Ontario Auditing Public Pension Plans?

Renata D'Aliesio of the Globe and Mail reports, Ontario audit puts pension fund’s pay levels, appointees under scrutiny:
A government audit of one of Ontario’s largest public-sector pension funds calls for greater scrutiny of board appointees and raises questions about pay levels, undocumented employee expenses and “significant” bonuses.

The year-long examination of the $15-billion OPSEU Pension Trust (OPTrust) also uncovered failures to follow rules on procurement and advisers and found gaps in risk management and whistle-blowing policies.

This is the first time the Ontario government has audited business and management practices at OPTrust, to which the province contributed $258-million last year. The review was launched in May, 2012, the same month former CEO Stephen Griggs filed a scathing wrongful-dismissal lawsuit.

Mr. Griggs alleged he was fired for attempting to rein in the “powers and financial largesse” of the pension fund’s private equity investment team, which includes John Walsh, the president of the Conservative Party of Canada. Mr. Griggs accused Mr. Walsh of improperly charging the provincial government’s employees’ pension plan for lavish dinners with prominent Conservatives, including Prime Minister Stephen Harper. OPTrust called the claim “patently false” in court documents.

Michael Patton, a spokesman with the Ministry of Government Services, did not specify whether Mr. Griggs’s departure triggered the audit, but noted: “We were made aware of some irregularities.” None of the province’s other public-sector pension funds was targeted for review.

The audit of OPTrust, which has almost 84,000 members and paid out $745-million in benefits last year, adds another dimension to the government’s struggles to contain the rising costs of its employee retirement plans. Faced with an aging population, sluggish investment returns and a multibillion-dollar deficit, the province has in the past year reached deals to freeze government and member pension contributions for five years for civil servants, teachers, health-care workers and community-college employees. Alberta, meanwhile, is planning to legislate – rather than negotiate – significant changes to four public-sector pension plans, including a moratorium on benefit improvements until 2021 and lowering cost-of-living adjustments.

The OPTrust review, done by the Ministry of Finance’s internal audit division and not an outside firm, resulted in 18 recommendations. It includes several proposals for changing the fund’s board that could spark a battle with the Ontario Public Service Employees Union (OPSEU).

The probe also zeroed in on OPTrust’s private markets group – which Mr. Griggs singled out is his lawsuit. The government audit found the group’s employees received substantial incentive payments, with a majority significantly exceeding performance ratings in 2011, compared with a small percentage of employees in the rest of the organization.

The review noted the group’s compensation was benchmarked against U.S. investment firms, such as Goldman Sachs and Bank of America Capital Investors, instead of other Canadian pension funds. The pay structure had not been updated since 2008, the audit added.

“In the absence of relative peer comparators … the current compensation design for PMG [the private markets group] may not be appropriate and may not be in line with OPTrust’s compensation philosophy,” the 43-page audit report states.

OPTrust is acting on many of the audit’s recommendations. While no changes have been made to pay levels of the private equity investment team, new CEO Bill Hatanaka said in an interview in September that all compensation programs will be reviewed next year.

“From my perspective, reviewing compensation on a relatively regular basis is important,” said Mr. Hatanaka, a former Toronto-Dominion Bank executive who joined OPTrust in December. “That doesn’t necessarily mean that anything would automatically change. It just means that as the new CEO coming in, I think it’s important to do my own assessment.”

Mr. Griggs, now CEO of Smoothwater Capital, a newly formed activist investment firm, declined to comment on the audit of OPTrust because he reached a legal settlement with the pension fund manager in June. The terms of the deal are confidential.

His dispute had depicted a picture of turmoil at the pension fund, the 10th largest in Canada. Hired in June, 2011, to be the fund’s first CEO, Mr. Griggs was ousted in April, 2012, less than a year into the job.

Mr. Griggs had previously been head of the Canadian Coalition for Good Governance, a powerful association of the country’s largest institutional investors focused on improving board governance practices at large companies. He claimed he was fired for attempting to reform OPTrust’s private markets group.

