Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 18 - Evidence - May 7, 1998
OTTAWA, Thursday, May 7, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:05 a.m. to examine the state of the financial system in Canada (the role of institutional investors).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Good morning, Ms Eastman. Please proceed.
Ms Jan Eastman, President, Canadian Teachers' Federation: Thank you very much for this opportunity to appear before you today, and to play a role in this consultative process.
The Canadian Teachers' Federation is an alliance of 13 provincial and territorial teachers' organization, which in turn represent approximately 245,000 teachers in publicly funded elementary and secondary schools across Canada.
At the 1997 Public Sector Pension Plans Conference, we became aware that the Standing Senate Committee on Banking, Trade and Commerce was planning to study the impact of institutional investors on the process of corporate governance and financial markets, as an extension to the work already undertaken on corporate government issues. Since pension funds and plans established for Canadian teachers collectively represent a significant portion of the total assets of the public sector pension plan funds in Canada, CTF and its member organizations felt compelled to engage in this consultation.
We have supplied you with copies of our written submission. Our brief is focused on the legal framework within which pension plans function in Canada, and on the concept of fiduciary responsibility within that framework. We understand that one of the purposes of this consultative study is to determine how institutional investors are governed. As far as teachers' pension plans are concerned, they are governed in total compliance with the federal and provincial legislative frameworks which presently exist, and those responsible for administration exercise fiduciary responsibility in the fashion expected by the law.
After receiving information documents leading up to your first set of hearings, and after reviewing presentations made by expert witnesses, it was our sense that a body of opinion exists which suggest that institutional investors, particularly public sector pension plans such as those operated for teachers, may somehow be having an unsettling impact on corporate governance in Canada.
The concerns, as we perceive them, focus in the first instance on the assumption that those responsible for investment, and for the administration of public sector pension plans, did not have the expertise or appropriate knowledge to make the decisions required of them, and that they did not have an understanding of the fiduciary responsibility which they hold. Our investigation of the administration of teacher pension plans shows this to be unfounded.
Secondly, the concern was raised that investment decisions are susceptible to political interference, and that union representatives may use power and influence working against the best interests of their members. Again, with respect to teacher plans, our assessment is that this view is completely unfounded.
Finally, concern was expressed over the influence that large institutional investors may exercise on the management of corporations in which they invest. In our view, if the action of any investor is designed to improve the performance of the corporation, and if that action results in a greater return to the corporation and the investor, then everybody gains.
The Chairman: We have had conflicting advice on the question of what the makeup of the board of a pension fund ought to be. In particular, the question is whether pension funds ought to have lay person boards representing those who are members of the group whose pensions are involved, or whether the boards ought to be made up of professionals -- people involved in money management.
On this committee, we are fairly familiar with the nature of the board of the Ontario Teachers' Pension Fund, which is largely made up of professionals. Is that true across the country, or do the characteristics of the board members vary?
Ms Eastman: It does vary across the country. In general, the people who sit on those boards are either very knowledgeable, experienced staff people who work for the organization, or they are teacher members of pension committees, who also have acquired a large body of knowledge in the matters that they are dealing with.
Mr. John Staple, Director, Economic Services, Canadian Teachers' Federation: Ms Eastman's response is correct. The Ontario situation is unique in a number of respects. The new Saskatchewan Teachers' Plan is owned and operated entirely by the Saskatchewan Teachers' Federation. The other teacher plans in Canada are, by and large, controlled to a great extent by either the Ministries of Education or the Treasury Boards of the various provinces. The governments of these provinces have considerable influence in the operation and the investments of the plans.
There are teacher representatives on the boards that either advise on investment, or actually conduct the investments themselves. By and large, they are individuals who have had a fair bit of experience and responsibility in these areas before they were appointed. That is a condition of their appointment, as a matter of fact.
The Chairman: You say that the provincial governments have influence over these investments. Can you tell me a little bit about how that influence is exercised?
Mr. Staple: Investment is influenced by way of control. My understanding of most of the pension plan investments across the country is that the involvement of government representatives, and the control of the Ministries of Education or Treasury Board, is to such an extent that they, in fact, control the investment procedures.
The policies and the representation mix are undertaken in cooperation with the employee groups, particularly the teacher groups, but there is considerable control from the departments involved.
The Chairman: Can you tell me what made Ontario different? How come there was a different evolution in Ontario than elsewhere? Why does the Ontario Teachers' Plan appear to have quite a different structure, in terms of its governance and the kind of people on the board, than a whole lot of other public plans? Perhaps you could help us with the history.
Mr. Tom Ulrich, Assistant General Secretary, Manitoba Teachers' Society: Manitoba is probably a good example of the influence of government over the investment side, although I am not suggesting that it uses that influence in an inappropriate fashion. However, our investment committee is structured to be three persons named under the Teachers' Pension Act. One is to be the Chair of the Teachers' Pension Plan Board, and that person is a government appointee, generally selected by the government for his or her financial investment expertise.
The Chairman: Sometimes that person is actually a government employee, as I know to be true in Nova Scotia.
Mr. Ulrich: In the case of Manitoba, that has not been the practice. It is someone selected from the business community. The second person on that board is the Deputy Minister of Finance for the province, and then the third member is a teacher representative, a role that I currently fill in Manitoba.
The voting power, if it came to a vote, is favoured toward the two government appointees. Having said that, however, I can say that, in the history of my involvement -- which is now five or six years -- there has never been a situation where it has been a 2-1 vote against the teacher representative.
I would like to comment on the Ontario situation, because I have some familiarity with it in our cross Canada connections. If you look at the history of that development, the Ontario Teachers' Federation wanted to try to restructure the pension plan in such a way as to make it more effective and better managed than it was historically. It particularly wanted to bring the investment management into a contemporary type of operation that would be at arm's length from government.
Mr. Staple: What Mr. Ulrich says of Ontario is correct from my perception. Also, in the various provinces within our member organizations, a number of things develop along different lines and fashions. I have never been able to figure it out. Perhaps it is because the cultures of each of the provinces are so distinct, and they follow different practices. In terms of what Mr. Ulrich has said, one thing that they do have in common is that much, if not all, of the positive changes that have been undertaken with respect to teacher pension plans in Canada have been undertaken at the instigation of teacher associations and teacher unions. These groups have served as the catalyst, primarily for developing more responsible and representative structure within their pension plan operations. In fact, they have been the catalyst for dealing with issues where these pension plans have been underfunded.
Senator Oliver: A couple of the groups that have presented before this committee have said to us that, in stressing the importance of good governance in pension funds, good governance means good performance of pension funds. One of the things that I did not see in your submission is anything about the kinds of performance that the various Canadian Teachers' Federation funds are actually getting. If you have done that kind of survey, could you tell us what they are like among the various teacher groups? Can you tell us how you stack up vis-à-vis other pension funds?
Mr. Staple: We have done comparisons of teacher pension plans in some detail across the country. I have some copies that I can leave with the committee that might help answer some of the questions that you raised. Owing to the questions and concerns raised by this committee, a section on administration will be added to our booklet this fall.
All of our teacher pension plans across the country have found themselves, at one time or another, in difficulty with respect to funding, and have had to address those issues. In all but two circumstances now, but primarily one, those issues have been addressed positively. Our teacher pension plans in Canada are, by and large, funded at adequate levels -- levels that compare favourably with those of other public sector unions. Only in Newfoundland, and to some extent in Alberta, is there major difficulty with respect to the funding of those plans.
Senator Oliver: Is that because they are not getting a good rate of return on the money that is invested, or because of the contributions? What is the problem?
Mr. Staple: I can speak about Newfoundland in particular. I do not think that it has been from the performance of the fund. It has been from a lack of consideration of addressing the problems related to unfunded liability.
Mr. Ulrich: In Manitoba, we had to address this issue back in the 1970s, when we found ourselves facing an unfunded liability. At that time, we moved to do two things, one of which was to clearly identify who was responsible for what, within the context of our pension plan. You may or may not be aware that within Manitoba we have a semi-funded pension plan. The employee's share is funded. Government has chosen not to fund its half, but to pay half the pension on a payroll payout basis. What we did was to raise the teacher pension contribution to a level that would adequately fund all future service, and then deal with the unfunded liability through investment return. By the mid-1980s, we were fully funded, and showing a surplus.
We were concerned with investment return as we moved into the 1990s. During the 1980s, particularly large pension funds were heavily invested in debt, because of interest rates. As we went into the 1990s, debt investments were not the place to be, and there has been a slow turn around. This is because of the massive amounts of money which needed to be moved into the equity market. When trying to change the structure of a pension plan in a rising market, it is always difficult to keep pace with those who have made that move before.
Our investment return over the early 1990s would certainly be below par if you were to compare it to typical mutual fund investments.
Senator Oliver: Do you have those numbers in front of you? Can you give us examples?
Mr. Ulrich: In Manitoba, the one year in the 1990s when we did better than the average was 1994, when there was a downturn in the equity markets. We were a -.2 and everybody was else was a -.4. As the equity markets have recovered since then, we have been a third to fourth quartile performer, which means that we have been lagging behind the median fund by 200 to 300 basis points. That is of concern to us.
As of 1997, we have finally moved to a comparably balanced fund, one which is about 50 per cent equities, and 50 per cent debt. Since that time, we have been having median performance, which last year was in the ballpark of 15 per cent.
Senator Oliver: In terms of your governance structure, is there anything that could have been done differently that could have helped make that turn around to equities earlier? In other words, have there been things that have been holding your performance back that are governance related?
Mr. Ulrich: Yes. The governing structure of the Pension Fund Board focused almost solely on the administration of benefits, and did not, until recently, get focused on the investment return. The advent of the roaring equity markets of the 1990s has people concerned about asset mix, asset selection, and those issues. Those were not issues in the 1980s, and, because of the size of these funds, they have been slow to respond. As you can see from looking at some recent figures from the Ontario Teachers' Pension Plan, however, the response has been quite remarkable.
Senator Oliver: In part, has your problem been due to lack of experience, skill, or knowledge on the part of some of the trustees?
Mr. Ulrich: That is not so much the issue as the necessity for a change in focus is. When you focused on one issue as the primary issue for the existence of the board, and suddenly you find that you must move into another area, you are into a very significant learning curve.
One of the conflicting issues in Manitoba that we have struggled with, is the fact that our act does not specifically give responsibility for investments to the Pension Fund Board. It gives them to the investment committee.
Senator Oliver: The investment committee is controlled by whom?
Mr. Ulrich: By the government.
The Chairman: I did not ask a question about the investment committee before, because I thought that they were one in the same. Can you tell us who is on the investment committee, as opposed to on the board?
Mr. Ulrich: I described the investment committee which is made up of the chair of the board, who is a government appointee, the Deputy Minister of Finance, and the teacher representative. The Teacher Pension Plan Board itself is a board of seven, of whom three are named by the teacher organization. Two are named by the school trustee organization. The chair and a citizen representative are named by the government, and have normally been selected from the business community.
