The technology crash of the early 2000s taught some painful lessons to 401(k) sponsors and their participants. When the stock prices of Enron Corp., Lucent Technologies and other highfliers of that era collapsed, so did the value of their employees company-stock-heavy 401(k) accounts: 60 percent of Enrons plan and 50 percent of Lucents consisted of their own shares. Employees sued those companies for encouraging investments in their shares without warning of the potential risk; Enron alone ended up paying more than $260 million in out-of-court settlements, and a few cases against it are still pending.
Amid todays credit market crisis, defined contribution history is repeating itself. Employee groups are reacting to precipitous declines in 401(k) assets by filing or contemplating lawsuits against companies caught up in the subprime mortgage debacle, particularly Citigroup and Countrywide Financial Corp.
To be sure, the magnitude of the problem isnt quite what it was. The proportions of Citi and Countrywide stock in their respective 401(k) plans are 32 percent and 33 percent. But thats considerably more than the 10 percent to 20 percent maximum allocation in a single stock that advisers typically recommend. The Citi and Countrywide figures are also roughly double the average 16 percent at 300 large companies surveyed last year by Lincolnshire, Illinoisbased consulting firm Hewitt Associates. That average has fallen steadily from 30 percent in 2001, suggesting that some diversification principles have sunk in.
But the disparities in 401(k) allocations in the Hewitt survey, company stock is second only to the stable value asset class (18 percent) are enough to trigger concern, not to mention action by the ever-aggressive plaintiffs bar. Fifteen lawsuits are pending against Countrywide and may end up being consolidated as a class action, says Andrew Volk, a partner in the Seattle law firm Hagens Berman Sobol Shapiro, which filed seven of them. Eight suits have been filed against Citi. Hagens Berman has also filed a suit against Washington Mutual. Merrill Lynch & Co. has publicly acknowledged that lawyers are considering suing it.
All these institutions, for the record, say the legal actions have no merit. Still, as David Wray, president of the Profit Sharing/401(k) Council of America, puts it, If you have company stock in a plan and the stock drops in value, youre going to be sued.
Why do participants continue to overexpose themselves to company stock? People have pride in where they work, says Pamela Hess, director of retirement research at Hewitt Associates. Wray adds that holding the stock makes them feel theyre part of the ownership of the company, but then inertia sets in. Its very difficult to get participants to take action on anything, says Hess. That includes voting to switch out if matching contributions are made in employer stock.
The lawsuits allege more sinister reasons. They say employees are deceived by senior executives who do not provide a complete picture of the companys financial condition. One suit against Countrywide, for instance, claims that even while foreclosures and delinquent loans were piling up troubles that led to a $1.2 billion loss in 2007s third quarter CEO Angelo Mozilo and president Stanford Kurland sent a series of all-employee e-mails, invariably touting the company and its stock. Attorney Volk notes that all of Countrywides matching contributions were made in company shares; their value in the 401(k) plan plunged from $350 million at year-end 2006 to $150 million in fall 2007. The litigation, particularly if it achieves class-action status, could take two years to reach trial, says Volk.
US Airways in August won such a case in U.S. District Court for the Eastern District of Virginia, in Alexandria. The court denied a class-action attempt to compensate 401(k) shareholders for the evaporation of the airlines share value in the year leading up to its August 2002 bankruptcy filing. The company protected itself with public disclosure: Plan literature repeatedly noted the risks associated with a nondiversified retirement portfolio in general, and the company fund in particular, said the court.
Joe Hessenthaler, a Philadelphia-based principal of the Towers Perrin consulting firm, urges companies to go beyond that standard, posting 10Q reports on office bulletin boards and warning of disappointing earnings.
At least in theory, share ownership makes workers more committed to the companys success, says Wray of the Profit Sharing Council. But, he adds, employers also have a strong motivation to downplay stock ownership: They dont want to be sued.