The Pensions Regulator’s expanded moral hazard powers and new criminal offences
Details
The Pensions Regulator’s (TPR) powers have long been relevant to corporate activity involving defined benefit (DB) schemes. However, the Pension Schemes Act 2021 (PSA2021) has now broadened the range of parties (including advisers and trustees) that are potentially subject to civil or criminal liability where corporate activity has a detrimental effect on a DB scheme.
The PSA2021 has also expanded TPR’s moral hazard and information gathering powers, as well as creating extra notification obligations on employers and trustees.
The new powers are in part to address the perception that TPR needs to be able to intervene earlier in situations where the security of DB Scheme benefits may potentially be at risk. This follows recent high-profile corporate failures involving underfunded DB schemes. The extra notification requirements make it more likely that TPR will receive more timely ‘red flag’ information. Overall, the new legislative provisions should act as a deterrent to ‘bad behaviour’, and provide TPR with stronger tools of redress where bad behaviour continues.
Criminal offences
Some of the notable new criminal offences include (in broad terms):
Acts that negatively affect or prevent section 75* debts becoming due to a DB scheme. The offending party must have intended that the act would have this effect. *(A section 75 debt may be imposed on an employer in certain circumstances (e.g. on insolvency) and is the difference between the DB scheme assets and the cost of securing benefits with an insurance company). | Acts that have a materially detrimental effect on the likelihood of DB scheme beneficiaries receiving their accrued benefits. The offending party must know or ought to have known that the act would have this effect. | Refusing to meet TPR or to answer questions on matters set out in a relevant notice. |
The criminal offences above apply in relation to any person that is a party to the relevant act (i.e. not just those persons associated or connected to the DB scheme employer). This can potentially include trustees, advisers and lenders, although insolvency practitioners are exempt.
Reasonable excuseA party may avoid criminal liability if they have a ‘reasonable excuse’ for their behaviour. The PSA2021 does not define reasonable excuse. However, TPR will be issuing guidance in due course. Presumably, this may follow the format of guidance that exists in relation to non-compliance with automatic enrolment, in which TPR gives examples of circumstances that might be considered a reasonable excuse, in addition to examples of what would not count as a reasonable excuse. |
Expansion of moral hazard powers
TPR has powers to ensure that entities do not avoid their pension liabilities with the result that such liabilities fall on the Pension Protection Fund (PPF) (the lifeboat scheme that pays compensation to DB members where an employer of an underfunded DB scheme becomes insolvent). These are TPR’s moral hazard or anti-avoidance powers and include the ability to issue a contribution notice (CN).
A CN is ‘fault based’ and requires the recipient target to pay a specified sum to a pension scheme, where the target has been a party to an act or deliberate failure to act, and TPR considers it reasonable to impose liability. The target may be the scheme employer or any party connected or associated with the employer. In addition, it must be ‘reasonable’ for TPR to impose a CN.
PSA2021 has introduced two new ‘faults’ or grounds upon which TPR can issue a CN, if TPR considers that it is reasonable to do so:
Employer Insolvency groundIn an underfunded scheme, if the act or failure to act would reduce the amount of a section 75 debt likely to be recovered, immediately afterwards. Example: Company draws down bank financing and uses funds to pay dividends. In this example, in a hypothetical insolvency following the bank financing, the bank’s creditor claim will rank alongside or ahead of the pensions scheme leading to lower recovery of the section 75 debt. | Employer Resources groundThe act or failure to act materially reduces the resources of the DB scheme employer relative to the section 75 debt. Example: Company enters into a sale and leaseback of property assets and uses the proceeds to fund a special dividend. This may fall within the employer resources ground depending on the size of a potential section 75 debt, the value of the disposed property and size of the dividend. |
Statutory defenceAs with the pre-existing ‘material detriment’ CN grounds, it is possible for a target to assert a statutory defence in relation to the two new CN grounds. In broad terms, TPR must not issue a CN if it is satisfied that: Employer Insolvency ground: The party considered in advance whether their act/failure would materially reduce any immediately subsequent section 75 debt and either reasonably concluded that it would not, or took all reasonable steps to eliminate or minimise the potential for this. Employer Resources ground: The party considered in advance the extent to which their act/failure would reduce employer resources relative to the section 75 debt and reasonably concluded that there would be no material reduction, or took all reasonable steps to eliminate or minimise the potential for this. |
Significance of new CN groundsIn broad terms, the pre-existing CN grounds require that either: (1) the main purpose of the act/failure was to negatively impact any section 75 debt; or (2) the act/failure was materially detrimental to the likelihood of beneficiaries receiving accrued scheme benefits. Neither of the new tests are intention based (ie it is not necessary to show that the parties intended that their acts would have a negative impact on the scheme (unlike the existing ‘main purpose’ CN)). Additionally, it is not necessary to show that the act detrimentally affects the likelihood of beneficiaries receiving accrued scheme benefits. Under the Employer Resources ground, it is enough to show that the resources of the employer have materially reduced relative to a DB scheme’s section 75 debt. Such a reduction may not always mean that there is a negative impact on the likelihood of beneficiaries receiving accrued scheme benefits. For example, a large company employer with a small DB scheme might pay dividends, which are affordable in the context of that employer’s resources but are material in the context of a section 75 debt to a small DB scheme. This may be where the reasonableness criteria becomes important (i.e. TPR must consider that it is reasonable to issue a CN in the circumstances). In addition, statutory regulations will set out further details, which may also provide clarification/comfort in a situation similar to the one outlined in this example. |
New notification requirements
In simple terms, TPR wishes to be in the loop much sooner in relation to any events that might potentially have a negative effect on the security of DB scheme members’ accrued benefits.
The PSA expands the existing notification regime with the result that there will be much more onerous obligations on employers (and connected or associated parties) as well as trustees to notify TPR of prescribed events.
The exact details of the new notifiable events will be contained in statutory regulations expected later this year. However, it will no doubt include material corporate activity. The relevant party must provide a notice to TPR and the trustees in advance of the notifiable event. The notice must describe the event, any adverse effect on the pension scheme and steps taken to mitigate such effect. The relevant party must provide further notices to TPR if there are material changes.
The new notification requirements will present a challenge in the context of fast-paced and evolving corporate transactions.
The penalty for a failure to notify is a fine of up to £1 million. In addition, it is a criminal offence to knowingly or recklessly provide TPR with information that is false or misleading.
Separately, in deciding whether it is reasonable to issue a CN, TPR may take into account any failure by the target to comply with its statutory notification obligations in connection with any act or failure to act.
Timetable
Guy Opperman (Pensions minister) announced on 2 March 2021 that statutory regulations, which will bring into force TPR’s new moral hazard powers and the relevant criminal offences, are likely to be in place by autumn 2021. In the meantime, there will be a process of consultation on the draft regulations. In relation to the new notification requirements, the minister stated that the Government would be consulting on the draft regulations later this year and the regulations would commence as soon as practical thereafter.
