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  • Brian Kallback

“Should we invest all of our 401(k) in Enron stock?”

Later in that same meeting [a December 1, 1999 participant meeting], Cindy Olson, who ran human resources for Enron, took to the podium to answer questions. One written on a card was handed up to her. “Should we invest all of our 401(k) in Enron stock?” she read. She looked up at the auditorium full of participants and replied, “Absolutely! Don’t you guys agree?” She smiled at Lay and Skilling” (McLean, 2013, p. 242).


As we know the eventual demise of Enron, this anecdote should make us all cringe.

Employer stock in a qualified plan is a complex issue. From an organizational standpoint, it can produce desired cash and liquidity. By creating a market for its own equity, an organization can pursue a variety of strategic objectives and initiatives. From a morale and motivation standpoint, participants who own employer stock may be better aligned with organizational goals as they “skin in the game.”


Participants may also benefit if the expected return of the employer stock exceeds other investment options. Though undiversified and concentrated, employer stock can provide an efficient, low-cost manner of investing. Finally, participants may receive favorable tax treatment due to net unrealized appreciation. (For NUA, it’s imperative an organization’s benefits’ team track the historical basis of employer stock contributions, as otherwise determining NUA could be a mess…but that’s a story for another day and column…)


The benefits for inclusion of employer stock sound enticing. Yet, “the increased risk of litigation has caused many employers to reconsider the decision to offer employer stock as an investment option. There have been numerous participant claims regarding participant stock in employer-sponsored plans” (Tedesco, 2017). Unbiased investment management for a qualified plan is difficult enough, and employer stock makes it all the more problematic.


ERISA CONSIDERATIONS

ERISA publishes rules concerning investments offered within qualified plans, but there is no list of approved or blessed investments. In general, a plan sponsor who wishes to act in a fiduciary manner should exercise judgment that a prudent investor would use in investing his or her own assets. ERISA requires plan sponsors – whether employer stock or not – to work solely in the best interests of the participants; exercise the prudence and diligence of a knowledgeable fiduciary; ensure diversified investments, especially away from employer stock; and adhere to the relevant plan documents.


Concerning employer stock, restrictions are based on whether the plan is a defined benefit or defined contribution plan. Plan sponsors can include employer stock as an investment alternative and avoid prohibited transaction status if “the acquisition or sale is for adequate consideration and no commission is charged on the acquisition or sale (Turley, 2017). A 401(k) plan, as long as it offers at least three diversified investments, may allow for greater flexibility concerning employer stock inclusion.


YES, ERISA §404(c) IS ATTAINABLE

But, it may not be easy. ERISA §404(c) is attainable in a limited manner for employer stock. The limitation results from the DOL’s recognition that conflict can occur in the inclusion of employer stock in a plan, as well as the difficulty many proprietary investments have in qualifying as an appropriate investment.


For ERISA §404(c) to potentially apply, the following requirements must be satisfied:


Is the employer stock publicly traded?

Employer stock must be publicly traded in order to qualify for ERISA §404(c) treatment. Stock of non-publicly traded, closely held companies are not subject to ERISA §404(c), regardless of whether the participant elects to invest in the employer’s stock.


Is there a liquid market for the employer stock?

Participants must be able to execute transactions as desired. When an investment is lightly traded, it may not be subject to ERISA §404(c) due to lack of liquidity. In addition to ensuring adequate liquidity, certain investment alternatives within the plan (money market or ‘core’ funds, for example) must accept transfers of employer stock as frequently as transfers can be made from other alternatives.


Is the information received by participants the same as that received by shareholders outside the qualified plan?

There are few complaints when an employer’s market value is roaring. Participants struggle with intentional investment selections and the rise in usage of target date funds and managed accounts suggests participant comfort in delegating allocation decisions. Participants (and many of us) are prone to behavioral biases and mistakes that may cloud prudence in allocation to employer stock. “Everyone thinks their baby – and their business – is more beautiful than all the others, no matter how statistically impossible that is” (Crosby, 2018, p. 72). Thus, over-allocation to employer stock can result when education is insufficient.


When employer stock is included in a qualified plan, extra attention should be paid by educators to the importance of diversification. Educators should not show any greater bias, excitement, or emphasis for the employer stock. Though not always as overt as the Enron example that begins this column, even subtle messaging (such as the fear of missing out) to purchase employer stock can be impactful for participants often looking for direction and guidance.


ERISA §404(c) requires participants receive quarterly statements that include ''a statement of the risk that holding more than 20 percent of a portfolio in the security of one entity (such as employer securities) may not be adequately diversified” (Turley, 2017). Yet, participants may not comprehend the risk they face, as “our brains are the most metabolically inefficient part of our body and one way we conserve energy is by going with the familiar” (Crosby, 2018, p. 67). Thus, the devil we know is less mentally taxing than deciding on a new avenue.


All voting rights, tender offers, and related rights must be distributed to the participant.

These rights must include confidentiality and protection for participants in the form of procedures regarding participant actions with regard to employer stock. Proper procedures should be well-documented and given to participants. Participants should feel no unspoken pressure or influence to retain employer stock based on feelings their employer is watching their investment decisions.


Is a fiduciary assigned to ensure lack of employer influence? Is he or she independent?

Influence from an employer is a main concern for regulators who appreciate a participant may feel compelled or pressured to maintain employer stock out of fear. Thus, a fiduciary must be assigned – whether in-house or independent - who is accountable for ensuring confidentiality of participant investments and undue influence from an employer.


CREATE A DILIGENT PROCESS

“Simply relying on the plan’s ERISA §404(c) language is not enough; there should be dedicated plan provisions devoted to the employer stock” (Henson, 2013). Just as with all investments within a qualified plan, plan sponsors should consider a process for evaluation of employer stock. The process should include documentation of not only the process but also how and why decisions were determined. Documentation is key under ERISA for demonstrating that a plan fiduciary took care to reasonably discharge his or her Fiduciary Duties with respect to the plan (Taylor, 2017). Without documentation, proof can be difficult to ascertain.

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Ultimately, “the propriety of including employer stock in a plan’s investment menu ultimately can depend on the unique character of that plan’s population, as well as the diligence and documentation of that plan’s decision-makers” (Turley, 2017). Care and prudence should be taken when choosing to include the equity of an employer within a participant’s qualified plan.


Knowledge of participants’ behavioral traits, regulatory and fiduciary concerns, and prudence of including the equity as an investment alternative are all considerations that can advise the process.


References


Crosby, D. (2018). The behavioral investor. Great Britain: Harriman House.


Henson, S. (2013). Reducing liability for employer stock in 401(k) plans. Society for Human Resource Management. Retrieved from https://tinyurl.com/y8vxnntf


McLean, B. & Elkind, P. (2013). The smartest guys in the room: The amazing rise and scandalous fall of Enron. NY, NY: Portfolio/Penguin.


Tedesco, K. (2017). Employer stock in a 401(k) plan. Milliman [blog]. Retrieved from http://www.milliman.com/insight/2017/Employer-stock-in-a-401k-plan/


Turley, E. & Rickard, E. (2017). The quandary of publicly-traded employer stock in a 401(k) plan. Bloomberg Law. Retrieved from https://tinyurl.com/yab4wgow

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