The Pensions Regulator (TPR) recently issued its draft guidance on its approach to investigating and prosecuting the new criminal offences under the Pension Schemes Act 2021. In this blog, we share our thoughts on the level of comfort that might be gleaned in relation to criminal risk if the draft guidance were finalised in its current form, focusing on corporate activity by non-distressed groups.
The Pension Schemes Act 2021 will introduce wide new criminal offences which will impact corporate activity involving groups with UK defined benefit pension schemes. Our latest blog and briefing on this topic can be found here. The two key criminal offences apply where any person acts in a way which:
- intentionally avoids an employer debt to the scheme (“avoidance of employer debt”), or
- they knew or ought to have known would have a materially detrimental impact on the security of scheme benefits (“risking accrued scheme benefits”),
in each case without having a reasonable excuse.
Both offences are punishable by up to seven years in prison and/or an unlimited fine.
A wide range of corporate activity could potentially fall within the scope of the criminal offences, including M&A activity, financing and refinancing, granting security, corporate reorganisations and dividends. Further, any person can be liable, including corporates, directors, lenders, commercial counterparties and advisers.
In response to concerns raised by the pensions industry about the breadth of the offences and the potential impact for scheme employers, the government indicated that TPR would provide guidance on its approach to investigating and prosecuting the new criminal offences. On 11 March 2021, the Pensions Regulator issued its draft guidance for consultation, with the consultation period closing on 22 April 2021.
Key points on the draft guidance
In preparing the draft guidance, TPR has clearly tried to take on board the concerns raised by industry and sought to frame the guidance in a way which will provide some degree of comfort. In particular, the draft guidance confirms that:
- TPR’s understanding of the new legislation is that it is not intended to achieve a fundamental change in commercial norms or accepted standards of corporate behaviour. Rather, the powers are aimed at giving TPR a stronger range of options to address the more serious intentional or reckless conduct that was already within the scope of its existing civil “moral hazard” powers.
- TPR would not “usually” expect to prosecute someone who would be able to establish a statutory defence under the current “moral hazard” powers.
- TPR recognises that a person’s actions and knowledge should not be assessed with the benefit of hindsight, but rather be based on the circumstances at the time (although, in practice, it may be very difficult for TPR to completely ignore the impact of hindsight when deciding whether to prosecute).
- Whilst whether there will be a reasonable excuse in any circumstances will be fact-specific, TPR has identified three key factors which it considers will be significant (see below) to try and provide some clarity.
- TPR’s view is that advisors are unlikely to be in scope of the criminal powers where they are acting in accordance with their professional duties.
- When investigating whether to use its powers, TPR will expect assertions made by parties (for example, as to whether they ought to have known there would be material detriment, whether they would have a “moral hazard” statutory defence or whether they had a reasonable excuse) to be evidenced by contemporaneous records. This will mean that the process for considering and addressing the impact of corporate activity on the pension scheme, and ensuring those actions are appropriately recorded will be crucial.
TPR also states in the draft guidance that conduct is more likely to be prosecuted where:
- the primary purpose of the conduct is the “abandonment” of the scheme without provision of “appropriate” mitigation;
- significant financial gains have been “unreasonably” made to the detriment of the scheme;
- there has been some other “unfairness” in the treatment of the scheme; and/or
- the trustees, TPR and/or the PPF have been misled or not appropriately informed.
Unfortunately, TPR’s approach under the current “moral hazard” regime has demonstrated that many of these concepts are inherently vague and subjective – so could result in the criminal investigation of good faith commercial decisions. Uncertainty and resulting nervousness around this may risk decisions being taken which damage, rather than protect, the sponsoring employers of pension schemes – to the detriment of all stakeholders, including employees, commercial counterparties and the pension scheme.
More detail on “reasonable excuse” – and some concerns
The draft guidance states that TPR considers that there are three factors which will be significant for deciding whether a person has a reasonable excuse for an act or failure to act:
- Where the detrimental impact was an incidental consequence of the act or omission, as opposed to a fundamentally necessary step to achieve the person’s purpose, the person is more likely to have a reasonable excuse.
