Too Much of a Good Thing: How to Manage the Pitfalls of Company Stock in 401(k)plans

Article excerpt


* Companies that allow employees to invest their 401(k) accounts in company stock face a serious risk if the stock declines precipitously. Faced with large losses, employees can take legal action to recover their retirement savings.

* To head off trouble, companies should consider limiting how much 401(k) money employees can invest in company stock. Left to their own devices, many employees invest heavily in these shares. In a recent survey 2?% of those who could invest their 401(k) in company stock had half or more of their plan assets invested in this way.

* There are steps CPAs can recommend companies take to avoid lawsuits. This includes capping the amount of company stock an individual can hold, making company matching contributions in cash rather than stock or, if matching is done with company stock, letting employees immediately diversify.

* CPAs can help educate employees about the risks of inadequate diversification. Companies should offer mandatory education sessions for all employees and counsel specific employees who have too much company stock in their plan accounts. The goal is for employees to understand how their retirement money is invested.

* Another key step is for CPAs to help companies understand the fiduciary issues related to maintaining a 401(k) plans. It's possible some employees may be unaware they are "functional fiduciaries" based on their job titles or actions.


When companies talk about managing their risks more effectively, many overlook a key risk area in their 401(k) retirement plans. Its not only the Enrons and WorldComs of the world that have to worry about lawsuits when stock price declines hurt employees who invested in company stock; other companies are being sued as well. While it would be unrealistic to try to avoid all potential 401(k) lawsuits, there are some steps CPAs can recommend companies take to head off legal action and to defend themselves if they are sued.


Enron is the poster child for companies whose employees had too much of their 401(k) invested in company stock. Some 57.3% of its employees' 401(k) assets were invested in Enron stock when it fell in value by almost 99% in 2001. Nearly 11,000 Enron employees lost $1 billion in just six weeks. While such enormous losses are rare, all companies can learn from what happened at Enron. "There is substantial risk associated with offering company stock as a 401(k) plan investment," says Michael Weddell, a retirement consultant with Watson Wyatt Worldwide in Detroit. "A company can expect a lawsuit every time the stock price drops significantly--not just when there is criminal activity"

According to a Watson Wyatt analysis of the 86 Fortune 100 companies that offer employer stock as a 40 l(k) plan investment option, 21 are currently being sued by employees over company stock losses. Weddell says most companies don't appreciate the risks as much as they should. Even when cases are settled before going to trial, the cost is significant, with the smallest settlements in the $10 million to $30 million range. When Electronic Data Systems Corp. tried to settle a case for $16.5 million, the judge rejected the settlement offer as too low

Few companies are taking the steps necessary to avoid or limit the damages from such lawsuits by, for example, restricting the amount of 401(k) assets employees can invest in company stock. In a survey of 458 businesses by Hewitt Associates, 83% of companies that offered company stock as a 40 l(k) investment did not place any restrictions on how much employees could invest in company stock.

So what can CPAs recommend to their clients and employers who are worried about the rise in 401(k) lawsuits? The recommendations fall into four major categories--deciding if company stock should be an investment option, modifying the plan to make sure employees don't over-invest in these shares, educating employees about diversity and other retirement planning issues, and making sure plan fiduciaries take their responsibilities seriously