtherance of their primary obligation. Importantly, all these criteria provide a normative standard (that is, a scorecard) to assess how well a fund is being governed.

As an aside, some of these responsibilities echo the responsibilities of a trustee of a trust where, similarly, there is no need to enquire into whether a trustee has a fiduciary duty because it is automatically so. And in trusts the governance obligation is expressed as giving effect to the terms of the trust, to act with the care, skill and diligence that is expected of a person who manages the affairs of another, and except as regards issues of law, to exercise an independent discretion.

Of course, not every responsibility of fund trustees falls within what I have described as these responsibilities that flow from the fiduciary obligation: for example, there are extensive compliance and purely administrative responsibilities, there are the conclusion of service provider contracts, the preparation of financial statements, the oversight of service providers, and so on. Interestingly, it has been cogently argued that in English law the two negative duties of no secret profit and no conflict of interest also serve a prophylactic purpose in ensuring that the other non-fiduciary duties of the fiduciary support and do not compromise the fiduciary obligation. This can similarly be argued in respect of the positive fiduciary duty owed in retirement funds: that there is a corresponding underlying prophylactic duty which flows from the fiduciary obligation in relation these non-fiduciary duties. Let me give an example: whilst the conclusion of an agreement with a benefit administrator is not in itself fiduciary duty, if the right of recourse against the administrator is inadequate, or the termination provisions are inadequate, in either case resulting in a loss to the fund and therefore ultimately by the members even if the financial soundness is not compromised, the positive fiduciary duty to provide the benefit promised will not be properly fulfilled. Thus, the non-fiduciary duty must support the positive fiduciary duty to provide the benefits promised.

So much for the fiduciary obligation in retirement funds. How does this affect the governance of funds in the future?

If the fiduciary obligation as I have set it out informs the nature of the governance arrangements, then these are some of the issues to be resolved what the governance of funds should be in the future. They are four areas which will make a profound difference to the improvement of fund governance:

Firstly, the governance arrangements should reflect the extent of the protective obligation of the trustees according to the vulnerability of the members and the nature of the fund. This is an extrapolation of the vulnerability test stated in Phillips. To put it differently, the members of a beneficiary fund are far more vulnerable than the members of an RA fund: the beneficiary fund members are usually minors with no or limited legal capacity who are likely to have either only a caregiver or parents without the financial sophistication required manage the benefit; the member of a RA fund will ordinarily have a financial adviser or be financially literate. So too the financial soundness risk of a DB fund is greater than that of a DC fund. The point is that the governance arrangements for the different types of members should be appropriate to their relative vulnerability; a single uniform governance approach does not work. The preamble to Reg 28 says as much in requiring an investment approach suitable to the risk profile of the fund membership. The same applies in respect of the greater financial soundness risk of a fund according to the type of benefit regime.

Secondly, as the governance rests with the trustees, a number of problematic issues that currently exist with how a board of trustees is constituted need to be resolved. There are essentially two areas of concern: either the board does not have the required expertise or it is conflicted. These two areas speak to Principle 1 in King V. As to the lack of expertise, we know that in this very complicated and difficult environment with significant financial consequences there is a necessary extensive reliance on outside expertise.

That expertise should really be on the board itself. It has been said that an expert possesses two sets of essential qualities, the one relating to the necessary skillset, the other a qualitative level of expertise:

• The skillset component has four requirements: (a) high levels of formal education; (b) professional education; (c) task specific training; and (d) significant experience;
• The qualitative expertise component also has four qualities: (i) spending proportionately more time assessing problems than solving them; (ii) being able to recognise and categorise problems based on deeper principles, unlike a novice who categorizes problems on the basis of surface features; (iii) being able to analyse or perceive large patterns of information quickly; and (iv), enjoying a superior memory, both short- and longterm, for problem relevant information.

Call it the 4 x 4 trustee test for the ideal trustee. Of course, we are not looking at someone who is an expert in every aspect of fund governance, which comprises investments, actuarial, accounting, administration, legal. We have all probably encountered persons with these capabilities; it is they whom we should be trying to recruit as trustees to set the standard. I should tell you that such trustees do exist, but that very often they do not and that it is only the even more impressive, skilled and expert principal officer who sustains the governance of the fund.

The second area of concern relates to trustees who are conflicted, not so much by a personal interest but by competing duties. As stated in the English case of Mothew already referred to:

A fiduciary who acts for two principals with potentially conflicting interests without the informed consent of both is in breach of the obligation of undivided loyalty; he puts himself in a position where his duty to one principal may conflict with his duty to the other: see Clark Boyce v Mouat [1994] 1 AC 428 and the cases there cited. This is sometimes described as “the double employment rule”. Breach of the rule automatically constitutes a breach of fiduciary duty.

This conflict of competing duties arises, for example, where a sponsor appointed trustee in a commercially sponsored fund is also in the employment of that sponsor, and who as employee is also obliged to promote the commercial proposition of the sponsor. The duties as trustee and as employee are not necessarily aligned, specifically when services or products provided to the fund may not be at a cost or in a form that is advantageous to the membership. Unless resolved, there is a problem with compliance with principle 5 in King V, which requires a trustee to act independently and free of any conflict or competing duty.

It is surprising that there are stringent fit and proper requirements for most service providers (other than lawyers) but not for trustees. Clearly what is needed are stringent fit and proper requirements for a person to act as trustee, which should apply to every type of fund; but more so in respect of funds where the profile of membership or the fund entails a more onerous fiduciary obligation.

The third area is the regulatory approach. There is a real problem with being overwhelmed by compliance; where a disproportionate amount of time and energy is spent on ensuring compliance with requirements that may well be appropriate for poorly governed funds but not the well-run funds. How can this be resolved? I have already alluded to the need to adopt a nuanced approach to how onerous the fiduciary burden should be according to the vulnerability of the members. So too, may I suggest, should the regulatory approach be tailored to being lighter according to the extent of that vulnerability and the extent to which funds have less risk of being financially unsound. If all the building blocks as above are in place for good governance, then there should undoubtably be room for risk based regulatory supervision that appropriately focuses more on higher risk funds according to their governance needs.

The fourth area relates to the development of a governance scorecard to assess the extent to which the trustees as a board fulfil their governance duty according to the type of fund, its membership and benefit regime. This should be an essential regulatory tool both to be an early warning system of possible governance failure and to assess potential risk to members and beneficiaries as well as the financial soundness of a fund.