Senator Oliver: In your brief, the main section dealing with the government's concerns that we are dealing with is what you call fiduciary responsibility. You are actually defining what you understand to be the fiduciary duties, and you are talking about the possibility of people acting out of self-interest or of bias. I want to know whether there has been an experience where that has been a problem in Canada.
Ms Eastman: Absolutely none.
The Chairman: You mentioned a few cases in which there was an actuarial problem, in terms of the unfunded liability with respect to certain pension plans. When that happens, who is to blame, and what happens to the person who is to blame? Is there a penalty imposed on the people managing the fund when it gets into trouble? I am seeking an accountability mechanism that would say that, when things do not go right, there ought to be some accountability somewhere along the line.
Secondly, when you have an investment board, controlled at least by government nominees, if not necessarily controlled by government people, are there either implicit or explicit rules that relate to where the pension fund can be invested? I am not familiar with the Nova Scotia scene today. I know what the rules were back in the early 1970s. They may have evolved since then. However, there was a significant amount of pressure for public pension funds in the Atlantic provinces to invest, firstly in the bonds of their province, and secondly in municipal bonds. There was the notion that, if there were to be equity, it was to be equity in the province. I am trying to understand to what extent the investment policy is bound, either implicitly or explicitly, to reinvest in the local community, which obviously has a significant impact on the potential rate of return.
Mr. Ulrich: We dealt with that issue about two years ago. In fact, there was an attempt within Manitoba to form a Manitoba Capital Fund into which, it was hoped, each of the major public sector pension plans would put a portion of their assets for investments -- venture capital investments -- in areas that banks would not touch.
The Chairman: In Manitoba?
Mr. Ulrich: Yes. We have rejected that initiative. Certainly, the government representatives on the investment committee were consistent with the view that, for them to make the decision to place money into that fund, it had to make business sense. It was not sufficient that it made political sense.
A similar initiative occurred in Ontario, and it is my understanding that, again, the Ontario teachers said that the fund did not make business sense for the investment of teacher pension assets. That is a concern.
Having said that, it is quite clear that, during the 1970s and through the 1980s, and particularly when interest rates went sky high, public bonds were the place to be. A lot of the assets were tied up in those investments, which is why we had the difficulty of effecting a turnaround in the 1990s -- to move quickly enough into equities so we would have a competitive rate of return. That is an ongoing issue in terms of pension plans. They are large sources of capital, and certainly the public that has an interest in that money wants to see a portion of that invested within their particular province.
In Manitoba, since the government half is unfunded, we do not have a difficulty with that situation. In fact, we have 50 per cent of all of it invested in the assets of the province, plus about 12 per cent of the balance.
Across the country, that comes up as an issue in discussion. However, I do not know of any pension plan that has made that a policy issue; they will not let geography determine a good business decision.
Mr. Staple: If you had asked me that question 10 years ago, I would have more difficulty with the issue than I would today.
The Chairman: My recollections of Nova Scotia when I was in the government there in the 1970s would have been right, then, but it might not be true today.
Mr. Staple: In the East, the mindset or philosophy has been that the way to pay for pension plans is to collect the premiums from the employees, and pay the benefit out of current account revenue. For a long time, a lot of these provinces had no funds, which is why they got into difficulty with unfunded liability into the 1980s and 1990s. In maintaining and developing a plan, from an employee perspective the major concern is what benefits will come from the plan. It is only when that structure is put into place and pretty much settled that employees begin to think about how the plan is funded, and how they can have an impact on that. That is what has been happening since the mid-1980s. In terms of the administration of funds, the involvement of employee representatives has caused some of the changes at the government level.
The Chairman: I am particularly intrigued by your comment that you were, for many years, in the third or fourth quartile of performance. In a lot of private sector plans, my instinct tells me than an investment group that up that was in the fourth quartile for two or three or four years would not be around very long. Is there a corresponding accountability mechanism in the public sector in general, but in your plans in particular?
Mr. Ulrich: Firstly, there is the responsibility issue, and we have seen that dealt with in different ways where unfunded liabilities have been revealed. The most extreme example at the moment is probably in Alberta, where any objective observer would say that neither the government nor the teachers were adequately funding, if you looked at the benefits that were being promised. As a result, the pension deal they arrived at means that both sides are now paying a far greater amount for pension contributions, and that is purchasing future service just to pay for the sins of the past.
When you have a pension plan that is controlled by government legislation, it is questionable whether it is appropriate to make future employees pay for past sins. In Alberta, however, that is the way that it is happening so far.
In Manitoba, we managed to get a handle on that situation a little faster. As a result, because the unfunded liability was a much smaller portion of the total assets, government did accept the responsibility for the historic underfunding. In our deal, teachers would take full responsibility for 50 per cent of all future unfunded liabilities, which is their share of the pension promise.
In terms of when the unfunded liabilities are revealed, then, most plans have now come to an agreement whereby they will deal with those in the future. The historic ones, where one party had absolute control over the structure and contributions to the fund, are always problematic to deal with.
On the investment side, that is an issue of concern. In 1994 in Manitoba, we established our own investment management corporation, an autonomous, independent organization, but wholly owned by the Teachers' Pension Plan. Its task was to bring our investments into the 1990s, and we expected that it would underperform during the transition. It would not be reasonable to expect any manager to do otherwise. We have reached that balance.
The Chairman: This was because there were a number of locked in long-term investments?
Mr. Ulrich: That is right. We reached that balanced fund in June of 1997. If, during a business cycle, the fund does not perform on average with the market, we will be seeking alternative management. That is just the way of the future. That is just the way of the future.
Senator Stewart: Could you compare the way that university professors' pension benefit arrangements have been made in Canada with those that apply at the primary and secondary school level? As I understand it, at the university level the university and the employee typically contribute to a professionally managed fund, and the benefits are based on the performance of the fund.
In the case of primary and secondary school teachers, I gather that there is a direct responsibility on the part of the provincial governments, at least in some of the provinces, to ensure that, whether there is a fund or not, the teachers are eligible for benefits. That would presumably explain why, in some provinces, there is such a heavy involvement by provincial governments in the management of the program. Is that correct? Is my comparison useful, and is my conclusion correct?
Mr. Staple: I cannot really speak on the structure of professors' pension plans. My guess is that the structure of those plans would vary from province to province. I do know that in Newfoundland for example, the university pension plan has the same structure as other public sector plans. It is a defined benefit plan, and the same guaranteed apply with respect to the government.
I understand the thrust of your question. The guarantees attached to these pension plans are not a great deal of comfort these days to members of teacher pension plans, when they see difficulties in the unfunded liability of their plans. This is why corrections of those unfunded liabilities have taken place across the country, as Mr. Ulrich indicated has been done in Manitoba. Through negotiations between the parties, they have been a combination of adjustments and benefits, increases in contribution rates, and extraordinary contributions by the governments or the employer to cover considerable unfunded liabilities that benefits and increases in contributions would never be able to accomplish. Those kinds of negotiations, and those kinds of mixes in fixing the unfunded liability problems, have occurred in each and every province where there has been difficulty.
I have just recently come from Newfoundland. There, a number of years have been spent dealing with the unfunded liability of the pension plan. The government's guarantee that it will meet the obligations of an unfunded liability in a plan that is probably well less than 20 per cent funded is little comfort to the teachers of Newfoundland, who are struggling to find a solution to the problem that would involve all three elements that I just indicated. They fully realize that, given the set of circumstances as they currently exist, the obligation will not be met, irrespective of whether or not there are guarantees in the legislation.
In all instances where there has been difficulty with an unfunded liability, the concept of the guarantee has not been a factor in negotiating solutions to the unfunded liability question.
Mr. Ulrich: We must look at the circumstances under which most of these pension plans were founded. It was that era, it was basically viewed as the paternalistic employer taking care of the future of his employees. The employer would expect the employees to make a contribution, and in return for that, he would guarantee a certain benefit, and would pay whatever would be required to ensure that.
Quite frankly, that has gone the way of the dodo bird. We are into a situation where everyone from both sides of the table is asked to be accountable for the future of the funding of pensions. It was a concept that worked well when we were looking through the 1920s to the 1960s, at what we hoped was constant growth and a fairly balanced demographic distribution. The concept of the retirement of the baby boomer has scared everyone into taking a very serious look at what cash flows will be required out of pension plans, just to meet those pension payrolls. As a result, we have a totally new psychology, and a new philosophy is being used to examine the funding of pension plans, and to determine who is responsible for what.
Ms Eastman: Across the country, our teacher members are very interested in what happens to their plans. They are not passive, and they are not ignorant of who represents them, nor of how those plans work.
Senator Stewart: The implication would seem to be that, if the plans were adequately funded by contributions from employer and employee, the best model would be an investment board or committee in which the provincial treasurer would not be involved, either directly or indirectly.
Mr. Staple: That would be my opinion, although I do not know how widely that opinion would be shared. We are seeing a gradual transition towards that. New Brunswick, for example, is the most recent to have established a superannuation commission. It is called the New Brunswick Investment Management Corporation, and it operates the portfolios of three pension funds -- the public service, teachers, and judges. It operates at arm's length from government, although there is still a connection, which I think will grow decrease as time goes on. I do believe that is the trend.
Senator Kelleher: We have been hearing some evidence from various pension fund managers -- what they do if they are unhappy with their investment in a particular company. Some of them feel that the best way is to meet with the chairman or management of that particular company, and voice their concerns. Sometimes they take the route of going public, because it is pretty difficult today, given the market, to just go and dump your shares.
What do you do when you are unhappy with an investment in a company?
Mr. Ulrich: It depends on the nature of the investment. I can think of three different areas, and we would deal with each of them differently.
With publicly traded equities, the decision would likely be to unload the equities. We also get involved in direct investments, however, in corporations as well as in real estate. In each of those, we would take a very active role in doing what we could to improve the performance of the company, or to improve the operation of a real estate development. We expect that of our investment manager. Where we have substantial direct investment in a business operation, be it business or real estate, we expect that we would likely have a seat on the board of directors of that operation. That is the only way that we can effectively do due diligence, to protect the interests of our beneficiaries.
Mr. Staple: The situation varies so much from province to province. My guess is that there would be far more flexibility in funds that are operating at arm's length from government, or separate from government. They would have far more flexibility to engage in that kind of interaction with the corporations in which they have invested.
From our perspective, any action that increases the performance of the fund benefits members. As such, that should be pursued within the bounds of the exercise of appropriate fiduciary responsibility and law.
Senator Kelleher: Let us deal just with publicly traded companies, because that is a concern that we have been hearing about. If your fund manager goes and quietly chats with the management of the company where you have an investment with which you are not happy, does this not give you, as an investor, an advantage over other shareholders? Secondly, does this not place the company in an awkward position, where it may perhaps give you information which could lead it into some problems with the securities regulations?
