Some large plan sponsors, including Walt Disney Co. and ChevronTexaco Corp., are revising their rules on company stock in 401(k)s.
By Jinny St. Goar
August 2002
Institutional Investor Magazine
Congress may adjourn for the year without enacting any postEnron Corp. 401(k) reform. But some large companies are making significant changes in the policies that govern company stock in retirement plans, without waiting for legislative action.
In the first six months of this year, several blue-chip names lifted long-established restrictions on employee sales of company stock in 401(k)s. AOL Time Warner, Ball Corp., ChevronTexaco Corp., Gannett Co., Gillette Co., Lucent Technologies, Mellon Financial Corp. and Walt Disney Co., among others, now give their workers much freer rein to sell their shares. For the moment, these corporations are in a distinct minority. But as a spate of class-action lawsuits against plan sponsors makes clear, the issue of how to treat company stock in 401(k)s is far from settled.
Of the plan sponsors that match employee contributions with their own stock, 86 percent continue to impose some restrictions on stock sales, according to an April 2002 Hewitt Associates survey of 300 companies with an average of 22,000 employees. That goes a long way toward explaining why the average large corporate 401(k) holds about 35 percent of its assets in company stock.
Of course the Enron collapse, which swallowed up $1 billion in employee retirement savings, called into question the vulnerability of plans overloaded with company stock -- and the fairness of standard restrictions against the selling of shares before employees turn 55. According to a class action suit by Enron employees, as of January 1, 2001, more than 60 percent of the company’s 401(k) was invested in Enron stock.
Fiduciary liability is one reason companies are rethinking the company stock issue. Plan sponsors may feel that giving employees greater freedom to sell their shares will protect them from lawsuits if the stock price collapses and with it the value of the 401(k). “Restrictions on the liquidity of company stock holdings are a potential liability for plan sponsors -- now and in the future,” says Daniel Cassidy, president of Concord, Massachusettsbased Argus Consulting, an actuarial firm.
AOL Time Warner, Disney and the other companies that recently rewrote their rules all had some sales restrictions on employees’ company stock holdings in their 401(k) accounts. For the most part the bans mirrored those in employee stock ownership plans, or ESOPs, since a num-ber of 401(k)s grew out of these programs. The regulations typically banned sales of company stock before age 55 (or 50, in some cases), and even then only allowed them if the employee had worked at the company for a minimum number of years.
Now the reformers have lifted all restrictions on selling company stock in 401(k) accounts. “Whatever we did, we thought we would only be one step ahead of the regulators,” says Scott Swasey, head of benefits for ChevronTexaco, where the sales ban was lifted on April 1.
Although only a small number of plan sponsors have changed the rules governing their defined contribution plans, more and more companies are considering such a shift. In the April Hewitt Associates study, 114 of the 300 companies surveyed offered all or part of their corporate contribution to the 401(k) plan in company stock. (Of those, 98 companies, or 86 percent, restrict the sales of those stock holdings.) Seventy companies, or 61 percent of the 114 that match with stock, said they were either about to eliminate the holding requirement or were seriously considering doing so, reports Lori Lucas, the Hewitt consultant who oversaw the survey.
“Don’t let anyone tell you that these changes are not related to Enron,” says consultant Cassidy.
What have not changed, however, are the financial incentives for companies to contribute their own shares to the 401(k) plans. The tax deduction corporations can claim for the market value of the stock they contribute to a 401(k) is the same break they get if they use cash. But when they use company stock, the plan sponsors are not dipping into company cash flow.
On the legal front things are very much in flux. These days plan sponsors are closely following several class-action suits, by employees of Enron, Global Crossing, Lucent and WorldCom, among others, alleging that management acted irresponsibly in encouraging workers to invest in company stock.
In mid-May one of these class-action suits was settled, pending the court’s approval. Ikon Office Solutions -- the troubled Malvern, Pennsylvaniabased distributor of office equipment, whose stock has been pummeled amid an earnings restatement and charges of securities fraud -- agreed to unlock the company stock held in its 401(k) plan. The agreement stipulates that employees will be free to trade the company match in Ikon stock if they have worked for the company for at least two years. (Ikon had previously paid $111 million to settle securities fraud charges). “On the issue of the employer stock in the 401(k), the changes to the plan will happen through the consensual settlement,” explains attorney Ronald Kilgard, a partner at Dalton Gotto Samson & Kilgard, the Phoenix-based law firm that represents the plaintiffs.
