The most dangerous
investment
The number of lawsuits about company stock in 401(k)
plans and KSOPs is largeand growing almost every week. All
of these share a common thread: substantial and dramatic
losses in the value of company stock.
In those cases, plaintiffs' class action attorneys have
filed lawsuits on behalf of the participants alleging,
among other things, that the fiduciaries had inside
information about the events that led to the losses, but
did nothing to protect the participants. Those fiduciaries
include plan committee members, key executive officers, and
members of the board and the compensation committee. In all
of the cases, personal liability is asserted.
In this article, I am focusing on two specific issues.
The first is the risk of fiduciary status as a "functional"
fiduciary; the second is the importance of assisting
participants in their investment decisions about company
stock.
On the first point, my experience is that most plan
documents provide that the companyusually through the plan
committeewill select and monitor the investments in a
plan. However, in reality, the plan committees of many
companies may not have the actual authority to remove the
company's stock from the plan. In fact, in some companies,
there seems to be an unspoken rule that only the CEO has
that authority.
However, under ERISA, that presents a complex and
problematic situation. If the CEO is the only person with
that authority (assuming the CEO is not a committee
member), then the CEO is a functional fiduciary for
purposes of monitoring the company stock in the plan. That,
however, does not relieve the committee members of their
responsibility, since the plan document specifically gives
them that authority. As a result, plaintiffs' attorneys can
sue both the plan committee for failure to perform its
duties and the CEO for failure to monitor and, if
necessary, to remove the stock from the plan. Companies
should consider carefully the issue of fiduciary authority
for removal of company stock, and should identify that
person in the plan document as the fiduciary for that
purpose.
Regarding the second issue, the investment practices of
participants, committee members need to understand that
participants who invest their accounts largely in company
stock are creating potential liabilities for the committee
members. Participants who invest much of their retirement
benefits in company stock will be the most seriously
injured in the event of a substantial loss and, therefore,
are most likely to support litigation against the committee
members. This is particularly true of older, long-term
employees with large account balances.
Committee members should consider steps to help
participants prudently balance ownership of company stock
with the need for secure retirement benefits. One approach
would be to increase the efforts to educate employees on
the risks of nondiversified investments, like company
stock, and of the consequences of potentially large losses.
Along these lines, at least one court has favorably
commented on language in a summary plan description that
noted the nondiversified source of company stock and its
inherent volatility. A more proactive approach would be to
work with investment advisory and management services that
will help participants manage their accounts prudently.
Those services would advise participants, or manage their
accounts, so that the company stock holdings are at a level
where the quality of a participant's retirement life would
not be adversely affected by the failure of the business or
a substantial diminution in the value of the business. It
achieves the dual purposes of alignment of interests and
risk management.
Don't get me wrong. I think that company stock is here
to stay as a 401(k) investment. I also believe that
employees enjoy having an ownership interest in their
employer. On the other hand, a retirement plan is a
retirement plan. As such, it needs to provide secure
retirement benefits.
How do you balance those two goals? That question can be
answered by committees working with their investment
experts to determine the prudent levels of investment in
company stock and then implementing effective programs to
educate employees about those levels.
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Fred Reish
Fred Reish is managing director and partner of the
Los Angeles-based law firm of Reish Luftman Reicher &
Cohen. A nationally recognized expert in employee
benefits law, he has written four books and more than 100
articles on ERISA, IRS and DoL audits, and pension plan
disputes. His recent writings include: "Enron, 404(c) and
the Personal Liability of Corporate Officers," Journal of
Pension Benefits (Winter 2002) and Participant Directed
Investment Answer Book (Panel Publishers, 2002).