Mr. Staple: Feeling that there might be some difficulty, any large investor might seek to speak quietly with the managers or board of directors of the corporation, in order to obtain some information, or to offer some concern or advice. I am uncertain who would be advantaged or disadvantaged if the intent of the whole exercise is to increase the performance of the corporation. I would think that everybody benefits to some degree, so I do not know that that kind of activity would be detrimental to other shareholders.
Any shareholder should have the opportunity to offer or to express those kinds of concerns, and to offer that kind of advice in some fashion.
Senator Kelleher: If a pension fund manager comes to the head of a large company, he or she will get through a lot more quickly, and be listened to more than a single shareholder would. That shareholder may only have several hundred shares, but, to him, it represents quite an investment. Does this give one organization or group an advantage that other shareholders do not receive?
Mr. Ulrich: We expect that our investment manager will visit companies, including publicly traded ones, with whom we make investments, in order to satisfy himself that this is a sound investment, now and in the future. That is part of due diligence. It is part of the exercise of fiduciary responsibility.
Does it give us an advantage? Only if it were to the detriment of someone else. Certainly, the fund does have the ability of any large pool of capital to effect more influence, but I am not sure that that is unique to teacher pension plans or any pension plans. That is the reality of our contemporary world.
Effectively, you could say that we represent thousands of little shareholders who have an interest in how well that company performs. We can hopefully have some effect of improving the performance of the company, and we therefore help, not just our own members, but all the other shareholders who do not have that kind of voice, because they do not have the collective involvement. A lot of those little shareholders do have collective involvement through mutual funds, however.
Senator Kelleher: What if you are told, "I am sorry, I cannot give you this information, because it might constitute insider information, and I can get myself in trouble." Is this a problem, or has anyone experienced this to date?
Mr. Ulrich: We certainly would not anticipate that information which would constitute insider information would be provided to us. There are times when we do get information about things happening in the business world that prohibits us from trading in those securities for a period of time. That is put as a general block -- our investment manager and his employees are unable to trade in those securities, or to take advantage of that sort of information. That is standard with all investment managers, whether in pension funds or elsewhere.
Senator Kelleher: This practice is becoming more common. Should the guidelines in this area be looked at or changed?
Mr. Ulrich: I would have to be convinced that a problem that exists. What is happening is to the betterment of corporations, not to the detriment. It is to the betterment of all of the investors in those corporations, and not to their detriment. Clearly, every investment manager establishes a conflict of interest policy to deal with those issues. We have such a policy with our investment manager, and we are satisfied that it is an appropriate one. There are also the general AIMR guidelines for investment protocol, which deal with conflict of interest issues. Those issues have been addressed, and I would hope that you would be satisfied that the policies do exist.
Senator Kenny: I must confess that I am uncomfortable with the answers that have been put forward. When an investment manager calls on a company, that is a big deal for the company, and the company is really concerned. The company is on its toes, and is anxious to put its best foot forward. It is very concerned that you may not like what you see. The careers and remuneration of everyone in the company are driven by how their shares perform. If the people working for you do not come back with a good report, there are problems. There is no question in my mind that we have some natural conflicts here which must be addressed.
I accept that it is reassuring to know that, when an investment manager receives insider information, he or she is not supposed to trade in the stock, and is supposed to advise those who report to him or her not to trade in it, until that information ceases to be insider information.
Having said that, I must believe that, in the course of the conversation, the individual will become privy to information that is not available to other people. This is what Senator Kelleher is driving at. I do not think that it is enough to say, "If we are offering good advice, and it improves the performance of the company, that benefits everyone." It might, and it might not. It might only benefit you. It is hard to tell. You can move in and out of a stock in a way that the ordinary investor cannot. I am left with a feeling of unease. I wonder if you would care to comment on what I have said.
Mr. Ulrich: There was a bit of an innuendo in that that I do not concur with, and I find that a bit objectionable. I understand where you are coming from. In our own monitoring of our investment manager, I am satisfied that those policy guidelines are adhered to rigidly. There would be serious consequences if they were not, including, of course, criminal consequences. I am satisfied that the guidelines are adhered to.
In terms of getting information, does that result in the ability to make better decisions? Is that very different for pension funds? If you are looking at the person investing a few thousand dollars, absolutely. A lot of individuals are putting in a few hundred dollars, to guarantee their retirement security. This is not a trivial matter that they are putting their money in for, and they expect that whoever is managing that money will use whatever means possible to protect it against undue risk, and, within reasonable risk, to make the best possible return.
That is the reasonable expectation of each of our beneficiaries. If we do not have the freedom to make knowledgeable decisions, that responsibility cannot be met, anymore than it can be met by banks or mutual funds who put all sorts of conditions on the granting of money as an investment, whether it be within the country or in the development of third world countries. The influence of that sort of capital is being felt around the world. It is not unique to pension funds.
Senator Kenny: I certainly did not intend to personalize the issue. I was talking in a generic sense.
Mr. Ulrich: I object to the generic sense -- the idea that that is how pension funds might operate.
Senator Kenny: There is a potential conflict there, and if you do not see it, that worries me a lot more. From time to time, this committee has been looking to see whether large investors could be relied upon to serve as protection for smaller investors who were not part of their pool. We have yet to see any case that supports that. The conclusion that I have come to is that large investors take care of large investors, and it is up to small investors to take care of themselves. Are you suggesting that your presence there would, in fact, provide some comfort and security to small investors who were not part of your fund?
Mr. Staple: I do not know that we have the information to answer that question one way or the other. We have not seen any evidence that the operation of the investments of teacher pension plans has had a negative influence on smaller investors.
In previous submissions to this committee, a witness -- I believe it was Professor MacIntosh -- indicated that, in his investigation of corporations in which there was a high institutional ownership, there did tend to be a higher return on assets and equity. That is the kind of evidence to which we are referring. We do not know of any to the contrary.
Mr. Ulrich: While I understand your concern about the potential for conflict, that must be evaluated within the context that there is also tremendous potential for synergy. Working together, the two can produce the best for both.
Senator Hervieux-Payette: Right now, there are no strict requirements for the investment, except for the foreign investment rule. There is nothing about the share versus the bond, or more secure investment. As we enter the year 2000, and globalization increases, there is a request to go to 30 per cent foreign investment, and we know that there is a duty of a lot of diligence on the part of the investment people.
If we open the door to more foreign investment, how do we make sure that nobody starts having losses and so on? What should the government rules or regulations for the investment strategy for the year 2000 be, or should the government have a role?
We switched from one very secure government bond. At the time it must not have been very difficult to manage the funds, but I guess that eventually it will become more complicated, and probably more risky. We are in a changing era, and we must avoid putting the funds at risk in the future. To that end, do you exchange views with others? How is the overall sector making sure that there will not be any big risk in the new era?
Mr. Ulrich: I do not know of anyone right now who would say that there is not a big risk. The equity markets have been extremely volatile over the past year, particularly since last October. There are a lot of people in the investment community who are very nervous, and who, as a result are taking defensive positions -- moving more to cash, reducing their equity exposure, those kinds of things. These are things that you expect your investment manager to do on an ongoing basis, in order to limit the risk to the degree that you think you can tolerate. The whole issue of what risk you can tolerate is a very critical question, and pension fund boards must deal with it. There is no single answer to it because it depends -- if you are in a significant surplus position, you can obviously take greater risk. If you are in a deficit position, it is already risky. That is a critical question.
We seek the best information that we can find, to tell us what is the best thing to move forward with. Right now, everybody I listen to says that they wish that they knew. So far, they are still saying that equities are the best for the future, but, as far into the future as anyone can see, it will be a volatile market.
Senator Hervieux-Payette: I come from a civil law province. When I did my law degree, when someone acted as a trustee you had some limitation in terms of the structure of the fund being managed. Only a certain percentage could be at risk. I am not suggesting that we should go back to that. All fund managers in the country do not have the same qualifications, and my pre-occupation is that we may have top notch people for the top notch funds.
I remember the story of Royal Trust. I thought that institution was almost as solid as the Bank of Canada, but a multi-billion dollar organization went down the drain. If we are looking at opening the door to more foreign investment, while at the same time the market is volatile, if I were an employee or a widow, I would want to know what is safeguarding the future of my pension fund. Fund managers are not perfect managers, so what measures or mechanisms can the government bring about to prevent chaos if there were a major downturn?
Mr. Ulrich: Pension benefits legislation is in place in every province, which spells out certain limits on the investments, and how much exposure you can have to certain companies. Those are contained in the law. In addition to that, most, if not all of those, also require each pension plan to have its own investment policy, which will describe its asset mix. That must be reviewed annually, in most cases, to determine whether it is still appropriate for the economic conditions of the day.
I can tell you quite frankly that this is cause for great nervousness in the investment community. Those of us who have fiduciary responsibility for pension plans think about it a lot, because the concerns you raise are real ones. You must balance those concerns against the beneficiaries' expectations that you will get them a very great rate of return, which will minimize their obligation to make additional contributions.
Senator Hervieux-Payette: Even though our legislation in Quebec is not federally regulated, we had changes in the law to allow us to go to 60 per cent in equities. There have been increases over the years. The goal is always to have a maximum return, but there must be a balance between the maximum return and the protection of the future pension to be paid. If I were a prudent fund manager, 60 per cent is certainly not the most prudent standard for what I can foresee in the future. If I had 60 per cent in shares outside of Canada as well, I would have some reservations, because we combine risk factors. That is why I was talking about percentage. Is it 50 per cent? Is it 40 per cent? Quebec started with a very small percentage that could be invested in shares. Now it is up to 60 per cent. Are we moving towards 70 per cent, or are we moving towards being more prudent?
Senator Angus: Prudent or restrictive?
Mr. Ulrich: That is the question -- is it prudence or restriction? I also sit as the chair of an investment committee for our disability fund. It has a different risk profile, and we have been as high as 85 per cent equity, simply because that was the prudent place to be to get the kind of return that we wanted, or to pay the benefits that we promised to pay our disabled teachers. This fund has a different duration of liability, so we could afford to take that sort of risk, knowing where the return would be received. We are not there at the moment, though, because the risk profile of equity investments has changed, and that is an ongoing decision.
The prudent decision is to make the right decision with all the information that you can collect. It is not prudent to say in advance that 60 per cent one day, or 40 per cent another day, is the right number, because you never know the right number until you have examined all of the information.
Senator Kolber: In my career, I have been involved in three or four really big pension funds. You said that you were heavily into bonds in the 1980s, and that gave you a big problem in the 1990s. I did not run the pension funds, but they were company pension funds, and huge worldwide ones, ranging anywhere from $10 to $18 billion. That might not be as large as your fund, but it is still significant. We did not run into those kinds of problems.
