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Some experts believe former Enron CEO Kenneth Lay may have violated his fiduciary duties under ERISA.
David M. Katz, CFO.com | US
February 15, 2002
Bad as the investment advice of Kenneth Lay looks now, the former Enron CEO may have felt legally constrained from actually telling Enron 401(k) participants that the company's share price was about to plummet.
According to some experts, even if Lay knew that the Houston-based company was in bad financial shape, he might have run afoul of insider-trading rules if he told plan participants — and not outside investors — about the troubles at the company. Indeed, no matter how much Lay might have wanted to warn plan members, he would have had "to treat his employees as he would treat any shareholder," says Richard Drake, co-portfolio fund manager of ABN AMRO/Chicago Capital Growth Fund, which manages 401(k)s. Says Drake: "[He could] only tell them what he told the rest of world." And it's doubtful Lay or Enron management wanted to tell Wall Street about the company's off-balance-sheet liabilities.
Hence, the former Enron CEO might have been caught between a rock and hard place: Don't tell employees about Enron's financial woes, and he breaches his fiduciary duty under the Employee Retirement Income Security Act (ERISA); tell employees alone, and he violates securities law.
As you recall, Lay reportedly told employees via E-mail last August that everything was just fine with the company's stock. That was just a week or so after Enron vice president Sherron Watkins allegedly sent a letter to Lay questioning the company's accounting practices. In that letter, Watkins said other employees were also expressing concern over the company's bookkeeping maneuverings.
The day after Watkins' claims to have sent the letter, Lay reportedly exercised options of 25,000 shares for a total value of $519,500. Did the chief executive cash out because he knew the company was on the verge of implosion? Lay's lawyer says no, pointing out that the sale was used to repay a line of credit — and thus implied nothing bad or good about Enron.
If Lay did in fact know that Enron was in serious trouble, and he still boosted the company's stock to employees, he could be prosecuted for having breached his fiduciary duties under ERISA. In such a case, Watkins' memo "could be a smoking gun," notes Linda Shore, a benefits attorney in Washington and adjunct law professor at Georgetown. Shore says Lay's upbeat electronic message to plan members might prove that the CEO breached a fiduciary obligation by knowingly giving inaccurate advice to 401(k) plan participants. At the end of 2000, Enron stock accounted for 62 percent of the total assets in the energy company's 401(k) plan.
To be sure, ERISA doesn't compel company executives to provide advice to 401(k) participants. Still, fiduciaries of the plan had "an ongoing obligation to provide updated information" about the plan's investments, says Shore, who represents employers for Silverstein and Mullens, a division of Buchanan Ingersoll. And if a plan fiduciary does give out information, it's got to be truthful, the attorney says.
That of course, raises the question: was the Enron CEO acting as CEO or plan fiduciary when he spoke to employees in August? "The question of when a company official is wearing his 'fiduciary' hat or his 'employer' hat is one that frequently gives courts difficulty," conceded Susan Stabile, a St. John's University law professor, in testimony before the Senate Committee on Governmental Affairs earlier this month.
A 1996 Supreme Court decision, Varity v. Howe, sheds some light on exactly when an employer may be considered a fiduciary. If an executive makes comments about a company's prospects during discussions about that company's benefit plans — and workers regard that executive as both employer and plan administrator — the comments "may be viewed as statements made by a fiduciary," asserted Stabile.
Stabile told lawmakers that Lay's ERISA liability depends on the nature of the Enron employee meetings and the content and purpose of the E-mails and other written materials sent to employees. She believes, however, that there is at least a question whether a fiduciary misrepresentation was made to plan participants. If such misrepresentations were made, "employees have a claim under ERISA to restore their losses," she told the Senate committee.
Day Late, Millions of Dollars Short
Lay and Enron could have avoided potential conflicts by appointing an independent fiduciary to handle the 401(k)'s investments, notes Shore. She says she's advised clients to do exactly that. A fiduciary who detects that a company is headed for a bad stretch can promptly start selling company stock held in the 401(k). Even without insider knowledge, Shore thinks, a truly independent fiduciary at Enron would have sensed that all was not right at the company. Why? Because Jeffrey Skilling, Lay's handpicked choice to succeed him as CEO, resigned after just six months on the job, Shore says.
Then again, Lay's possible 401(k) dilemma might have been beyond the grasp of even the most scrupulous independent fiduciary. That dilemma could have existed only if Lay had actually been dishonest — that is, in possession of damaging nonpublic material information but saying otherwise. So far, Lay and other former Enron executives aren't talking about that. (CFO.com placed a call to Enron's public relations department about this story but received no answer.)
Meanwhile, the Enron 401(k) plan is likely to have an outside investment arbiter soon. Ann Combs, assistant secretary of labor in charge of the Pension and Welfare Benefits Administration, reportedly said the Labor Department is moving to replace the trustees of the Enron's 401(k) plan with an independent fiduciary. The department is said to be bringing in an independent fiduciary for Enron's defined-benefit and employee stock ownership plans as well. Enron employees, who have seen much of their retirement savings wiped out, are no doubt thrilled by the move.