The Fiduciary Liability of Corporate Pensions and the Formulation of a Corporate Pension Basic Law

1. Introduction

The relaxation of asset management regulations for welfare pension funds in recent years has elevated the awareness of fund managers regarding fiduciary liability. Problems of insufficient funding have stimulated discussions emphasizing the need to protect the benefits of participants. Recently， the government has begun work on preparing a comprehensive basic law relating to corporate pensions. Fiduciary liability and the protection of benefits are important issues that the new law will need to address.

This paper compares how， amid asset management deregulation， fiduciary liability is treated in the welfare pension fund system and qualified pension system. Then， in studying various ways to protect participants under the corporate pension basic law， we discuss the need to clarify the fundamental right to receive lump-sum and other retirement pension payments.

2. Deregulation of Welfare Pension Fund Management and Fiduciary Liability

(1) The Welfare Pension Fund System
The welfare pension fund system， based on the Welfare Pension Insurance Law， substitutes for part of the national welfare pension and also pays additional benefits from corporate pension plans. To manage the pension system， a special corporation called a welfare pension fund is set up with the approval of the Minister of Health and Welfare.

The fund is organized of companies and employees. There is a council of representatives and board of directors， each composed of representatives of management and labor. The fund is operated with the consent of labor.

(2) Deregulation of Welfare Pension Fund Management
Asset management of the fund has been entrusted to life insurance companies and trust banks. Asset managers， under supervision of the MOF， have had the type and proportion of assets under management governed by the 5.3.3.2 rule (at least 50 percent in safe assets， under 30 percent in stocks， under 30 percent in foreign currency denominated assets， and under 20 percent in real estate; life insurers follow a 3.3.2 rule).

Since the "expansion of management methods" was implemented in 1990 to increase management efficiency， regulations have been successively relaxed or abolished.

Presently， funds satisfying certain conditions and approved by the Minister of Health and Welfare can allot up to one-half of their total assets in life insurance companies， trust banks， and investment advisory companies. Moreover， since the 5.3.3.2 rule now applies not to asset managers but to individual funds， funds that are approved by the MHW as being properly managed are not subject to this rule. In addition， funds can invest on their own in bonds under conditions that have been tightened.

The 5.3.3.2 rule will be terminated during fiscal 1998， and from fiscal 1999， all funds will be able to use investment advisory companies without any quantitative restrictions.

In this way， quantitative and form-related restrictions on fund management have been gradually relaxed or abolished， thus greatly expanding the area in which funds can exercise discretion in their investments.

(3) Introduction of New Rules Through Legal Revision
On the other hand， the Welfare Pension Insurance Law， which is the basic law for funds， has made clearer the requirement that funds are to independently and appropriately manage pension assets.

For example， regarding expanded management， the law stipulates that pension fund assets be managed safely and efficiently. Moreover， an investment officer responsible for asset management operations has been newly established， and trustees have a duty of loyalty and are prohibited from certain acts regarding asset management. Presently， funds also have the duty of formulating a basic management policy and presenting it to the asset manager.

(4) Clarification of Fiduciary Liability
The deteriorating asset management environment and deregulation have focused attention on the fiduciary liability of trustees and other fund personnel， something that had previously been concealed by good overall results and regulations.

Fiduciary liability refers to the duty of trustees and other fund personnel to perform their work， and to their accountability should they violate these duties.

A fund is a legal entity independent of the company， and the trustee is installed as an executive. The trustee has a relationship of trust with the fund， and must perform his job with prudence. In addition， the Welfare Pension Insurance Law establishes the trustee's duty of loyalty with regard to asset management.

The problem is that since these duties are not clearly defined， the fund's management system and sense of responsibility among fund personnel are insufficient.

Under growing demand to clarify and specify fiduciary liability from many quarters， in April the MHW formulated "Guidelines for Roles and Responsibilities of Trustees and Other Personnel of Welfare Pension Funds" and notified all funds in Japan.