It is bizarre to equate equities with non-prudence. Your answer was a good one -- prudence means trying to make the right moves at the right time. I really do not think that this committee should get involved with guidelines. That would be the height of stupidity.
Earlier, you said that the board of directors of the Manitoba fund only looked after administration. The fact that the powers were separated, and that there was a leaning towards provincial investment, struck me as being archaic and Mickey Mouse. Our job ought to be to say to you, "How can we be of help to you? What do you think the government should legislate?"
The running of a pension fund is a many splendoured thing. The Seagram pension fund is heavily overfunded. Basically, we have only ever owned equities. This is not a time for an economic lesson or a management lesson, but equities have outperformed virtually everything else over every reasonable length of time. Of course, if you want to buy penny mines, you are making a mistake. That is not the purview of this committee, and that is not where we are. You were supposed to help us, to advise the government as to what sort of legislation you think ought to be incorporated.
I know some of the people who help to run the Ontario Teachers' Pension Fund, and these are people with vast experience. Ted Medlin was the head of Wood Gundy for as long as I can remember. I have been doing business with him for longer than I can say, and these people are doing a very good job.
If there is something that we ought to be thinking about by way of process or legislation, fine, but we absolutely must not get into any guidelines as to X per cent this, or Y per cent that. That would be stupid. You did that yourself in the 1980s. You bought all the bonds because interest rates went up to 20 per cent. It looked like a wonderful deal, but they slowly slithered back to 5 per cent, and you were left without any growth whatsoever. As you said, prudence is making the right decision.
Senator Angus: You are preaching to the converted.
Mr. Staple: I know that it has been a long struggle for pension plans in the public sector to develop to the stage where they have a degree of meaningful input and involvement from the employee group. It has gone far beyond expectations in some provinces, and it still is in the dark ages in others.
In terms of dealing with benefits, and the day-to-day administration of the plans, it is now accepted that there is a direct and meaningful involvement and input from employee groups. Specifically, from our perspective, members of teacher organizations.
In terms of meaningful input and involvement in the majority of plans, I am not talking about size of assets now -- I am talking about the sheer numbers of the plans. In terms of the meaningful involvement of employee groups in the investment procedures, there is still far less of that than there should be. In a number of provinces, the battle for employee groups has been to get meaningful input into the investment procedures. When that happens, we will begin to see some different benefits as well.
The Chairman: Thank you. I understand that our pushing that line would be of some assistance to you. Thank you very much for coming. We appreciate your candour.
Mr. Kelly, please proceed.
Mr. Peter Kelly, Executive Vice-President, Power Workers Union: I have a totally different perspective to put before you.
The people in the Ontario Hydro Pension Fund, whom I represent, are totally shut out of any role in governance or investment decisions. We have a fund which is well in excess of $10 billion. When it comes to pension issues, we have an incredibly acrimonious relationship with our main employer, Ontario Hydro, because of this. We are constantly before the courts; we have a litany of court cases. Just yesterday I was informed that once again the Ontario courts have ruled in our favour on a pension issue. Mr. Justice MacPherson will give us the written award in a few days time.
We have been all the way to the Supreme Court of Canada on pension issues. The company has a history of illegality when it comes to the administration of our pension fund. In fact, in 1989, the Ontario Court of Appeal judged that:
Hydro is not entitled to avail itself of surplus in employees' pension plan in order to discharge its obligation to contribute towards the cost of the benefits to be provided by the plan.
Later that same year, Ontario Hydro's application for leave to appeal to the Supreme Court of Canada was denied. In fact, in the settlement of that court case, the employer had to repay in excess of $600 million to our pension fund. Over a number of years, they had illegally removed that money from the pension fund during a series of actions.
We have the highest respect for the actuarial profession, but even professional people who are employed take direction. The case that I just mentioned is a method that has been devised by the employer's actuary to, we believe, get around the court decision which caused them to have to repay $600 million. They have devised a method which they have called the "dual valuation method" to come up with the of money that they are required to contribute to the plan. It is a more aggressive set of assumptions, which in fact reduces their annual contribution requirement by approximately $50 or $60 million a year.
We are once again before the courts. Justice MacPherson has just ruled that the issue be dealt with by the Pension Commission of Ontario, and we have every expectation that we will be successful again. It does lead to an incredibly acrimonious relationship in very difficult times, however.
As I am sure that you are all aware, the electricity industry in Ontario is facing significant restructuring. In fact, if the legislation goes through as planned, Ontario Hydro as a corporate entity will disappear sometime in the year 2000, and will be resurrected in a number of Crown owned successor companies sometime in the same year. When it comes to the pension fund, the implications are not lost on you. We have a huge surplus. It is well in excess of $3 billion, and we believe that it is fast approaching $4 billion.
The fund has performed. We are not critical of the method in which the fund has been managed. We think that the managers have done a good job. In this day and age, retirement income is so important to millions and millions of people. This is especially true in light of government decisions; private pensions and individual savings are becoming a greater part of retirement income, and government will become a lesser source of income for many people in the future. In light of that, we believe that it is prudent for government to mandate a more encompassing method of governance of pension funds.
If a private pension plan must become the main part of my retirement income, it is important that we, as plan members and representatives of plan members, have some say in how that would be invested, and how it is governed. Currently, we are totally shut out. We have an employer who has a track record of showing some disrespect for law, and this whole system is totally inappropriate, in our view.
The Chairman: Do employees contribute to the pension plan?
Mr. Kelly: Yes, we do. We pay a combined total of 6 per cent, and once we reach the YMP for CPP we contribute 6 per cent. Prior to reaching the YMP, we contribute 4 per cent, so the average is 5 per cent.
The traditional rate has been about 2 to 1, employer to employee dollars. That has shrunk in recent years. It is now about 1.7 employer dollars to one employee dollar.
The Chairman: Are you in a situation in which the fund is managed entirely by employer representatives or, since you are a Crown corporation, is the government involved at all? What is the governance structure of the plan?
Mr. Kelly: The governing structure is unique, and quite incredible. Ontario Hydro's board of directors is also the board of trustees of our pension plan.
The Chairman: In its entirety?
Mr. Kelly: Yes.
The Chairman: Someone must be the general manager of the fund. To whom does that person report?
Mr. Kelly: There is a manager of the fund. Mainly the managers are hydro employees, but generally management employees. In recent years, some of the investment portfolios were given to outside managers, but they do ultimately report internally to the Chairman of the Board.
The Chairman: Is this structure one that was negotiated as part of a union contract, or is it by legislation?
Mr. Kelly: It is governed by the Power Corporation Act of Ontario.
The Chairman: Are there other sizable Ontario provincial government Crown corporations that would have the same structure?
Mr. Kelly: I do not know. Most, like OMERS, the Ontario Municipal Employees Retirement System, have a joint board.
The Chairman: They are not totally owned by the government.
Mr. Kelly: They are not owned by the government, but they are owned by local government and municipalities. They are a public fund. I do not know what the structure of the government's own employees fund is.
The Chairman: Your court cases are almost a decade old now. Over the years, have you attempted to get the legislative change required to change the management structure of the plan?
Mr. Kelly: For a number of years, we have tried to negotiate a method of joint governance with the employer. The court case said that the plan moneys belong to the plan members, and that the employer cannot take a contribution holiday without the consent of the bargaining representative.
We have tried to achieve what we think is the proper method of governance; one where we would have joint governance and joint control over actuaries, and joint administration. We have offered the employer a share of the surplus, but it seems to think that it can get the legislation rewritten to its benefit. The employer wants it all, even though we have said that we will give it a significant share.
We jointly hired a company, and for some time we were working with Dr. John Paul in order to achieve a governance structure. We came close, but then the restructuring of the industry came about, and the company decided to go for control of all of the service.
The Chairman: Do you know if your structure is similar to that of other provincially owned electric utilities around the country? Is there something unique about the power industry?
Senator Angus: Is Hydro Quebec the same?
Mr. Kelly: We are unique, in so much as we have a specific piece of legislation, the Power Corporation Act, that actually contains wording about our pension. Our legal advisors have told us that we are unique in that respect.
The Chairman: Senator Angus, you were on the board of Air Canada when it was a Crown corporation. I am not familiar with the structure of Crown corporation pension plans, other than the CN one, which has both employee and employer members. Is Mr. Kelly's case completely unique?
Senator Angus: I have never heard of a case like it before.
Mr. Kelly: Our legal firm is Gowling, Strathy and Henderson.
Senator Kelleher: Law firms like to feel that, for every cloud, there is a silver lining.
Senator Angus: Have you taken any steps to have that provision of law amended?
Mr. Kelly: During our 1990 negotiations we were able to get wording into our collective agreement which says that the employer cannot unilaterally approach government to seek changes to rules and regulations which involve our plan, such as changes to legislation, without our consent.
The reason for that is fairly self-evident. At the time, their track record demonstrated that they would do whatever pleased them.
The method we used was a preventative method, which made them incapable of doing things unilaterally. They have continually tried to remove those words. We have tried to elicit government support to bring pressure on the employer to consider a more appropriate, joint governance arrangement.
I do not want to offend any one, but due to the current regime in Ontario, the chances of our impressing our needs upon the government of the day are very slight.
Senator Angus: The government listened on hepatitis C.
Senator Stewart: In a sense, the witness has introduced my question. He told us that the troubles with the employer go back a long, long way. He has just now mentioned the present Government of Ontario. Previous governments have also been aware of the complaints against the existing arrangement. This is not intended to be a politically embarrassing question, but, when Mr. Rae was premier, did you attempt to get the situation corrected? Did you attempt to get it changed when Mr. Peterson was premier?
I am asking a more fundamental question. Does the government have a good reason for not making the kind of changes for which you have been asking?
Mr. Kelly: With respect to Mr. Peterson's government, and Mr. Rae's government, I have been involved since 1990. During those periods, and with their help, we attempted to negotiate a governance arrangement with the employer that would be beneficial to both parties. We have not sought direct legislative intervention.
We have been told that we can expect to see legislation introduced in the Ontario legislature in June, which will do away with the Power Corporation Act. Different legislation will give control of the surplus to the successor companies. In our view, that is why the company has abandoned our joint effort with Cortex to establish joint governance. They have, perhaps, been forewarned that there is no need.
Senator Stewart: You were extraordinarily patient, perhaps to the point of imprudence, when you relied upon negotiations.
Mr. Kelly: The great benefit of the Power Corporation Act, from our view, is the language that says the employer will contribute. That is the language that we took to the courts. We were successful in saying, yes, it is plain language, and that is what it says. Obviously, we did not want that changed. We wanted the arrangements changed. Rightly or wrongly, we felt that the best way to do that was to arrive at a non-imposed settlement. Rather that having one party feeling totally aggrieved, and the other party perhaps wagging its tail, we wanted to reach a negotiated settlement, and we have been unsuccessful. Perhaps our impatience will prove imprudent.