He accused the group of spending millions of dollars annually on travel and entertainment and alleged the group’s chief lawyer, Mr. Walsh – an OPTrust employee who is also Conservative Party president – had billed expensive dinners with Mr. Harper, federal Finance Minister Jim Flaherty and Ontario Conservative Leader Tim Hudak to the provincial government’s employees’ pension plan.

Mr. Griggs’ claims were never tested in court. Mr. Hatanaka said he could not comment on the allegations because of the settlement’s confidentiality conditions.

OPTrust denied Mr. Griggs’ claims in its statement of defence. The pension fund manager called allegations Mr. Walsh expensed political dinners “patently false” and noted his expenses were approved by three levels of authority. It accused Mr. Griggs of incompetence and of holding “personal vendettas” against the private-equity team.

A document filed with the Ontario Superior Court of Justice in January reveals Mr. Griggs’s legal team had wanted OPTrust to turn over numerous documents as part of the civil suit, including consultant reports, documents from closed-door board meetings, and a Deloitte review of the private market group’s expenses. A court document filed in October shows Mr. Griggs had also sought Mr. Walsh’s expense and travel records for the one-year period before he was elected Conservative Party president in December, 2009, and for the years after his election.

It’s unclear whether Mr. Walsh’s expenses were part of the government audit. When asked, Mr. Patton of the Ministry of Government Services said in an e-mail that a random sample of expenses was examined from across the organization.

Auditors looked at 55 expense reports with travel and entertainment claims. They found 16 reports (29 per cent) lacked receipts or a detailed breakdown of costs. No dollar figure for the undocumented expenses is being released, neither is the nature of the expenses. Mr. Patton described the transgressions as “minor irregularities.”

OPTrust has revamped its expense reimbursement policy, requiring more detailed documentation for claims, said Karen Danylak, director of communications for the pension-fund manager. Other changes recommended in the government review were put in motion before the audit was finalized in May, 2013, Mr. Hatanaka added. The ability to perform internal audits was introduced this year; an executive succession plan and a training program for trustees are being developed.

Several of the audit’s recommendations are directed at OPTrust’s board of trustees. The government review found competency requirements, training and performance evaluation were lacking at the jointly sponsored plan.

The Ontario government and OPSEU each appoint five members to the 10-member body. Proposals for altering the board – including establishing selection criteria, term limits and a process for removing ineffective trustees – could trigger a tussle between the province and the union. Although the union is still reviewing the audit’s proposals, OPSEU president Warren Thomas sounded a note of caution to the government.

“They don’t get to tell us who our trustees are, how we appoint them,” he said.

The government plans to discuss the audit’s recommendations with the union at their next joint-sponsors meeting. Mr. Patton said the province believes the audit’s recommendations, when fully implemented, will improve OPTrust’s accountability to its members. The fund earned a gross investment return of 10.1 per cent last year, surpassing its 6.5 per cent target.
You can read the entire audit report on OPTtrust by clicking here. It is a very well written report and I highly recommend pension plan stakeholders, senior managers, board of directors and government regulators take the time to read through it.

Don't know what prompted this audit but if the Ontario government got involved it tells me they had sufficient reasons to believe an external audit was warranted. And the fact that this audit was conducted by the Ontario Internal Audit Division and not some external auditor tells me the government wants to send a strong signal to other Ontario public-sector pension plans that they are prepared to audit their plans too if they think there are reasonable grounds to do so.

Right now, none of the province's other public-sector pension plans are targeted for review. The focus was only on OPTrust and the findings uncovered "minor irregularities" in expense reports but more importantly, the report recommended a full review of the compensation of the private markets group (PMG) and changes at the board of trustees.

The review noted OPTrusts's pay structure has not been updated since 2008 and the private markets group’s compensation was benchmarked against U.S. investment firms, such as Goldman Sachs and Bank of America Capital Investors, instead of other Canadian pension funds:
"In the absence of relative peer comparators (i.e. the Canadian market), the current compensation design for PMG may not be appropriate and may not be in line with OPTrust’s compensation philosophy."
Keep in mind that large Canadian public pension funds pay their private market professionals extremely well so I find it surprising the review zeroed in on this group's compensation. I looked at the 2012 Annual Report and found that executive compensation (on page 36) was more or less in line with their Canadian peers (in fact, it was a bit on the low side). But the compensation of the senior officers of the private markets group is not disclosed (this is not in line with their peers who typically publish the top five highest paid senior officers).