Examples are given of arm’s length business activity with third parties, such as lenders and suppliers. Whilst this is helpful, there is an important caveat here, which is that TPR expects the purpose of the act to be unrelated to the pension scheme. This introduces an unhelpful grey area – for example, a lender may not wish to continue lending because of the risk associated with the employer’s liabilities to the scheme.
- The adequacy of any mitigation provided to offset the detrimental impact will contribute to a person having reasonable excuse.
Examples are given of the impact of corporate activity being fully addressed by amending the terms of the activity to remove the detriment to the scheme or providing alternative covenant support to the scheme.
This limb is less helpful. Although TPR only says that full mitigation is “more likely” to give a person a “reasonable excuse”, in practice, if mitigation fully offsets any detrimental impact it is difficult to see that this is an aspect of “reasonable excuse” at all – rather there is no relevant act to which criminal liability could attach. Further, the question of adequacy of mitigation is inherently vague and subjective, as illustrated by TPR’s express expectation that mitigation will only be adequate where the scheme is treated “fairly in relation to other parties” rather than where the actual detriment caused is addressed.
- Where no, or inadequate, mitigation was provided, there is less likely to be a reasonable excuse where there was a viable alternative which would have avoided or reduced the detrimental impact.
Again, this is couched with an expectation that the scheme will be treated “fairly”, without necessarily recognising the very different circumstances of different parties. There is an express recognition that TPR won’t “generally” expect someone to pursue an alternative that means unreasonably disregarding their own interests – such as a lender declining to lend additional funds where it reasonably considers there to be a high risk of default. However, a key concern will be the extent to which TPR will expect alternatives to be explored and what view it takes on viability, in particular whether it will accept the commercial judgments made by parties in good faith on those issues.
TPR also notes some additional factors which it says may have a bearing on whether to begin a criminal investigation, including the extent of communication and consultation with the trustees and TPR. Whilst the draft guidance states that these are unlikely to be determinative alone, in practice it is difficult to see how a criminal prosecution could be brought which second-guessed the conclusions reached by parties as to material detriment or reasonable excuse where there has been full, honest and open consultation with the trustees/TPR and steps have been taken which fully address any concerns.
Limitations of the draft guidance
Whilst the draft guidance is helpful, a number of areas of concern remain in addition to those flagged above in relation to TPR’s view of “reasonable excuse”:
- The guidance has no statutory effect and will not bind TPR to act in a particular way. In addition, the wording of the guidance is deliberately (and sometimes quite painfully) couched so that it is not definitive on any issue. This gives TPR a wide discretion in making a decision to prosecute. Where conduct is the subject of significant public outcry, TPR may choose to make use of the flexibility in the guidance to adopt a more expansive approach to prosecution.
- TPR expressly notes that the draft guidance represents TPR’s view alone and that the other potential prosecutors of the criminal offences (e.g. the Secretary of State or the Director of Public Prosecutions) may take a different approach. It would provide considerably more certainty if all potential prosecutors confirmed that the same principles would be applied.
- Stating that the criminal offences are only likely to be pursued where actions would fall within the current “moral hazard” regime is of limited comfort when there has been only limited testing of that regime in the courts, TPR itself takes a wide view of what actions are caught and has demonstrated that it can assert that there may be a case in a wide range of circumstances.
- There is no clearance regime specifically for the new criminal offences and TPR does not provide any comfort that parties which obtain “moral hazard” clearance are likely to be considered to have “reasonable excuse” for the purposes of the criminal regime.
- The guidance is very focused on the “risking accrued scheme benefits” criminal offence (i.e. where actions cause material detriment). Very little is included in the draft guidance about how TPR will approach the “avoidance of employer debt” criminal offence, bearing in mind that this encompasses compromises and restructuring of pension liabilities.
- The guidance is likely to be of significantly less comfort in a distress scenario. Our separate blog on this topic can be found here.
Hopefully feedback from the consultation will help TPR to refine the draft guidance to provide additional comfort and further reduce the risk that, rather than protecting pension schemes, the new criminal offences worsen their position by making it harder for their sponsoring employers to do business.
If you would like to discuss any issues relating to the Pension Schemes Act 2021 or that you would like us to consider for our response to the consultation, please do get in touch with your usual Freshfields contact or any of the authors.