Who's Really to Blame For Too Much Company Stock in 401(k)s?

Last Updated Jul 7, 2010 11:05 AM EDT

Blaming the folks running a 401(k) when company stock owned by plan participants implodes has become popular sport in litigation circles. As I recently reported, lawyers are circling the wagons around BP's 401(k) retirement plans, seeking damages for the big losses participants have taken on BP stock since the Gulf oil spill hammered the stock. The courts have already rendered decisions on 10 "employer stop drop" suits this year; dismissing six and giving four the green light to proceed. And just last week PlanSponsor reported that Radio Shack is being sued by a plan participant who is arguing the plan was remiss for allowing employees to stuff more than 80 percent of 401(k) assets in company stock.


Pointing Fingers After the Fact
At the heart of these suits is the fact that 401(k) plan sponsors are required to operate a plan in the best interests of the plan participants. The fiduciary standard that Congress didn't have the spine to impose on brokers in the recent financial reform bill already exists for the folks running retirement plans covered by ERISA. In 401(k) stop-drop cases, plaintiff arguments typically focus on whether it was prudent for a plan to continue to offer investment in company stock if it had knowledge the company had some skeletons in its closet. These suits typically bubble up only in hindsight after a steep stock drop, as we're seeing in the aftermath of the BP oil spill.

To date, plaintiffs haven't had an easy time getting their cases past first base. A 1995 legal decision gives plan sponsors a "presumption of prudence." Interestingly, the Department of Labor-the enforcer of ERISA-recently filed an amicus brief in a case involving a Motorola stop drop case, challenging presumed prudence.

Plenty of Blame to Share

The lawyers will be busy for years arguing these cases, and with every investment bubble, financial crisis or BP-ish implosion new cases will materialize. But attacking the problem after it happens misses the real need: Render stock drop cases obsolete by making it hard, if not impossible, for plan participants to over-load on company stock. If you only have 5 percent or so riding on company stock, your retirement isn't derailed no matter how severe the blow up. Yet even today, after a string of stock-drop implosions, Hewitt Associates reports that plan participants who can invest in company stock have an average of nearly 20 percent of their assets riding on that one stock.

Washington took a stab at the company stock issue in the wake of Enron's 2001 collapse-many employees had more than half of their retirement assets invested in company stock-passing regulations that made it easier for employees to diversify out of company stock received as a matching contribution. And indeed, there has been a drop in the overall reliance on company stock. But a 20 percent average is still way too high. Washington understands the power of nudges and automation. So how about automating a company stock cut-off feature? When participants' reach a preset limit in company stock-say 5 percent to 10 percent of their account total-any additional investments would require the employee to override the limit by selecting to opt-out.

Employers could step up to the plate as well. Why invite the lawsuits in the first place? Change your policy to restrict investment in company stock and it becomes a moot issue. And that includes circling back to employees when market appreciation of old stock purchases pushes the weighting into the danger zone. Moreover, if a participant has a high percentage in company stock, might it be prudent to consider making the matching contribution in something other than company stock? Just saying.

And I am well aware employees shoulder plenty of the blame here. In 2010 there's just no excuse for not understanding and heeding the laws of diversification. Sure, it would be helpful if Washington and plan sponsors provided some nudges, but at the end of the day all of this would be unnecessary if plan participants simply took responsibility for their retirement security by keeping their company stock allocation below 10 percent.