When I spoke with Bill Hatanaka, OPTrust's CEO, he struck me as a very sensible person who will take the time to review what needs to be changed, ensuring that OPTrust will follow the highest governance standards. He praised his internal team for the strong results in 2012 and gave them full credit for delivering these results.

I've also spoken with Stephen Griggs in the past and found him to be equally nice, smart and competent. I don't know what led to his dismissal but it was messy and it reflects badly on any organization when a CEO is ousted after only a year on the job.

As far as changes on the board, the review recommends election criteria, term limits and a process for removing ineffective trustees. These are all sensible recommendations but the union should have a say because it is a jointly sponsored plan.

While some think union members shouldn't sit on boards because they don't have the expertise required to fulfill their duties properly, I take a more tempered view and think that there should be some union representation on any jointly sponsored plan. After all, they are the beneficiaries of these plans and have a right to have their say on the way their contributions are being managed.

But you can also make the argument that boards should only be composed of independent professionals who have the expertise to make the proper decisions for the plan's long-term success. There are good arguments on both sides and I'm not sure if there is only one right approach. Ontario Teachers' and HOOPP are two of the best pension plans in the world and their board composition is different (HOOPP has union members sitting on their board while Teachers' doesn't).

Interestingly, the report did make the following recommendations for policy advisors to the Board (page 24):
Given the need for ongoing specialist advice to the Board, the scope and application of the Professional Advisors policy should be expanded to include all advisors to the Board, whether ongoing or on a project-by-project basis (ad-hoc). Selection criteria should be developed to guide Trustees in selecting and managing advisors with significant industry expertise and experience.

As well, annual work plans and performance expectations should be prepared so that the Board can evaluate the knowledge and skills of advisors throughout the contract period to ensure governance responsibilities are met. A formal tendering process should be performed every 4-6 years to align with industry best practices, and an assessment of advisors should be performed after each engagement or at least annually to ensure that professional advisors provide excellent professional services, avoid conflicts, and are independent of OPTrust.

In addition, a cost benefit analysis should be performed and presented as part of the annual report to the audit committee, to demonstrate value for money for plan members. This documentation should be retained to support the Procurement Policy and Professional Advisors Policy and to validate that appropriate procurement standards are followed when vendors and advisors are engaged to provide services to OPTrust and the Board of Trustees.
I just wrote a comment on whether investment consultants are useless and think these recommendations are needed to assess advisors and vendors, making sure the audit committee can demonstrate value for money for plan members.

Finally, I note the following recommendation (page 26) for bolstering OPTrust's whistleblowing policy:
Given the sensitivity of whistleblowing incidents, OPTrust should develop and implement reporting procedures to track the performance of the organization over time. An independent assessment of the whistleblowing process should occur at least once every two years to ensure all whistleblowing incidents are appropriately managed.

The whistleblowing process should include requirements to retain documentation of complaints raised and actions taken to demonstrate the organization is taking reasonable measures to investigate and address concerns (i.e. number of incidents, how they were handled, root cause analysis, subsequent updates to policy, etc.).

Consideration should also be given to seek advice from legal counsel on the appropriate steps to document a claim and the investigative actions taken and to benchmark this process against industry best practices.
I think these are all sensible recommendations and once again, recommend my readers take the time to carefully read the entire audit report on OPTrust. It is an excellent report and OPTrust has already acted on many recommendations. Other pension plans might find these recommendations very useful too.

Below, an interview with Warren "Smokey" Thomas, president of the Ontario Public Service Employees Union. First broadcast April 4 2012 on CFRC 101.9 FM, Thomas discusses the 2012 Ontario budget, the Drummond Report, and the state of the Ontario labour movement. He also dispells public pension plan myths.