Senator Oliver: Eleven years ago, the Supreme Court of Canada's decision said that Hydro's management cannot give itself a holiday from management contributions, and cannot tamper with the surplus without the approval of employees. You have known that for 11 years, and have not made efforts to have the legislation changed. What, if anything, are you asking this committee to do?
Mr. Kelly: We have exhausted our patience, and we do not believe it will ever be possible to negotiate an appropriate governance structure, an appropriate surplus sharing arrangement, or an appropriate liability sharing arrangement -- all the things that go with having a say in governance and investment. We have convinced ourselves that the employer has no interest in doing that, even though we have attempted to do so on numerous occasions, and even though we have jointly hired consultants to help us on a number of occasions.
In legislation, we would be looking for basic requirements for employers to set up governance structures. In non-union environments they would share authority and control when the majority wish it, and they would share them in unionized environments when it is the wish of the bargaining agent.
We believe that employers need a legislative push. Our own experience clearly suggests that, even with the strength of that court case behind us, it is virtually impossible to negotiate a satisfactory arrangement. This is true even when you give it a long period of time, and even when you go to the lengths of hiring people to assist you.
We hired Cortex jointly twice -- not once -- and we tried this extensively. We were trying to negotiate a settlement where no party would be aggrieved. If our patience turns out to have been imprudent, we will be guilty of that. At the time, though, we felt that that was the course to take. Now, we believe that our employer and other employers need a legislative push.
Senator Oliver: You were not able to achieve your goal through contract negotiations. The language in your contract is still insufficient, is that correct?
Mr. Kelly: The language in the contract still prevents the employer from unilaterally seeking change. Unfortunately, we discovered two weeks ago that they went ahead and did just that. We put in a claim for $5 million worth of damages, but that is beside the point.
Senator Angus: I can see why you cannot negotiate.
Mr. Kelly: Just think about what we offered. In that award, the employer was told that it had not say in the ownership fund, nor in the distribution of the surplus, unless by mutual consent with the employees and the bargaining agent. We offered to share it. We offered to take over some of the liabilities, to take responsibility for unfunded liabilities if and when they came about, and we wanted equal sharing on the board of trustees. We wanted 50 per cent union appointed, and 50 per cent employer appointed. No deal. We offered them a share in a huge pot of money, to which they have no access without our consent. They still would not do it, because they want it all.
Senator Angus: What exactly are their arguments?
Mr. Kelly: The employer's only argument is that the courts were wrong.
Senator Angus: Are they saying to you, "We do not care what the modern view of governance is, we like the original legislation the way it reads, and we do not wish to change it?"
Mr. Kelly: One of their arguments is that they must define benefit plan, and they are on the hook if there is a deficit. They feel that, if that is the case, then they should call all of the shots; they should hire the actuary, they should be the trustees of the board, and they should have ownership of the surplus. Even though we do not buy that argument, and they say that the courts were wrong, we said to them, "Fine, enter into an agreement with us where we share all of those things, including responsibility for unfunded liabilities." The answer was no.
Our opinion is that they truly believe that they will be given access to all of that money through legislation to all of that money and they therefore do not need to change anything.
Senator Tkachuk: Are they right?
Mr. Kelly: A partner at Gowling, Strathy, and Henderson recently told me that governments can write retroactive legislation. I did not realize that. That is apparently what is being planned, and we will once more be fighting before the courts.
Senator Tkachuk: What do you think should happen to surpluses?
Mr. Kelly: Let me create an example where the employer establishes a plan that is non-contributory from the employees' point of view -- that is, the employer is the only one to put in money. It is structured so that it keeps pace with price inflation, and is 100 per cent indexed for members who are active employees and for pensioners. In that situation, an employer would have a claim for gains in the plan. In a situation where employees also contribute, and where the gains in the plan really have nothing to do with the contributions, and everything to do with plan performance, why should that automatically revert to the employer? It is the plan members' money.
On a wind-up of a plan, if it is in shortfall, in deficit, guess who gets to own that? The plan members, not the employer. In a wind-up of a plan, if the plan is in surplus, the employer suddenly steps forward and claims ownership. In the wind-up of a plan where there is a short-fall, the plan members will see reduced benefits.
Perhaps I can ask a question. Why is there the belief that an employer in a jointly contributory plan should automatically own any surpluses?
Senator Kolber: Are there not laws about that?
Mr. Kelly: Yes, but in our case, because we have a specific piece of legislation, they do not own it. The Supreme Court of Canada said, in the case of this particular plan, that the plan members own it.
Senator Tkachuk: Should the surpluses be invested with the same care as is taken with the actual pension funds themselves? Alternatively, will they be used for more risky investments? Should it be the same mix?
Mr. Kelly: I believe that pension funds are pension funds. The fact that some might be designated surplus at a given time should not make a difference to the diligence that is used in the type of investment. Any investment, for any pension fund, it should be a sound investment. There should be a sound business case for making that investment.
Senator Kolber: Services are not segregated.
Senator Tkachuk: I understand that, but sometimes, if you have much more money than you need, you may not handle it with as much care.
Senator Stewart: We talk about employee contributions. Surely there are situations in which the employee contribution is really an employer contribution. The negotiation goes on. They make an offer to the potential employee of a pension fund, and they give 5 per cent or 6 per cent over the amount now offered. That will be deducted from your take-home pay, and will go into the pension fund.
I realize that, in a highly competitive labour market, it could not be argued that the contribution credited to the employee was really an employer's contribution. Surely there are some situations, however, where you are dealing with professional people, or quasi-professional people, and that could well be an accurate description of what goes on. You are familiar with negotiations, I am not. Does that really happen?
Mr. Kelly: In the negotiations with which I am familiar, I would suggest that the reverse happens. When we secure a pension improvement, it is all part of the employer's total compensation package, and, in many cases, we have sacrificed other things. We have not been able to obtain other improvements, because we have bought a pension improvement out of the total money that the employer has as part of its negotiating strategy.
In fact, we take less in one area to achieve a pension improvement. I would think that it is the reverse of what you said.
Senator Stewart: One reads about the top people at Ontario Hydro, who are the atomic cult. The number of people who could make entry into that group is relatively small. When those people discussed their pay, it was really not an ordinary bargaining situation. Is that correct?
Mr. Kelly: The people in the cult, I can assure you, were not our members. We did not negotiate on their behalf.
Senator Stewart: The cult was a relatively small group in the hierarchy at the top?
Mr. Kelly: The official hydro term for those people is "ESR"-- executive salary role.
Senator Stewart: Structurally, is that quite distinct from the people with whom you work?
Mr. Kelly: Yes, but they are in the same pension plan. Historically, the person who sat spent two months denying us the benefit in negotiations also receives we finally achieve it. It is an intriguing situation.
The Chairman: Mr. Kelly, thank you for taking the time to be here with us.
Our next witness is Mr. Claude Lamoureux, from the Ontario Teachers Pension Plan Board.
Mr. Claude Lamoureux, President and Chief Executive Officer, Ontario Teachers Pension Plan Board: As you know, the question of the large pension funds in the capital market raises questions which your committee is examining. To whom are those funds accountable, and to what extent do they have economic influence?
Your committee provides a useful forum. One of your areas of examination involves what we can do, and how provincial legislation can be influenced. When it comes to pension funds, there is federal legislation. Many times, provinces tend to follow what you put in the federal legislation. In a sense, that is useful for the pension funds, as there is an influence. It is a case of best practice. If the federal government can establish best practice, it will be easier for the provinces to follow.
I will touch on three areas: Our influence as an institutional investor, how our plan is governed, and public opinion about large pension funds.
Pension funds and mutual funds manage investments on behalf of millions of working Canadians who are looking for financial security. Our only reason for existence is to pay a pension at the end.Our task is not to invest money; that is just a means by which we can eventually pay those pensions. In the process, pension funds become substantial investors in Canadian corporations. In 1975, pension funds and mutual funds had $5.3 billion invested in Canadian equities; today the figure is more like $180 billion.
This growth reflects two developments. One is our ageing population. In the popular book, Boom, Bust and Echo, David Foot argues that, as more baby boomers reach 40, their financial priorities change from paying their debt, to managing their assets, and thinking about their retirement. This, in part, helps to explain the dramatic growth in the number of assets in mutual funds and pension funds.
The other development is the shift of pension fund assets from fixed income securities into stocks. Pension and mutual funds own nearly one-third of the shares of Canada's publicly traded corporations. This is a dramatic change from two decades ago, where it was closer to 1 per cent.
For our part, the Ontario Teachers Pension Plan has more than $18 billion invested in Canadian stocks, compared with nothing in 1990. How does a plan such as ours exercise influence on the Canadian market? We invest in two ways; we buy a basket of stocks, what we call quantitative or index investment. If the stock is in the index, we buy it; it is not more complicated than that. Roughly $15 billion is bought on a quantitative basis, and only $3 billion is selected individually. We select individual stocks that we think are undervalued, and they also form part of our portfolio.
The Toronto Stock Exchange 300 Index contains shares of Canada's 300 major public corporations. When we invest in the index, we invest proportionally on every stock listed on the exchange, to match its market capitalization. If a stock is in the TSE 300, we buy it in proportion; if a stock represents 1 per cent of the index, we buy 1 per cent.
If it is one-quarter of 1 per cent, we will buy one-quarter of 1 per cent. That is how the portfolio is run.
Senator Kolber: Do you actually buy the stock, or do you buy the index?
Mr. Lamoureux: No, we buy the stock. We mimic the index.
Senator Kolber: Why?
Mr. Lamoureux: We do so because it is a very effective way to invest today, especially in the U.S., where the index will beat 75 per cent to 80 per cent of the managers.
Senator Kolber: I thought that there was an easier way to do it.
Mr. Lamoureux: There is an easier way when you buy TIPS and HIPS. TIPS is the TSE 35, and HIPS is the TSE 100. When you are a large investor, why pay someone else to do it? The exchange charges you about five points to run the TIPS and HIPS programs. We can do it for one point or two points. We do it on our own.
On occasion, we have bought TIPS and HIPS, which is a program run by the exchange. It is fairly efficient. As an individual investor, it is a great way to invest. That is my stock tip of the day.
Senator Kolber: Could you explain to me why more pension funds do not do exactly that?
Mr. Lamoureux: Everyone thinks that they can do better than the average. Investing is a discipline, but for a lot of people it is a fallacy.
Senator Kolber: They cannot do better than the average.
Mr. Lamoureux: When all institutions together represent the universe, it is difficult for all of us to beat the average, because we are the universe. That is the fallacy.
From a policy standpoint, we have done it that way. In Canada, $15 billion out of $18 billion is in the index. In the U.S., 95 per cent of our exposure is in the index. In the EC countries, Asia, and in the Far East, the largest proportion of our investments are unindexed. They are managed actively because we feel that it pays. Through the active selection of stocks, we believe that we can do better than the average.