(5) Fiduciary Liability Guidelines for Asset Management

Based on existing Civil Law and the Welfare Pension Insurance Law， the guideline specifically describes the duties and responsibilities of the trustee and other fund personnel regarding asset management. Much of it is compiled from MHW notifications. Below is a summary of the general remarks regarding the trustee's duties.

In line with their duties as full-time or part-time trustees， trustees must exercise a level of caution regarded as socially acceptable， and perform their duties faithfully.
In executing the duties of asset management， trustees must exercise a level of caution normally used by persons familiar with this business.
Trustees must consider only the interests of participants and beneficiaries， and must not sacrifice these interests for other interests.
Entrusting asset management to financial institutions (their subsidiaries， etc.)with which the business owner has close capital， business， or personal ties may constitute breach of trust， except when there are rational reasons for the selection and contract conditions are no worse than normal conditions.

Thus in interpreting present law， the guidelines state that trustees have a strong duty to exercise caution (item 2)， and must put the interests of participants and beneficiaries before those of the sponsoring company (items 3 and 4). Given the disparities in the status of fund management systems， concern has arisen that the strict guidelines will make candidates for trustees hard to find.

3. Deregulation of Qualified Pensions and Fiduciary Liability

(1) The Qualified Pension System
Under the qualified pension system， companies receive tax benefits on premiums paid in connection with corporate pension contracts with life insurers and trust banks (and Zenkyoren， the National Mutual Insurance Federation of Agricultural Cooperatives) that satisfy corporate tax law conditions (enforcement regulations) and are approved by the National Tax Administration Agency. Other than this tax benefit， there are no laws or regulations that apply to the pension system itself.

While companies are the main administrators of the pension system， most of the system's management including asset management is entrusted to life insurers and trust banks. Employees are direct recipients and beneficiaries of the life insurers and trust banks.

(2) Deregulation of Qualified Pensions
Regarding the asset management of qualified pensions， the MOF requires managing institutions to follow the 5.3.3.2 rule. Thus before the expansion of fund management can be approved， the corresponding situation has long been maintained.

This regulation was abolished in April of this year (except for the general accounts of life insurers). The 5.3.3.2 rule did not apply to qualified pensions at the individual company level， nor was it introduced. As a result， assuming they use life insurers and trust banks， companies enjoy considerably greater discretion in their investments. In addition， the prohibition on using investment advisory companies may be lifted.

In contrast to the deregulation of the welfare pension fund， which occurred over a decade with new rules implemented and accompanied by clarifications， the restrictions on qualified pensions were swept away quickly without any replacement measures.

(3) Enhancing the Fiduciary Liability of Qualified Pensions
The abolition of management restrictions on qualified pensions has stimulated discussion of how it would affect the protection of participants. For example， in the Administrative Reform Committee's discussions on deregulation in July 1996， proponents of abolishing the 5.3.3.2 rule argued for liberalization based on the principle of the accountability of companies， while opponents emphasized the following two points:

Protection of beneficiaries is insufficient in the event that losses are incurred from unsafe or inefficient asset management.
Unlike the welfare pension fund， the manager is not independent of the company， raising concerns that the management may be used to pursue the company's interests. The duty of care of corporate executives may conflict with their duty of loyalty in managing pension assets.

The opponents thus asserted that as with the welfare pension fund system， deregulation must be premised on two points−ensuring benefit payments and clarifying fiduciary liability.

There should be little difference in fiduciary liability between the welfare pension fund and qualified pensions， in which companies set up retirement plans for employees， conduct funding outside the company， and manage the funds safely and efficiently.

With regard to the welfare pension system， funds are strictly supervised by the MHW， while trustees are independent of the company and bear fiduciary liability. Moreover， fund executives are treated as public employees and subject to criminal prosecution for bribery and other charges. This approach was taken ostensibly because the funds serve as a substitute for public pensions， and are not suitable as a purely company-based pension plan. In addition， this arrangement may not always work in practice (as indicated by the confusion over guidelines)， and management expenses are also incurred.

Incidentally， while the Employee Retirement Income Security Act (ERISA， 1974) in the U.S. provides for property separation by settling trusts， individuals who have the power and responsibility to administer pension plans bear fiduciary liability. A corporation independent of the company is thus not set up.

