Taking Stock

    Company stock became a legal battleground with Enron and WorldCom, creating instant liability for employers. Since the beginning of 2003, 16 of the Fortune 100 employers have been named defendants in class-action lawsuits brought against companies that include their own stock in their retirement plans, according to Watson Wyatt Worldwide.

    "That means every time your stock drops, you could get hit with a lawsuit," says Michael Weddell, senior retirement consultant at Watson Wyatt. "At some point, it’s just not worth the risks."

    The details of employees’ complaints vary from case to case, ranging from allegations that it was the employers’ fiduciary responsibility to warn them that the stock could tank very quickly to accusations that companies withheld information about the stock’s declining value and would not let them cash out. As a result, company executives are more frequently asking attorneys and consultants if they should stop offering employee stock in their retirement plans, says Bruce Kosakowski, senior consultant at Mercer Investment Consulting.

    This is easier said than done, however.

    There can be serious consequences for a stock when outsiders see it being removed from a company’s own retirement plan, Kosakowski says. "Everyone is going to look at that move and check out how the stock was doing before the freeze," he says. Also, the notion of offering company stock as a way of encouraging employees to invest in their own work has its merits, and employers need to take that into account, Kosakowski says.

    Yet another aspect that employers should consider before liquidating a company stock option plan is whether that decision could itself lead to a lawsuit. Companies need to ask, " ‘Are you taking away a good investment opportunity, and is this the most opportune time to liquidate?’ " Kosakowski says.

    After evaluating these alternatives, many companies decide to either just offer company stock as part of a separate profit-sharing plan or drop restrictions around the stock in a retirement plan. Consultants say that there’s a widespread move among employers to drop lock-in periods that set a period of time during which employees can’t cash out of company stock. Also, fewer employers are matching employees’ contributions to 401(k) plans with company stock, consultants say. According to Watson Wyatt, only 16 percent of the Fortune 100 companies have restrictions about how long employees must be invested in company stock before they can diversify, while 37 percent do not match employee contributions with company stock.

    Companies that decide to maintain their stock in employee retirement plans are hustling to make sure controls are in place to reduce liability. Chief among these measures is muzzling stock-hyping top executives.

    For many CEOs, it’s second nature to act as cheerleaders for their companies. That’s not inherently bad, but when their fervid predictions about future performance of company stock are the centerpiece of the corporate pep rallies, it can only end badly.

    "It’s about protecting them from themselves," says David Wolfe, an attorney and partner at Gardner, Carton & Douglas.

    While it’s fine to talk about the future of the company, CEOs should stay away from talking about the stock, says Joe Hessenthaler, a principal at Towers Perrin. "It’s OK to say, ‘We think the company is doing well,’ but don’t overhype that you think the stock is going to continue to go up," he says.

    Another priority for companies that offer stock in their plans is removing executives who are privy to company financial information from the 401(k) plan committees.

    "People on the committee need to be people who don’t know what’s going on financially," says Don Stone, president of Plan Sponsor Advisors, a Chicago retirement planning consulting firm. While having the head of human resources on the committee would not usually pose a problem, CEOs, CFOs and COOs are a different story. They probably have inside financial information and could present a conflict of interest if they are part of the decision-making about offering company stock in the 401(k) plan. Board officers also should be barred from the plan committee because they often have access to confidential financial information, says Amy Moore, a partner in the Washington office of Covington & Burling.

    Many firms are dividing their 401(k) plan committees into two groups: an investment committee and an administrative committee. "A number of large public companies have done this because of the kinds of litigation and issues that are coming out," Stone says. With the two-committee system, executives with insider financial knowledge serve on the administrative side, overseeing operational issues and making sure that things are running correctly. The challenge, Weddell notes, is that it can be difficult to identify investment-savvy people within the company who do not also have insider financial information.

    Companies are also learning the name game, identifying exactly which employees are acting as the fiduciary to the plan, rather than just naming the entire organization. In the Enron case, for example, plaintiffs went after the top officers and members of the board because the entire company was named as the plan fiduciary, thus making all senior officers susceptible to litigation when the problems broke out, Moore says.

Educating employees
    Providing specifics about the goal of the plan and its risks is also important when designing the plan, Moore says. "The way these cases are playing out, it’s very useful to have a statement saying that your plan is intended to offer employees the opportunity to invest in company stock and have employees share in the fortunes of the company, whether they be good or bad," she advises. By doing this, companies are saying that as fiduciaries, they do not have the discretion to pull employees out of the plan when the stock goes down.

    Larger companies with money to spare are tapping third parties to act as independent fiduciaries for their retirement plans. The advantage is that they have someone else to take responsibility for at least some of the liability. Large companies generally pay 10 to 15 basis points to independent fiduciaries for this service, according to Weddell.

    In the end, employee education is the best risk mitigation for companies that offer stock in their retirement plans, consultants and attorneys say.

    "It’s not just sending one-inch packets home and saying, ‘Read this,’ " says Brent Longnecker, president of Longnecker & Associates, a Spring, Texas, consulting firm that specializes in corporate governance issues. He advises companies to hold periodic brown-bag lunches for employees and explain retirement needs, the concept of compounding and the importance of diversification.

    Providing disclosure on everything is key to avoiding lawsuits, Hessenthaler agrees. "Don’t tell them, ‘We will send a proxy,’ " he warns, adding that too often companies think that by providing employees with their prospectuses, they are answering any potential questions and thus absolving themselves of liability.

    Instead, it’s better to err on the side of too much information, Hessenthaler says. "Tell them everything."