Monitoring DC Plans’ Company Stock Investments During Market Volatility

Decisions for 401(k) plan sponsors with company stock on their investment menus are different than those for sponsors of true ESOPs.

Following past financial crises, the retirement plan industry saw a wave of Employee Retirement Income Security Act (ERISA) lawsuits alleging plan sponsors maintained the company stock investment in their retirement plans when they knew or should have known it was imprudent to do so. Some speculate the same will occur because of the market effect from the novel coronavirus pandemic.

Katie Hockenmaier, partner and defined contribution (DC) segment leader, West Market, at Mercer in San Francisco, sees these so-called “stock drop” lawsuits as a possibility. “It is hard to predict, but if the past is any indicator of typical reactions, I would anticipate we might see stock drop lawsuit,” she says. She notes however that this market downturn is different because it is caused by a public health crisis. Stock performance is very much dependent on the future of consumer demand, so if that ramps up quickly, there may be less probability of such litigation.

Hockenmaier says she has seen company stock perform better than other equity investments within some 401(k) plans—it depends on the plan sponsor’s financials. However, she also has seen a flight to safety from retirement plan participants.

So how do DC plan sponsors with company stock on their investment menus fulfill their fiduciary duties and keep participants protected during this time of strong market volatility? “Broadly speaking, they should continue monitoring the stock fund as they do any other investment; look at it with the same level of scrutiny they always do. And they should also recognize company stock is a concentrated position versus other investment options,” Hockenmaier says.

Aside from that, she suggests that plan sponsors that have not engaged an independent fiduciary should consider whether that would add value. An independent fiduciary may have more level-headed reactions to the market environment and be better able to keep up with all factors affecting the performance of a plan sponsor’s company stock, Hockenmaier points out. She adds that providers that monitor other investments in a DC plan may not be able to monitor company stock, so hiring an independent fiduciary could be a good step.

For plan sponsors that don’t have limits in place for how much participants can invest in the company stock fund, Hockenmaier recommends they consider limits. For example, a plan may decide that participants can only have at most 20% of their assets in the company stock fund. “It could be in the best interest of participants to have all available tools to diversify and provide protection in this market environment,” she says.

She adds that her suggestions should be discussed with legal counsel.

Some DC plan sponsors may be in the process of sunsetting their company stock funds. Hockenmaier explains that plan sponsors that decide to remove company stock from their plans tend to do so over a long period of time so participants can divest on their own pace in accordance with their own risk return goals and profiles—hence the term “sunsetting.” She says plans already in that process should re-evaluate their timeline because participants could lock in losses if they move out of company stock now.


In true employee stock ownership plans (ESOPs) participants are only invested in company stock. This presents its own set of fiduciary responsibilities for plan sponsors.

Corey Rosen, founder of the National Center for Employee Ownership (NCEO), in Oakland, California, says there is no mitigation for participants losing value when an ESOP’s share price goes down. Plan sponsors could decide not to invest further in the ESOP, but the damage is still done. It is certainly a time when participants shouldn’t be selling their shares, he says.

However, older participants may be better off. Rosen explains that in ESOPs, participants who are older than 55 and have 10 years of service must be given the opportunity to diversify up to 25% of their account balance—and that increases to 50% over the next five years. “If these participants made that choice, they may be better off in their ESOPs than other participants,” he says.

But Rosen notes that one thing research has shown about ESOPs—and is surprising given economic theory—the beta (risk) on ESOPs is lower than the beta on 401(k) plans, which he says has been true for 30 years. He says the reason, most likely, is that ESOPs are valued to be forward-looking based on expected returns over the next five years. “With the residual value over the end of a five-year period, if there’s a terrible event, but a one-time event, it’s something ESOPs will recover from,” Rosen says.

Still, he notes, there will be some companies that, through no fault of their own, will go bankrupt because of the coronavirus crisis and have nothing in their ESOPs. In a situation in which a company finds itself in real trouble, it may look for a buyer, Rosen says.

So do companies that sponsor ESOPs put participants at a greater risk than if they had a more diversified retirement plan? Rosen says ESOP companies are more likely to offer another retirement plan.

From a fiduciary standpoint, Rosen says ESOP sponsors need to be thinking about whether they should have an interim valuation. To do that, the company’s board would have to authorize it and would have to consult with attorneys to make sure it is allowed by the plan document or if the plan sponsor would need to amend the plan. In a webinar hosted by the NCEO, Kevin Long, an attorney at Employee Benefits Law Group in San Jose, California, said whether plan fiduciaries have the discretion to reset the company stock’s value for current payouts is hard-wired in the plan document.

He adds that if the ESOP has plenty of cash and plan sponsors don’t expect many transactions—distributions or loans—a company may not have to do interim valuations.

During the webinar, Steve Nelson, managing director at Chartwell Financial Advisory in Dallas, Texas, said a challenge with doing an interim valuation is whether there’s any clarity about the coronavirus’ effect on business in the next few months. “To the extent plan sponsors can delay an interim valuation, it is prudent to do so. It will give plan sponsors the ability to be reasonable, while not directly accurate,” he said.

Rosen explains that if a plan sponsor did an interim valuation in April and the situation improves, the valuation would be outdated by June. “If they don’t expect many distributions from the ESOP, companies wouldn’t do an interim valuation. They would pay participants what is presumably now a higher price,” he says.

Nelson told webinar attendees the next item a plan sponsor should consider if it thinks it needs an interim valuation is whether it can just get a quick letter or if it needs to get a whole new valuation report. Long said one viewpoint is that if a plan sponsor is going to declare an interim valuation, it needs to dig down and provide the best projection it can and produce a complete report because ESOP participants may challenge the valuation.

Rosen concludes, “The one thing we know about ESOP companies from prior research and responses from similar situations is ESOP companies emerge from recessions better than non-ESOP companies. One research project that goes back to 2000 and is done every four years looks at the layoff experience of employees in ESOP versus non-ESOP companies. It finds ESOP companies experience one-third to one-fifth the layoff rate than non-ESOP companies. And the biggest difference has been in the worst years.”