One of the worries that we have is what is the incentive to do better than the average? All of our employees are on some kind of incentive. If you run a quantitative fund, you must be close to the index. You may lose a little bit, because we charge some expenses, but you have to be close to the index. Through quantitative methods, we are normally able to better the index.
I do not know why most individuals do not do it. The newspaper will tell you over and over that most mutual funds do not beat the index. You are looking at a 2 per cent charge for expenses to start off. If you buy TIPS, you are looking at a maximum of 10 points, but more likely 5 points. A 1 per cent difference in that business over the lifetime of a person will make a 20 per cent to 25 per cent difference in the amount of pension at retirement.
When people talk about going from a defined benefit to a defined contribution, and that the two will give them a stream of income at the end, that is also a fallacy. If you try to beat the index, and it costs you a lot more to administer, such as 1 per cent or 2 per cent, you will receive a pension that is 20 per cent to 25 per cent smaller. Most people starting their careers do not really get interested in this issue.
We are a fan of quantitative investment, and we have been since the start. This is a very disciplined way to invest.
Senator Kolber: Thank you.
Mr. Lamoureux: We have a very active program of proxy voting. In the material, we have included our proxy voting guidelines. An individual does not get up in the morning and say, "This is how I will vote." Guidelines are approved by our board of directors, and we give them a report once a year on how we voted; if we made exceptions and why these exceptions exist, and if we voted against the proxies presented to us.
We feel that proxy voting is an economic matter. You can sell your proxy voting rights. People will pay you to vote your proxy in some situations. Proxy voting has an economic value.
Senator Angus: Is that in standard situations, or just in takeover situations?
Mr. Lamoureux: In standards situations.
You go sell almost anything, but a proxy is one thing you can sell or someone can sell to you. It is not done on a grand sale, but it is done to the same extent that you can lend your shares for someone to sell short. It is a way to increase your revenue.
Senator Austin: I am curious to know the motives of one who would want to buy your proxy rights. What are their interests in voting more shares in a standard situation? I can understand a takeover bid.
Mr. Lamoureux: If we talk about options granted to management, they might object to a slate of directors or to voting director by director. People may need more votes on occasion to do something, or to have a greater impact on a proposal in front of them.
Senator Austin: In a situation like that, do you make an inquiry as to the reasons for interest in bidding for your proxies? Do you make a qualitative judgment on whether you ought to support this?
Mr. Lamoureux: If I want to sell a share, I do not inquire as to why someone wants to buy. We have not done that, but I do know pension funds that do. We have never sold proxy voting, but it can be done. Why should I inquire?
Senator Oliver: You still own the shares.
Mr. Lamoureux: Generally you will know. It is obvious.
Senator Austin: You are concerned about the quality of your investment on a long-term basis, but you may sell the proxy, just as a negotiable instrument is transferred. You may find that the individual is Mr. Michaud, and that Senator Kolber is financing him. Let us assume that this person is looking for a change in corporate governance that may not be in your interests. This person, in the singular voting for directors, may want a director removed, and that may not be in your interest.
Mr. Lamoureux: Do not forget, we invest around the world. Maybe someone calls from New Zealand and says, "I understand you have shares in this company, and here is what we would like to do." That person may have more influence on the situation than we would. As I said, we have never done it, but I know that it is done. You can trade many things today, and a proxy is just one more thing that you can trade.
Security is lending. When we lend our securities, do we ask if someone wants to sell short? That is much more common, and yes, we do that. If we are long one way and someone is selling short, you might ask why we are doing that. This is just another way to make money. Clearly, we own the stocks, and someone we know will sell them short. In some situations the result will not be in our favour. However, if we feel strongly about going long, we should not worry about someone wanting to sell short.
Senator Austin: I agree. That is the vital distinction. That is essentially an investment decision.
When you come to the use of your proxy for governance, then the proxies are affecting other issues besides the investment quality of your decision.
Mr. Lamoureux: It is an investment decision.
Senator Oliver: It may not enhance shareholder value. You do not know.
Senator Angus: You are saying that they have not done it, and they would not do it if it has a negative effect on governance.
Senator Austin: I am not sure that the witness said that. I believe that he said that he sees the right to vote as another value item to market.
Mr. Lamoureux: Clearly, it has economic value.
Senator Austin: Thus far, you have not exercised this particular potential value. You may or may not be contemplating it, but, if it becomes an industry-wide practice, it can have very interesting impacts on corporate governance.
Mr. Lamoureux: I think that Senator Kelly was worried about the small, individual shareholders. Individual shareholders can get together that way, and that is one way to get more votes.
Senator Austin: The concern is whether management needs to protect itself by bidding for those proxy shares when there is a race to gather up such proxy rights? For example, today, management solicits the shareholders for votes, but it is not soliciting them for payment.
Mr. Lamoureux: Let us get the thing straight. Management is there as an agent of the shareholders. Management cannot protect itself from the shareholders. The fallacy here is to think that management is a group that is separate from the shareholders. The sole reason for the existence of management is to be an agent of the shareholder, to the same extent that the board is an agent of the shareholder. To think that management has to protect itself is not correct.
Senator Austin: Management is given rights under current corporate law to solicit the support of the shareholders --
Mr. Lamoureux: It is the corporation that is given those rights. Management exercises those rights.
Senator Austin: The board exercises those rights.
Mr. Lamoureux: The board represents the shareholder. That is its sole reason for existence. As a board, you cannot protect yourself from the shareholders. You represent them.
Senator Austin: When the board of directors knows that some shareholder is seeking to change the board, and is purchasing proxies, is it not proper for it to make an announcement that the board is purchasing proxies, in order to protect the existing board's interests in the corporation?
Mr. Lamoureux: I go back to the fundamental. Why is there a board and who do they represent? A lot of times that is the problem. A lot of boards think that they do not represent the shareholders. Clearly, at least in our minds, they are there to represent the shareholders. They are not there to protect the shareholders. The shareholders can protect themselves very well, thank you.
It is the same when there is a takeover bid. We have always said that we will decide in 20 or 30 days, if a bid is proper. Many times, the board wants to have two or three months to make these decisions. These decisions can be made more quickly. A lot of times we want them to come and talk to us, because you can analyze it. If ABC could decide to sell to Disney within a few hours, then this is not rocket science. People make it sound like rocket science, but evaluating a company is not rocket science.
The Chairman: You can understand why those of us who have run campaigns are somewhat reluctant to ask questions about buying votes.
Senator Austin: That is one observation that I cannot accuse your research staff of providing to you.
The Chairman: Mr. Lamoureux, do you want to continue with your statement?
Mr. Lamoureux: I know that your committee is interested in how our plan is governed. In our case, successful governance of pension plans really has three elements. One is a very competent board made up of individuals who have expertise in pension matters or investment. A lot of times, the fallacy is that people will go to school once they are in the board. Very few of you would go to a doctor who is about to study brain surgery. We do the same when we come to financial matters.
Secondly, we need a clear purpose. You have heard the Canadian Teachers' Federation indicate in its brief that its purpose is to pay pensions. It is not there for all kinds of other purposes, although at one point that might have been popular.
I heard the witness this morning. When someone comes to a committee representing the minister -- it could be the deputy Minister of Finance -- who is the boss? They will do whatever the boss wants, as opposed to seeking to do what is right. In this case, what is right is making sure that we can pay those pensions. Good governance also means the independence of the directors. Most directors today know what good governance is. A lot has been written on this.
In our case, we try to follow the best practice. We have a board that is independent from management, and knows clearly it has to act -- and that is by law -- in the best interests of all beneficiaries. We have management compensation that is tied to the results of the organization. In other words, people in management know they will do well, if they provide good results. That is both on the administrative side -- the handling of the pension, and the collecting of the data -- and also on the investing side.
You also need a management group which is open, communicative, and does not hide anything from the board. The board can only act on information that is granted. Sometimes the biggest challenge for the board is to get the information. The standards we operate with are also those advocated by the industry, and the Pension Investment Association of Canada, in its model for pension plan governance. In fact, we helped develop these standards, and encourage pension plans to implement them where they apply.
We also tried to follow the recommendations of the Day committee. In our annual report, we will essentially give our members the same kind of information that we would if we were a public company. We will show them the independence of the board, the construction of the committee, and all of that, so that people can judge whether we eat our own cooking here.
I always like to think of our clients and the public in general. In focus groups, plan members have shown confidence in how we are managing the retirement income of Ontario teachers and their survivors. This is consistent with the attitudes of Canadians about large pension funds. A national poll conducted late last year on Canadian attitudes toward large pension funds found that over half of Canadians feel that pension funds are doing a "very good" or "good" job of securing a stable source of retirement income for their members. Seven per cent answered "very good", and forty-six per cent said "good."
Two-thirds of Canadians feel that the government should have no involvement in determining how independent pension plans can invest members' assets. Only 15 per cent of those surveyed think that large pension funds have too much influence on the Canadian economy. Two-thirds feel that pension plans invest responsibly.
I will now try to address your initial questions. The problem of the unfunded liabilities is an interesting one. A lot of people like to think that this happened by accident, but it did not. It is a bit like the CPP. Today we wake up and we ask why we have this problem. We knew about the problem in 1967. The same occurs with the unfunded liability of pension plans. Most government and teachers organizations knew, or should have known, that the benefits that were being promised were not adequately funded by the contribution. Twenty years later, it is easy to come in front of this committee and say that they did not know.
The teachers of Newfoundland, which is probably the worst situation in Canada, have known for years that their plan is underfunded. In the case of the teachers of Ontario, where I am much more familiar with the situation, we had an unfunded liability of about 15 per cent of the assets in 1990. This was the result of one single decision -- the granting of inflation protection. At that time, contribution only increased by one third of what it should have. This was known. This was not a surprise. This was negotiated. People cannot come today and that they did not know.
By 1990, the teachers were very concerned about that. They also knew that we could get a better return if we invested in the market at large, as opposed to Ontario government debentures. This is somewhat similar in a lot of other situations. These things were known. Unfortunately, a lot of the public plans do not have to live by the pension legislation of their various provinces.
These things were known. Unfortunately, a lot of the public plans do not have to live by the pension legislation of their various provinces. That is why they were able to be underfunded. If they had been private plans in Ontario -- Ontario Hydro was treated more like a private plan -- since we have had good markets recently, generally they would be over-funded.
That, in my mind, addresses the problem on the whole question of the unfunded liability.
Your last question was an interesting one. How do we break the mould? In 1990, perhaps by luck -- although sometimes you make your own luck -- the Ontario Teachers Federation that was involved in setting up the board decided that they wanted an outstanding board, a group that would run this for the benefit of the teachers. The first Chair was Gerald Bouey, who is known to many of you. He was appointed chair and was involved in selecting a board of mainly business people with experience. Even the teachers appointed people with business experience, because, in their mind -- and there were a few leaders who were concerned about that -- they wanted to have someone who could really understand what was going on around the table.