Industry observers make particular note of the fact that, as Kilgard puts it, the settlement acknowledges that “unlocking the company stock holdings -- lifting the sales restrictions -- doesn’t do much good if no one acts on it.” Judge Marvin Katz of the U.S. District Court’s Third Circuit in Philadelphia is being asked to approve an agreement whereby, for at least three years, two independent advisers will have to consult with Ikon’s plan.
One adviser will review communications materials -- most importantly, the brochures that will be distributed to Ikon employees informing them that they can now sell their company stock. To keep tabs on the progress of the employees’ diversification, the plaintiffs and defendants agreed to name Pittsburgh-based consulting firm Yanni Partners to act as an Ikon adviser. Although declining to comment on the specifics of the company’s plan, David Hammerstein, chief strategist with Yanni Partners, notes that he and his colleagues have always held “broad diversification of investment assets” to be an “ideal.”
Ikon’s 401(k) dates back to October 1995, when the company turned its ESOP into a defined contribution plan offering expanded investment options and using company stock as the match. At the outset, the percentage of 401(k) assets invested in Ikon stock was close to 100 percent, and the shares traded at about $43. Employees could not sell those holdings until age 55. By year-end 2000, with the stock at $2.50, only 22 percent of the 401(k) assets were invested in Ikon stock. As of June 14, 2002, when the settlement was signed, the stock had recovered to $8.93 a share and made up some 50 percent of the plan’s assets.
The roller-coaster ride of Ikon’s stock price reflects the company’s changing fortunes. In August 1998 Ikon took a $110 million charge to earnings, reflecting the closing of an underperforming business, an increase in reserves and other operational changes. The following May the company paid the $111 million to settle the securities fraud suit over management’s representation of its circumstances before the earnings restatement. By late 2000, with Ikon stock down more than 96 percent from its May 1996 high, employees in the 401(k) were amending a class-action lawsuit originally filed in 1999 under ERISA alleging that the plan fiduciaries -- members of the human resources staff of Ikon -- had known about the company’s failing fortunes but continued to encourage employees to invest their 401(k) money in Ikon stock -- which hit a low of $2.01 in October 2000.
In 2001 Ikon’s fortunes improved; in late January 2002 the stock hit a 52-week high of $14. In May a settlement was reached with no payment involved. It was signed the following month and is still pending the court’s approval. By late July Ikon stock was down, along with the market, trading at $7.60.
Another class-action suit involves Lucent Technologies. At the end of 1999, Lucent had about 50 percent of its $21 billion in 401(k) assets invested in company stock. One year later 17 percent of the $11 billion plan was in company stock, reflecting the much lower share price -- the stock plunged from a high of $82.28 on December 20, 1999, to $13.13 on December 28, 2000 -- and a smaller group of employee participants. (Lucent shares recently traded at $2.10.)
Lucent employees sued the company in July 2001, marking the first time a large employer had to defend itself against allegations that its own stock was an imprudent investment option in a 401(k) plan. Lucent spokesman William Price dismisses the class-action suit: “We believe it is totally without merit, and we are confident that our view will prevail.”
In mid-April of this year, the company lifted the sales restrictions on the company stock holdings in the 401(k) plan for unionized employees, effective May 15, 2002. In addition, Lucent announced that the employer match would no longer be in stock, but would instead follow the patterns of individual employees’ investment choices.
Among the other corporations that have loosened their sales restrictions on company stock held in 401(k) plans, several are keeping at least some of the company match in their own stock.
In the case of ChevronTexaco, where company stock makes up some 65 percent of the newly merged oil giant’s 401(k) plan, the energy company will continue to match employees’ contributions with its own shares. As of April 1 employees could sell as much stock as they wanted whenever they wanted.
As more and more plan sponsors watch their stock prices decline in this tough bear market, that freedom may prove infectious.