In considering how to enhance fiduciary liability， a useful reference is the Administrative Reform Committee's first recommendation (December 1995)， which points out that "social restrictions should be minimized， and social restrictions that are truly needed should be based on laws and regulations with this very aim [of protecting participants]."

Protecting participants in pension plans by regulating the asset management of financial institutions is not the best approach. In addition， there are limits to protecting participants through tax measures. In the basic law on corporate pensions expected to be proposed， fiduciary liability of qualified pensions should be studied while striking a balance with the benefit rights of participants and clarification of funding duty within the overall framework of participant protection.

4. Issues in Formulating a Corporate Pension Basic Law

(1) Formulation of a Comprehensive Basic Law Relating to Corporate Pensions
The deregulation plan (third revision) approved by the Cabinet in March contained not only deregulatory measures for corporate pensions， but also instructed the Ministries of Finance， Health and Welfare， and Labor to begin the groundwork for formulating a "Comprehensive Basic Law Relating to Corporate Pensions."

In addition to the major corporate pension systems such as the National Welfare Pension (Kosei Nenkin) and qualified pension system， Japan has other systems that serve similar functions， such as the mutual fund union for small and mid-sized companies and designated mutual fund union. These systems are independent of each other−they are derived from different laws and overseen by different regulatory agencies. Companies can also operate their own inhouse pension plans.

Establishment of the corporate pension basic law is extremely significant in that it will cut across all the corporate pension systems and revise them from a functional standpoint. Besides defining the tax treatment and respective roles of public pensions， corporate pensions， and annuities， the law should clarify the minimum requirements of these various systems to protect participants in corporate pensions. Further study should also be made on ensuring the portability of pensions when employees change jobs and need to rollover the accrued benefits.

(2) Protection of Participant Benefits Under ERISA in the U.S.

For comparison， we look at laws relating to the corporate pension system in the U.S. In addition to tax benefits and regulations， there is a law known as ERISA (Employee Retirement Income Security Act of 1974) that comprehensively regulates corporate pensions. The law protects the benefits of participants in corporate pensions in the following ways:

Rights earned by employees based on years of service cannot be taken away.
There is a minimum requirement for funding corresponding to the accrued benefits.
A pension benefit guarantee corporation is set up to help participants in case of plan termination due to insufficient funding.
Financial and other information must be released and reported to participants and supervisory agencies.
Standards are established regarding the duties and responsibilities of the fiduciary.
Procedures are provided for helping participants and prosecuting violators (including governmental supervision and corrective measures).

The first three are substantive stipulations relating to participants' rights， and mutually interrelated. The latter three are the means by which these rights are realized. Let us look more closely at the rights mentioned above earned through length of service.

Employees who are either at least 21 years old or have one year of service are eligible to join the pension plan.
After joining， the right to receive a pension payment upon retirement accumulates every year. A certain limit is applied to the preference to long-term service.
Once acquired， rights cannot be revoked after five years (or become established at 20% per year from the third year， becoming fully irrevocable in the eighth year).

By stipulating that participants are vested with benefit rights early， ERISA provides the basis for an overall framework to protect participants' benefits. While this protection derives from a social consensus that corporate pension payments are nothing more than deferred salary payments， the law is nonetheless instructive as a legal measure to protect participants.

(3) Japanese Laws Related to Retirement Plans
In Japan， corporate pension plans have generally replaced retirement payments， and many companies use both a lump-sum payment prepared by the company together with a corporate pension contribution from elsewhere (often for the lump-sum payment as well). Thus any consideration of corporate pensions needs to be broad enough to encompass all severance payments.

If severance payments (both lump-sum and pension) and their standards are stipulated in labor agreements or employment rules， employers have a legal responsibility to pay the severance payment. In addition， any changes in the employment rules that are disadvantageous must be "reasonable." However， severance pay becomes vested only upon severance， and not sooner. Also， since it has characteristics of being both a payment of deferred wages as well as a reward for service， the amount varies depending on whether the company or employee initiates the separation， and may be reduced if it is a disciplinary action or the employee is hired by a competitor.