I think we have a very good management team, and we try to be imaginative. We are probably one of the largest users of derivatives, but a lot of organizations have used us as an example of how to use derivatives. We went into equity very heavily because it was clear that the risk that we faced was unanticipated inflation. The risk of a pension fund that is indexed is not that the market would crash. The biggest risk is unanticipated inflation. That is clearly your biggest risk. That is one that people sometimes tend to overlook.
We are a large buyer of real-return bonds. Why? Because that is a nice match against our liabilities. We tend to watch not our assets; we tend to watch our surplus. It is the interplay between the assets and the liabilities that we always watch. If the stock market drops by 20 per cent today because interest rates went up, our liabilities would probably drop in value by more than 20 per cent. You have to watch both. If the stock market drops 20 per cent but your liability drops by 25, there is no problem.
One of the years in the stock markets was 1995. It was one of the worst when you look at the surplus.
The Chairman: Why?
Mr. Lamoureux: Because the surplus went up by 40 per cent, 45 per cent for a lot of companies, whereas the stock market went up by 35 per cent. Let me use GM as an example. That is an U.S. example but I use it because there are more indexes in the U.S. In 1995, for the average pension fund in the U.S., the liabilities went up by over 40 per cent, when the assets did not do as well, although they did very well.
You have to watch not just the assets, but also the surplus. As I said, we have to pay pensions.
Senator Angus: Mr. Lamoureux, I think you are well aware that your comments were one of the principal reasons we are doing this study.
Mr. Lamoureux: Is that good or bad?
Senator Angus: When we had our first go-round on corporate governance, some of the things you told us led us to understand the importance of looking into institutional investors. I am finding myself wondering whether we should not also be looking into the governance of Crown corporations, but that is for another day.
Mr. Lamoureux: Yes, you should.
Senator Angus: Yesterday, we had before us some representatives from OMERS. You are here today. Your two organizations are principal Canadian institutions and yet you have substantially different governance, if I understand well. I thought it might be useful for the purpose of the record if you could outline the main differences between the two.
Mr. Lamoureux: In terms of governance, the main difference is that OMERS has a lay board and we have what I would call more an expert board. We have a board of people who have experience in financial matters. We have people like Robert Korthals and Ted Medland, people who have run large financial institutions. Jalynn Bennett is on the board of a number of companies, including a large bank. We have quite a number of people who have broad experience. OMERS, generally, tends to appoint people who come from the ranks. Mind you, they are generally the leaders in the organization. If they have someone who has been in the union, it will be someone who has had experience, and who has been on some boards, but none of a financial nature.
As I said earlier, jokingly, I prefer our model, but if you look at the history of OMERS, it took them quite a while to build a large percentage of equity. They started in 1975. We were able to do it in about two or three years. We were at close to 70 per cent in two or three years. When you do things that appear aggressive, like using derivatives, if it is the first time people even hear the word and the only thing they know about them is that the press says that derivatives are bad, it will take you a long time to get there. I am certainly comfortable with the model we have.
It has also been helpful on the pension administration side. We had a huge problem when we took over. The previous model at the teachers' fund was the same as OMERS. We also had to recalculate 55,000 pensions. The data were wrong; procedures and controls that should have been in place were not there. It is also very helpful to have a good board, one that understands why you invest in a computer system. That is why it is important to get the best people. It is a model that I am very familiar with, and one that I think works.
I am not saying that the OMERS model will not work, but OMERS also had experts -- I do not know if it was a committee of the board -- to help them with investment. They disbanded that a number of years ago, but for quite a number of years, they had that. I do not think there is necessarily only one model that will work, but I certainly prefer the one that we have, and I know that I will get much better questions from people who have experience than from someone who has no experience. The frightening thing is that these funds today are dealing with billions of dollars.
When you talk about making decisions, most people relate a big decision to their salary. A big number is above my salary, a small number is below my salary. Suddenly, the board members have to talk with numbers that start with "B" and very few people are paid at that level. You need people who are used to making those kinds of decision and who are not afraid to make them. Otherwise, it will take a long time to get there. That is why I advocate the model with which I am involved. I know it has been helpful for us to have experts on the board.
Senator Angus: Taking it from there, the main difference, and it is a significant one, is the compensation of the board and the source of the board members. Of course, as we have already learned in our study, there are hundreds of different types of institutional investors out there, be they the teachers or OMERS or mutual funds or the smaller of the corporate pension funds. In the first study, with which you helped us, we had the benefit -- or corporate Canada had the benefit -- of earlier studies, such as the Day report and the TSE guidelines, which have evolved and which have made a very significant difference in the corporate governance practices prevalent today in corporate Canada. We were wondering last night what would be an appropriate list, or how we, as a committee trying to develop some public policy in this area, could articulate a series of enforceable good practices for governance of institutions. I would add that we recognize that one size does not fit all.
Mr. Lamoureux: You already know the top expert in North America, Keith Ambachtsheer. He has studied pension funds around the world. He started in North America. In fact, when I worked in New York, I thought he was an American, although I have learned better since.
He has written a book, which will soon be available, whose topics cover more than just the governance of pension funds. The fact that one of the chapters in the books is about us should not bias you. You can read the rest. He has done a lot of quantitative work on investments versus expenses: Who adds value? How do you add value? Why do you add value?
He has done a quantitative study of management. He has talked to many boards and many managers of pension funds. I believe that he is one of the experts in his field in North America. He has had a book translated into Japanese. He is the author of a fabulous book, which I gave to each of our directors, that says that pension funds should essentially be treated as a business. I also share that view. I do not see it as assets and liabilities, and I do not see it as each group reporting to the board. The two must be brought together, which we have done.
Mr. Ambachtsheer could tell you what he has seen in terms of pension funds that run well and why they run well. I have my own bias, obviously, but I also talk to many other managers of pension funds. Eventually, you get to know who is good at this game and who is not. Some people are good at some aspects and may not be good at others.
We try to be good on the system side. If you can increase the return by half a per cent, that makes your pension 10 per cent larger later on. That is a big difference. You cannot beat the index by a lot, but you can beat it consistently. If you can beat it by half a per cent, you are doing very well. For most people, that is very tough to do. I have already indicated to you that we are the universe. It is pretty hard for all of us to beat the index. I am happy to have the board that I have because they push us to try to beat the index.
Senator Angus: Mr. Ambachtsheer and Mr. John Por, our opening witnesses, gave us a framework in which to operate.
We see examples of pension fund managers, like yourselves and many others, who have really good practices. We are also hearing, anecdotally and otherwise, some horror stories. You were present this morning when we heard another example of a less-than-best practice at one of the Crown corporations in Ontario.
Mr. Lamoureux: You mentioned OMERS. A few years ago, they had a problem with the valuation of real estate. This was a problem of nothing other than corporate governance. If they had had a board with more expertise, I dare say that that problem would not have occurred.
That is why I am an advocate of people who can ask the right questions. Although that will not prevent all problems, it will prevent most. There will still be problems. That is life.
Senator Angus: How can the committee help to raise the level of good governance across the spectrum?
Mr. Lamoureux: You have already done that somewhat with your work on the CPP. You have ensured that the CPP sets the example. People look to the biggest funds. If they are well run, that helps.
Your work on the CPP raised the profile. Suddenly, people realized that we need good boards. A good board member must have knowledge; it is not good enough to just be someone's friend on the board. It is very important that this kind of work be discussed. In law, if the current practice is at a certain level, you have to be at least at that level or, hopefully, above. You raised the bar with your work, which was certainly helpful. Obviously, you cannot change the provincial legislation, but it is essential to ensure that these boards are good.
The United States is not a model for that. In fact, sometimes the United States can teach us how not to do it. I would not compare many of the public funds in the U.S. with the Canadian funds, because there is a lot of patronage in those funds. They are not subject to the Employment Retirement Income Securities Act, which applies to private corporations. As a result, we have seen not-so-nice things happen to some of these funds.
Senator Austin: Last night, Bill Dimma seemed to advocate the licensing of directors of pension funds in Canada. He said that there should be objective tests and training, and that directors of pension funds should be licensed or chartered before they are permitted to practise.
Senator Angus: I do not think he restricted it to pension funds. I think he meant directors of public companies, as well.
Senator Austin: What is your reaction, with regard to pension fund boards? You made several comments about the necessary expertise of these people. Do you see a more formal system being necessary in Canada?
Mr. Lamoureux: Licensing is an interesting idea. On the other hand, the board is a team. A board must be comprised of people with different backgrounds. You need people who know marketing, people who know public relations and people who know finance. It is like licensing common sense. Much of it has to be common sense.
Two professors from the University of Western Ontario wrote a book in which they say that on a board you need people who can create dissent; people who can ask the tough and obvious questions. How do you license people for that? Maybe you can. However, you certainly need people who have some experience. Mr. Dimma's idea is an interesting one, although I do not know how it would work. In my opinion, you need all kinds of people.
I am sure everyone has heard of Peter Lynch, who was involved in two fiascos in the U.S. He would have passed the test with flying colours. I would have put him on any board. However, he had trouble coming up with creative dissent, and that is hard to judge in advance. You can pass the test, but you have to be able to confront the CEO and ask the tough questions.
The Chairman: The analogy we used last night was the Day report. We said that you do not have to legislate anything, provided you have guidelines and the enormous leverage that potential embarrassment to people invokes. You are able to get a lot done with people voluntarily opting in, because their peer group will think much less highly of them if they do not follow the guidelines, even though they are only guidelines.
What could we do to create an equivalent-type mechanism for the governance of pension funds so that, without requiring formal regulation -- which is hard to do because it is a provincial jurisdiction -- we can nevertheless use the potential lever of fear of embarrassment to persuade pension funds of various kinds to follow appropriate governance guidelines?
Mr. Lamoureux: The best mechanism is fear of embarrassment. The one thing that directors are afraid of is being embarrassed. Clearly that works, and it works for most of us.
The Chairman: What is your leverage? How do we get there? What is the mechanism?
Mr. Lamoureux: You can put some of this in the federal plans, but clearly you need a board of people who are knowledgeable. If you look at the Day requirements, you might ask the following questions: Is the board independent? Is the CEO on the board? What is the nominating process? Is there an independent nominating process?
In most public plans, in the nominating process, clearly there is independence. However, if you have a deputy minister on a board and his boss is the minister, I have trouble seeing how there can be that element of independence. Certainly the deputy wants to think about what the minister wants: "Do we invest in this little thing that is in front of the board, or do we do what is right and say no to it?" It puts that person at least in a conflict of interest position, one that may not be recognized, but it is there.
Also, not all deputy ministers, even in the Department of Finance, have experience in investment. They are experts sometimes on borrowing. A lot of them are adverse to investing in equity. You need to have some people who have some knowledge of the capital market, but not just one part of it, the whole part of it.
