Company Stock in Your Company's Retirement Plan By: Gabriel PotterMBA, AIFA® 2012.10.01

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

-Cindy Olson, Executive VP for Human Resources at Enron

December 1999 employee meeting for Enron

The worst case scenario

In Cindy Olson’s book, she claims her response to an audience member question was given and received as a joke.  But after testifying at a Congressional hearing, explaining her comments to the Department of Labor and being personally named in a civil suit, I’m sure she wishes she hadn’t said it.  We contacted Cindy to see what she might have said given the opportunity to redo that moment.  Sadly, she did not reply to our query.

When Enron collapsed in 2001, it knocked out the retirement savings for thousands of its employees who had high allocations of their retirement plans invested in company stock.  Specifically, the Financial Industry Regulatory Authority (FINRA) estimates 57.73% of Enron employees’ 401(k) assets were invested in Enron stock.  Employees lost $1.2 billion in retirement funds (not to mention the $2 billion lost in pension funding due to the bankruptcy).

Disadvantages of company stock in your lineup

We have been discussing the implications of including company stock in retirement options for employees (usually through a 401(k)) with our clients.  In this whitepaper, we’d like to consider some of the advantages and disadvantages.  A full company collapse (like what happened at Enron or WorldCom) is arguably the worst case scenario for a retiree, but there are other significant downsides to consider. 

Even without a full scale shut down of the company (i.e. chapter 7 bankruptcy), individual and class action suits may occur against companies which include company stock in their lineup.   After a decade of painful declines in their stock and growth prospects, Kodak filed for chapter 11 bankruptcy (wherein business operations still continue) in January 2012, and shareholder equity dropped to pennies on the dollar.  Immediately following the bankruptcy filing, Kodak was sued by employees for allowing company stock as an investment option.

The Kodak suit and Enron debacle highlights problems with insiders, disclosures, and conflicts of interest.  For instance, the Kodak suit alleges board members for the Kodak Savings and Investment Plan and the Kodak Employee Stock Ownership Plan (ESOP) continued to sell company stock to employees even while the company was preparing for bankruptcy and against all principles of prudence.   In the case of Enron, insiders were able to unload millions of dollars of company stock while advertising the health of the company to employees and other investors.  In both cases, company employees individually named key insiders and board members for compensation.

Beyond bankruptcy, let’s consider other troubling implications.  For instance, the investment committee or plan committee takes the responsibility of selecting investments for a 401(k) lineup and must apply some prudent guidelines to their selection process.  Investments for a lineup aren’t picked arbitrarily; they are screened and monitored for compliance against a number of quantitative and qualitative variables.  Why should the addition of a single stock to a lineup be any different?  An investment committee would be hard pressed to demonstrate any objective application of their selection process if they proffered their own company stock. 

From a purely quantitative viewpoint, the basics of diversification suggest high concentrations of single stock create inefficient investment portfolios.  In other words, highly concentrated portfolios may experience higher levels of risk for any targeted level of return.  The quantitative principles of diversification are fundamental to Modern Portfolio Theory. Modern Portfolio Theory greatly informs the application of investment law (i.e. NYPMIFA, UPIA, and UPMIFA) and related fiduciary standards.  We stray from these basics at our own peril.

There are smaller, nuanced elements to consider when adding in company stock into a lineup.  For instance, some companies provide ownership to company stock in the form of marginal shares in a mutual fund - a unitized stock fund.  To demonstrate operational prudence, these companies need to examine and document the impact of unitized vs. share accounting and note if this has any material effect to employees. 

Companies must also check on the impact of stock concentration has to qualification standards.  Companies which provide matching funds to participant contributions in a 401(k), often provide the match in company stock.  That has the effect of democratizing exposure to the stock.  Alternatively, large vestments of stock made to key professionals can concentrate ownership at the higher echelons of the company.  Employers should be cognizant of the combined exposure employees have in company stock, but also the relative concentration.

Advantages of company stock in your lineup.

Despite these unique challenges, we must note thousands of companies continue to offer company stock in their investment lineup.  There are unique advantages and encouraging factors to providing company stock to employees within the retirement plan.

The first and most important reason why companies offer company stock in their retirement plan is because it aligns the incentives of the employees with the business itself.  Even a marginal ownership can make the employees feel literally invested in their company’s success.  Employees who are also owners should be more likely to consider the interests of the business along with their existing short term incentives of a weekly paycheck.  Employees who are also owners should be more likely to cooperate, act as a unified team with common goals of success, and exhibit pride in their company’s output. 

Second, employees who were already interested in owning the stock now have the benefit of ownership in a tax deferred vehicle like an ESOP or 401(k).

Third, the laws of supply and demand have an effect on stock market prices which encourage employee stock ownership in the retirement plan.  Key executives have a vested interest to the market price of their company as it reflects upon their personal performance.  These executives may be on the investment committee or they may monitor other committee members.  If an employer offers the company stock in a lineup, potential demand for the stock is increased and so is the market price.  If you remove company stock from an investment lineup, the market gets flooded with excess supply and the price falls.  As a related example, we’ll be watching how 1 billion new shares of Facebook stock affect the price once the IPO restrictions on trading are lifted next week.

There are ancillary benefits to offering company stock in a retirement plan.  Employers can benefit from indirect ownership programs (i.e. stock options, restricted stock, and other rights). A company can conveniently provide benefits without paying for them immediately.  Ownership of company stock vested to an employee can accrue over time.  Gradually allotting these incentives over time is intended to reward and retain key employees (who might forfeit their stock positions if they leave the company).  There are direct benefits for employees too.  For example, there are stock purchase programs offered at substantial discounts (e.g. employees can buy stock at a price 15% less than its lowest point within a quarter). 

One potential solution:  Restrictions

Limitations on the plan structure can reduce employees’ portfolio volatility and employers’ liability.  For instance, a plan which offers company stock might set up a restriction which limits an employee’s ownership of company stock to no more than 20% of their total account.  Other restrictions may adjust the terms of liquidity for employees, insiders, or control persons with company stock. Not every recordkeeper or third party administrator (TPA) can implement these restrictions, so employers should work with their consultants to investigate their options.

Westminster Consulting’s Research

Westminster Consulting has conducted its own survey to large recordkeepers to investigate how common company stock is within a retirement plan, how many use restrictions (like those mentioned above), types of accounting used, and so on. 

In general terms, our research suggests there is a slight decrease in the popularity in plans with company stock and there is heightened sensitivity to fiduciary obligations and the legal landscape (e.g. ESOP provisions in ERISA and Pension Protection Act of 2006).  For more information about the specifics of our survey and our research, please contact us.

In conclusion

We’ve only scratched the surface of these potential issues and the answers which best suit any individual company are going to be unique. Westminster Consulting looks forward to helping employers identify their fiduciary responsibilities and analyzing the operational success of these issues, large and small.  Please feel free to get in touch with us with your questions.



Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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