The Non-Cash-Match Catch
At the root of it all, of course, is the employer's decision to offer company stock as a 401(k) option, and/or match their employees' contributions with company stock. "There is absolutely no good reason to use employer stock in 401(k) plans," insists Munnell. Except that employers like the option of matching contributions without putting up cash.
And employees? They love it. "Many have seen numerous [executives and other employees] get wealthy holding on to company stock," says Lori Lucas, director of participant research at Hewitt Associates. "Consequently, they almost view it as a lottery ticket."
Why hasn't that view changed in the wake of so many scandals? "When you drill down," says Lucas, problems with Enron and others are seen as unique, and are not "extrapolated to anything that could happen to their company." In other words, "familiarity leads participants to be more confident in their own company," she explains.
Moreover, inertia rules. Even when employers authorize changes — easing the sale of employee holdings — there's resistance. Some 36 percent of firms investing matching contributions in company stock now allow employees to diversify out of employer-match shares, up from 15 percent in 2001, Hewitt says. But, says Lucas, "there has been very little reaction to this by participants. It's been a nonevent."
So far, Congress has also been a no-show on the issue. After Enron's collapse, there was debate on Capitol Hill on how to prevent employees from holding too much company stock in their portfolios. But nothing tangible ever materialized, nor is anything on the horizon.
Companies do have ways of protecting themselves, however. Policy documentation is a good place to start. If it's surprising that so many companies allow investment in employer stock, it's somewhat shocking that some offer employees no way out of their positions. "Any company that still has those policy issues in place is asking for trouble," says DuFour. He recommends that companies matching contributions with stock allow employees to elect non-company-share matches instead, letting them sell off company-share matches over time. And "companies need to document the reasoning behind any policy change," says PwC partner Stephen Metz. "Very often what hangs people in court is that they can't show how they weighed the pros and cons of a particular policy decision."
Education is also crucial. Even now, "employees just don't understand diversification," states DuFour. The offering booklets and seminars on the subject are clearly not enough. Instead, despite the cost, one-on-one education may be necessary to avoid legal liabilities in the future, he says. And training should not be limited to employees. Although ERISA doesn't require education for plan trustees, "the prudent CFO or CEO should be sure those trustees have some idea of what they should be doing," he says.
Others suggest more-drastic measures. "The way to solve this problem," says Munnell, "is to diffuse it by getting employees to invest automatically in broad-based indices," even though Labor Department rules would have to be changed. In addition, says Matthew Lee Wiener, a partner at law firm Dechert LLP, companies should follow the lead of Sprint Corp., Quest Communications Inc., and Duke Energy Corp., and hire outside fiduciaries. Having a third party oversee the 401(k) plan "might not eliminate the suits, but it would drastically change the landscape," he says.
To date, most settlements have been covered by fiduciary liability insurance — although former Enron directors agreed to pay $1.5 million on their own. Still, the insurance will do nothing to stop the lawsuits. "As soon as something happens to a stock," says Munnell, "employees assume that employers knew, and they sue." No matter "how forearmed and forewarned" employees are, adds Metz, "they will always feel aggrieved if something goes wrong."
Lori Calabro is a deputy editor of CFO.
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