Investing is really a discipline. You can codify some of the best practices that already exist, at least to put them in a report. Eventually, it becomes a standard, to the same extent that we now use the Day committee at least for the governance of our board. We use it because there was nothing else that was similar to the pension industry.
PIAC developed a fabulous document. If I were starting on the board of a pension fund, I would at least read it and ask where the board is vis-à-vis these standards.
These standards are hard to legislate. I do not know; I am not an expert in that.
The Chairman: Let me offer you an idea to which you can react. Let us deal for the moment with federal plans. Suppose that OSFI were to adopt guidelines, governance guidelines, and were to require, as part of its annual audit of pension funds under federal jurisdiction, that each federally regulated pension fund would respond to each of the guidelines exactly the way we do with corporations, and that those reports would not only be made available, would not only be sent to every member of the pension plan as is the annual report, but would also be made available to other pension plans. You would know what was happening to other plans.
Is that at least a modest step in the embarrassment direction?
Mr. Lamoureux: That would raise the bar and probably significantly. Recently, OSFI published some regulations stating that, on pension funds, nobody is on a board to advocate a position. If I am a government employee, I am not there to advocate investment in my pet project. If I am a union leader, I am not there to advocate investment in my pet belief.
The Chairman: And if I am a deputy minister, I am not there to advocate that you invest in my province, for example.
Mr. Lamoureux: I am there to invest for the benefits of the members. OSFI came up with that. I used it as an example. I think it was a draft regulation, but it was a nice little paragraph. Clearly, if you are the director of a pension fund, you have to think about that. Under most laws in Canada, the directors on these boards have to invest for the benefit of the members, period, end of story.
We have had some flak, over a number of issues, with some OTF members. People can say that we hide behind fiduciary duty, but this is very important. I was very glad to see the brief of the Canadian Teachers Federation in that respect because it says the pension fund only exists for the members.
The Chairman: Knowing your fertile mind, you might reflect on this over the next month or so: Are there ways, without using brute force, that we could nevertheless persuade people that changing governance practices would be helpful?
Mr. Lamoureux: I also like to publish our rate of return; have the auditor audit our rate of return. What is my bottom line? It is my rate of return. That is the benchmark. Our rate of return is included in the notes to our financial statement. I have seen the report of a public fund in Canada that showed the rate of return for 13 months as a one-year rate of return. You had to read the footnotes and be very knowledgeable to find that out.
The Chairman: You want a rate of return equally defined for everybody, regardless of whether it a mature plan that is running down or whether it is a plan with new contributions?
Mr. Lamoureux: There are rules to do that.
Senator Oliver: It also must meet generally accepted accounting principles.
Mr. Lamoureux: In this case, it is called the AIMR, the Association for Investment Management and Research, which has published extensively on this. They have standards for this. In our case, we wanted our auditor to say that this was done accurately.
Senator Stewart: In answering Senator Austin, you told us some of the kinds of people whom you would want as directors of a pension fund. I am looking for a classic statement on the question of independent directors. I understand that, about a week ago, you made a public comment about corporate governance at a company called Philip Services Corp.?
Mr. Lamoureux: Yes.
Senator Stewart: I have a quotation here that is attributed to you.
I am sure that this will be an area that not just us but a lot of other investors will look at. Everybody's going to look at whether more independence would help. The board will be looked at very carefully.
I am looking for a classic statement, a quotable statement, on how greater independence on the board of such a corporation would help to make that corporation more successful.
Mr. Lamoureux: In this case, the problem was one of accounting, and that is preventable. If you have an independent audit committee, you can ask better questions. There have been a lot of things in the press. I am not an analyst on this company. We have people who do that for a living, but what I have read in the press is that the problem is one of accounting. This is a company where two brothers control the company. They do not own the majority of the shares, to my knowledge.
Better directors can ask better questions. The auditors will be more independent. A director will know that he or she works for the shareholders and not for management. As a result, the dynamics on the board will change. Better questions will be asked. When you go to the audit committee, you can review the financials in five minutes -- generally, if it takes five minutes, it is because there is something to hide. Someone can point out to you the problems and the issues. You can talk to the clerks in the company, if you want to know what happened.
If you have a good board, they will make a point of getting information, not just from the CEO but from other members of management. As a result, they get a sense of what happened. At one point, we organized a meeting with two directors of a company in which we had invested. A week later, they both cancelled on me. Why did they cancel? They cancelled because they had talked to the CEO. Were these directors independent? No, they were not. Again, it is the same issue as we discussed earlier. They think that they represent management when in fact they represent shareholders. That is the basic fallacy. The directors are there only because of the shareholders. Not all of us can go to the meeting. I do not know the whole situation there, senator, but this is a case where, yes, we watch, because we have an index investment in that company. It is part of that index, so we will not sell. When you cannot sell, you have to care. We will do our homework, and we will do it in our normal, quiet way instead of going to the press to try to influence what happens in the company.
Senator Oliver: There are things that even the auditor could not find out about Philip. That information was hidden even from the auditor.
Mr. Lamoureux: But senator, if you are the auditor, your job is to find out.
Senator Angus: Or not sign the statement.
Mr. Lamoureux: If you find you are not given access to certain things, your job is to resign. Deloitte is our auditor but they know how I feel about a lot of the work. You need to bring in the best expertise that you can, and if you see that you have trouble getting information, you resign. No public company wants to see their auditor resign.
Senator Stewart: I have a very different question. You are handling a very large sum of money. We have been told that the Canadian market is relatively small. In a word, do you believe that the 20-per-cent rule should go, and if so, by how far should it go?
Senator Angus: And if it does, will you stop dealing in derivatives?
Mr. Lamoureux: You have given my answer.
In a way, the 20 per cent for large funds -- and I have mentioned that to you, and the federal government knows -- is not a huge handicap. If you are a large fund, you can use derivatives. No, we will not stop using derivatives. Today, derivatives are tools. We started using derivatives to resolve a problem. We had non-marketable, non-assignable, non-negotiable, Ontario debentures. We wanted to change them into equity. The way to do that is to do a swap. Once we got going on that, we realized that we could do a lot more than that.
We now have 12 per cent of our investment outside Canada, representing 40 per cent of our return. How do we do that? We take an Ontario debenture and we get a S&P return. Today, this is a tool. I know of one case in the U.S. where a co-op was sued -- they were dealing in commodities -- because they did not use derivatives.
Derivatives are a tool that we like.
The 20 per cent, I think, could easily go to 30 per cent. No one will lose any sleep because over 50 per cent of CN is held outside Canada. I hope no one loses sleep over that, because it is very tough to move the train from here.
There is some fallacy that this will provide capital. I think it forces a small pension fund to stay under 20 per cent. The big ones, if they want, can get out from under it through derivatives. I would like to see it go to 30 per cent. It would not be a catastrophe for the Canadian economy.
In some ways, the fact that we earn more if we invest outside Canada helps the Canadian economy. This is not a win-lose situation; it is a win-win situation. When I was growing up, the worry was that the Americans owned too much of Canada. Why did they own too much? It was because they could get a return from outside the U.S. If Canadians owned more of other economies, we would bring income here and Canadians would benefit. To have it at 30 per cent would not be a problem, in my eyes. I think that it would help everybody, but mainly the small saver and the smaller funds that have fewer options than we do.
The Chairman: You are a member of PIAC, and you gave us originally this effective pension plan governance paper.
Last night, the ACPM, when they appeared before us, gave us a document, which emanated from a questionnaire they had done of their members, called "Governance of Pension Plans." Keeping those documents in mind, I want to go back to the issue of guidelines that I put on the table earlier.
It would be really helpful to us if some of the key players in the industry could begin to develop for us their thoughts on what the pension plan guideline equivalent would be to the Day report. I get back to the notion that if OSFI were to have a set of guidelines, and the only regulation would be one requiring a report on the guidelines and that that report be made public, the question then would become: What precisely should those guidelines be? From those two documents, particularly from the PIAC one, we can begin to develop a set of guidelines, but if you know of somewhere where such a set of guidelines exists, or if PIAC wants to develop one, that would be helpful.
Mr. Lamoureux: What PIAC has done is very good. I am more familiar with those than the ACPM ones.
The Chairman: Theirs was done only recently.
Mr. Lamoureux: I do not think there would be huge contradictions between the two.
The Chairman: The PIAC is more process than guidelines. I guess we have to take the process and convert it to guidelines. Given your involvement at PIAC, if someone would begin to take a look at that, that would be helpful.
Mr. Lamoureux: I think that could be done.
The Chairman: Does the teachers plan appoint people to boards on companies in which they have a major involvement?
Mr. Lamoureux: On occasion, but very rarely.
The Chairman: What causes the occasion?
Mr. Lamoureux: I will give you an example of what causes the occasion, but let me first describe our general process. We have a list of names, known only to us, of people who are directors, and senior members of management know that we keep it. That is what I call the list that I always go to.
Senator Angus: This is the licensed directors.
Mr. Lamoureux: On occasion, someone may ask us, or in the case of Maple Leaf Foods, we initially had the right to appoint three directors. We own a substantial stake in Maple Leaf Foods, and we wanted to make sure that things got on the right track.
Right now, we have only two directors there, although we still have the rights to three. One of them is a vice-president in our operation. That is one way that we will appoint people to a board.
An example of the second way is as follows: When we buy a private company, we might have one member of management. In the case of The Toronto Sun, I think we have one member of management and we appointed an outsider, again from that list. When the company becomes public, our person on the board will resign within two years of that company becoming public. That is our policy. We can always make an exception, but the danger in that <#0107> and this was alluded to by an earlier witnesses -- is that if we learn inside information, we cannot trade. When you have 40 per cent -- and, economically, we have 40 per cent of Maple Leaf Foods -- there are all kinds of other rules that come into play. If we want to sell, we have to issue a prospectus and we have to ask for exemptions. If want to buy, it is the same thing. Because we have one senior employee there, we know we are already restricted. It is a large investment. At the same time, the main shareholder certainly welcomes our presence there, because he also owns a large stake and there is a lot of communication between the two. We get privileged information, but since we have bought, we have not been able to buy.
So that is the second way. On a private company, we will name some member of our group, an employee, we will name some outsider, and generally two years after the company becomes public, we will not be there. For example, Automated Tooling Systems (ATS), we had two directors when the company was private. We have no one now. We have done that several times.
We are also involved in an organization called the Taylor Group, which invests funds for us, and Tom Taylor has been named on a number of boards in Canada. Generally, they tend to invest in companies that are underperforming. They do their work essentially through corporate governance. If they are not welcome, they disappear. Generally, he goes on the board at the invitation of someone as opposed to us forcing it. I have asked many people with whom he is on a board and they welcome his presence because he adds a totally different dimension.
The Chairman: Thank you, Mr. Lamoureux, for attending. Please do think about the guidelines. That is important to us.
The committee adjourned.