The Institute of Chartered Accountants in England and Wales (ICAEW) has published its thoughts on the implications of the Virgin Media judgment for pension scheme sponsoring employers and their auditors.  Although not primarily aimed at trustees, the document sets out the ICAEW's view of what actions it is reasonable for trustees to be taking in response to the Virgin Media judgment. In this briefing we consider the implications of the document for trustees.

Our key takeaways

• Trustees are likely to get questions from scheme employers about what action they have taken to identify "section 37 certificate" issues, as employers' auditors are likely to raise this issue.  We expect most employers to get to a place where section 37 issues can be dealt with via a note to their financial statements, ie the issues won't require balance sheet liability figures to be altered or result in qualified auditors' reports.  
• Trustees who have not yet undertaken a minimum level of analysis are likely to come under pressure from their sponsor's auditor to do so, unless they can credibly assert why the ruling will not impact the scheme.
• Care needs to be taken with any requests to share legal advice (with the scheme employer or auditors), as this can result in loss of "privilege", ie the right not to disclose legal advice in court proceedings. It's generally better to share a summary of the trustees' position, not the legal advice itself.  If legal advice is being shared, there are steps that can be taken to reduce the risk of losing privilege.
• The ICAEW's document does not alter our that view decisions over how to respond to the ruling will be sponsor and trustee specific with no "one size fits all" answer.  
• We know that another court case is due to raise section 37 issues, and judgment in that case is likely to be handed down later this year. However, schemes going through a buy-in/buy-out may need to act sooner.

Background

In Virgin Media Ltd v NTL Pension Trustees II Ltd, the Court of Appeal upheld a High Court judgment that a failure by trustees to obtain a "section 37 certificate" when required would render the amendment ineffective.  The term "section 37 certificate" is commonly used to refer to a written confirmation from the scheme actuary that the scheme would continue to meet the standards for contracting out of the state pension scheme following a proposed amendment. A wide range of rule changes made between 6 April 1997 and 5 April 2016 required a section 37 certificate.  However, there was no requirement for a section 37 certificate to be appended to or mentioned in the amending documentation, so for many rule changes it may not be immediately obvious whether a section 37 certificate was obtained.

Why has the Virgin Media judgment caused issues with audits?

An ineffective rule change could result in the scheme having significant additional liabilities that have not been funded for. The judgment has therefore prompted auditors to question sponsors and trustees about the potential impact of additional pension liabilities stemming from the court's decision.  However, employers are often not in a position to answer such questions without the trustees carrying out a detailed legal and actuarial investigation. There are various reasons why sponsors and trustees may have decided not to conduct such investigations at this stage. 

What does the ICAEW say about trustees?

The ICAEW document is primarily aimed at sponsoring employers and their auditors, but does also comment on the position of scheme trustees.  Apart from some broad brush generalisations about trustee duties, this is mainly in the context of how the actions trustees do or don't take may affect an auditor's approach.  In particular:

• it notes some of the reasons why trustee legal advice may have recommended a "wait and see" approach, whilst also observing that trustees may, as a minimum, wish to be aware of any amendments made to their scheme which required a section 37 certificate and further noting that sponsors and their auditors may wish to obtain that information when performing risk assessments; 
• it says trustees who are unsure of the above points may wish to conduct at least a limited investigation and to consider whether a more in-depth investigation or analysis is needed;
• it acknowledges that trustees may not currently be able to quantify any exposure taking into account various uncertainties in the law; and
• trustees may conclude given their fiduciary duties that it is not a prudent use of scheme resources to perform a detailed analysis whilst current legal uncertainties remain and there is a risk of having to later reverse decisions taken now.

There is no escaping that there is a degree of tension between the comments aimed at trustees and those aimed at auditors (see below). On the one hand ICAEW acknowledges the reasons why trustees may prefer to "do nothing" at this stage, but in the comments aimed at auditors it states that "it would be reasonable to expect [trustees] to have considered the situation [in accordance with the document so they have] some idea of whether the scheme is likely to be affected".

What does the ICAEW say about the position of sponsoring employers?

Accounting standards generally require employers to recognise pension scheme liabilities on their balance sheet.  Benefits attributed to members in both the current and prior accounting periods may have been mis-stated if scheme amendments were invalid.  Many employers are currently facing questions from auditors about the risk of additional benefit liabilities from the judgment.

The ICAEW document explores what scheme sponsors may wish to consider when deciding how to respond to their auditor's queries, focusing on three approaches:

• do not recognise any amounts or make any disclosure;
• disclose the potential implications of the ruling in the pension note, but do not recognise any amounts; or
• remeasure the defined benefit obligations and recognise a change in the liability.

The ICAEW says that the most appropriate approach will depend on the scheme's circumstances and the actions taken by the trustees, but it is quite directional in pushing towards a specific disclosure as "the bare minimum" likely acceptable action, unless legal advice has confirmed that the scheme is unaffected by the ruling. 

In particular, the ICAEW suggests that taking a "no recognition or disclosure" approach is only likely to be appropriate where:

• trustees are *confident* the ruling has no relevance eg because there were no relevant amendments or it is clear that section 37 certificates were always obtained if required; or
• where the size of the pension scheme relative to the sponsoring employer means that any additional pension liabilities are unlikely to be material to the employer.

Whilst there is a nod to the possibility of adopting a "no disclosure" approach in "less clear cut cases", the tenor of the commentary here suggests auditors' requirements in terms of disclosure could be onerous to comply with.

The ICAEW warns sponsoring employers that they may not be able to see/share legal advice obtained by the scheme trustees.  Where sponsoring employers plan to provide their auditors with information obtained by the trustees, the guidance suggests this should be discussed in advance with the trustees to agree what can be shared.

The ICAEW says it understands that most trustees will not yet have made a detailed assessment of the impact of the case on their scheme as they may be waiting for various legal uncertainties to be resolved. Therefore most sponsors won't be able to do this either.  In such circumstances it suggests that the appropriate way for sponsors to deal with this will be to disclose the issues in the pensions note, but not attempt to adjust figures in the accounts. Some companies will have adopted this approach in the previous year's accounts but will need to update and potentially add more detail into the disclosure this year.

What does the ICAEW guidance say to auditors?

The emphasis for auditors is on information gathering, particularly around the state of trustee investigations and actions, in order to underpin the specific disclosure in accounts.  However, it warns that legal advice obtained by trustees "may not always be shared with the [sponsoring employer] or their auditor".  

It suggests that sponsoring employers should discuss with the trustees what can be provided, but it somewhat controversially also suggests that this might be extracts of trustee meeting minutes where legal advice is discussed. However, trustees need to be careful with that as that could also result in a waiver of legal privilege (ie the right not to disclose legal advice to regulators or in litigation). The ICAEW does acknowledge the privilege issues.

The ICAEW anticipates that in most cases a qualified audit report may not be a proportionate response "unless it seems probable that a scheme will have an additional material liability to pay benefits as a result of [the Virgin Media judgment]".  The ICAEW comments that, "Given the current uncertainties, this is a high bar."