A 1976 law to ensure the payment of wages calls on employers who have a severance payment plan to take measures to preserve a fixed amount of severance pay (with a payment bond from a financial institution， or by setting up a retirement allowance preservation committee)， unless they have funds outside the company for the welfare pension or other fund. In addition， the law says that if a company goes bankrupt， the state will step in and pay part of the unpaid wages including severance pay.

However， since the law merely urges companies to comply， the level of preparedness is thought to be insufficient at companies who prepare their own severance payments and need protective measures the most. Also， the emphasis is almost entirely placed on preservation safety， with little attention paid to efficient asset management.

While the Labor Standards Law Research Committee issued a broad-ranging report in 1985 on "Problems Regarding Retirement Allowances Under the Labor Standards Law，" the law's revision in 1987 merely sought clarification of items to be included in the employment rules of companies.

Since corporate pensions with funds outside the company do not qualify as wages under the Labor Standards Law， they are not protected. However， participants are protected in the various systems in terms of participation qualifications， benefit design， and preservation of pension principle (participants are protected in case the funds outside the company or the company itself go bankrupt).

(4) Clarification of Participants' Benefit Rights
Corporate pensions are essentially part of the employment terms voluntarily agreed to by labor. While pursuing deregulation， the corporate pension basic law needs to clarify the minimum conditions for corporate pensions to protect participants.

Compared to ERISA in the U.S.， there is room for improvement in Japan on clarifying benefit rights， particularly the most basic right of pensions， the vesting of benefit rights at an early stage. Recently， while there has been frequent discussion on preserving and protecting benefit rights， the discussion needs to focus on the specific benefits， including severance payments， that are to be covered.

Presently， individuals who have retired and are receiving or will receive pensions (beneficiaries) cannot in principle have their benefits reduced without their consent. On the other hand， employees who are presently working (participants)， including those who have become fully eligible for benefits and have a right to expect benefits， do not have clearly defined rights. The idea that the right to severance pay does not become valid until separation seems to loom in the background. Furthermore， the welfare pension fund requires procedures to have a decision issued.

For both the lump-sum and pension severance pay， since both are paid after long years of service and are critical to financial security in retirement， some form of legal protection seems warranted while employees are still working.

Beginning this fiscal year， inspections will be made to ensure asset availability in the event the welfare pension fund is terminated， while the appropriate level of preservation for individual participants has been clarified and will be protected as a vested right. While this represents a big step in the right direction， it also seems to reject the derivation of funding (preservation) duty from benefit rights.

To limit the retroactivity of disadvantageous changes in pension stipulations， and to establish the basis for participant protection measures such as the duty of funding， we should consider defining severance payments including corporate pensions as deferred wages (that are tax-deferred). Doing so would legally establish an inalienable right to expect payment corresponding to length of service. It would also heighten the awareness of participants.

While popular sentiment opposes giving severance payments to individuals who have been implicated in corruption， some companies pay the equivalent of severance pay by adding it to annual salaries. Today's increasingly fluid employment environment seems to require that the role of severance pay be refined (or that a reduction rule be formulated).

Incidentally， in line with world trends， the Deliberation Council on Corporate Accounting is studying the establishment of accounting standards that incorporate accrual standards for both lump-sum severance payments and pensions.

In drafting a corporate pension basic law， the clarification of benefit rights−that is， the early vesting of these rights−should be the starting point in examining the overall picture and integrating key components such as the preservation of these rights (funding outside the company)， the establishment of a benefit guarantee system or some form of secure backing， information disclosure， fiduciary responsibility， and oversight.

5. Conclusion

Given the declining birth rate and aging population， the importance of corporate pensions in supplementing public pensions is growing. Public pensions are characterized by being a form of inter-generational support， with benefits and burdens determined in the political arena based on the public's agreement.

On the other hand， corporate pensions are a long-term agreement with labor to pay pension benefits， which are actually deferred wage payments. Participants' rights need to be protected to ensure that these pension benefits are paid. To this end， the rights of the employee/participant， who is the central figure in the corporate pension system， need further clarification and reinforcement.