ESOP's fable

United Airlines' crisis marks the latest case of how workers' stakes fall with firms' fortunes

By Beth Healy, Globe Staff, 12/8/2002

It's been a brutal year for workers who own a slice of corporate America.

First came the collapse of employee stock ownership programs at Enron Corp. and WorldCom Inc., under the weight of fraud and scandal. In Cambridge, the failures of 116-year-old consultancy Arthur D. Little and instant-photography pioneer Polaroid Corp. left thousands of employees with damaged nest eggs. And now the giant of all ESOPs is in flames, as United Airlines grapples with bankruptcy and 50,000 of its workers face the possible loss of some $4 billion in retirement wealth.

The devastation at United comes as no surprise to ESOP specialists. To be sure, the economy's slump and the drop in travel after Sept. 11 have taken their toll on the nation's second-biggest airline. But even zealots of the employee ownership concept, who say stock plans can improve companies and help workers accumulate savings, say the eight-year-old United plan was doomed from the start.

''Employee ownership is not a magic solution,'' said Michael Keeling, president of the ESOP Association, a Washington lobbying group. ''If you're in a troubled company, employee ownership's not going to make a silk purse out of a sow's ear.''

There were warning signs even back in 1994, when the ink had barely dried on the buyout deal that put 55 percent of United in the hands of pilots, mechanics, and nonunion employees in exchange for $4.9 billion in wage concessions.

Professors decried the use of ESOPs as bailout tools. Critics attacked the unorthodox design of the United plan: Without the participation of the flight attendants - the public face of an airline for many consumers - how could United be truly employee-owned? And with no plans for permanent employee ownership, nor the offering of shares to new workers, the plan was a thinly veiled fix to save a sickly organization, analysts said. Over time, there would be two clear classes of workers at United - owners and nonowners.

''It was only a short-term, expedient solution to restructure the company,'' said Jim Megson, a senior consultant at the ICA Group, a Brookline firm that assists companies in designing ESOPs. While United early on reaped some of the benefits that are meant to accompany such programs, like greater efficiency and fewer union grievances and missed work days, the changes didn't last, Megson said. ''That's the kind of improvement we look for in ESOPs,'' he said, ''but they failed to get it in other years.''

United pilot Herb Hunter agrees. Despite all the high hopes for the plan at the outset - even Robert Reich, secretary of labor at the time, had championed it as a new model for workers having a stake in their companies - the ESOP has been a huge disappointment.

''What you need for the ESOP to work was a change in corporate culture,'' United pilot Hunter said in an interview Friday. In 1994, when everyone but the flight attendants signed up for the deal, there was lingering rancor and resentment over past strikes and labor disputes. ''We decided to try to make a cultural change to make everybody work together, get everybody on the same team,'' Hunter said. ''On paper it looked great. But there was never a change in middle management.''

There is widespread frustration among the employee ranks at United that, while Wall Street assumed the workers were in the driver's seat, with representation on the board and half the company's stock in a trust in their name, the employees never wielded the kind of power they would have liked. The key power of a stockholder, Hunter said, is the right to sell shares to influence management. But in an ESOP, employees can't touch their shares until they're 55 and have met their employer's vesting requirements.

''The only way I get paid for my stock is to die, get fired, or retire,'' Hunter said.

Over the past two years, United employees have watched their fortunes dissolve. The airline's share price has slumped from $128 in 1994 to 94 cents at the close of trading Friday. A senior captain at the Chicago-hubbed airline, Hunter was making $150,000 in 1994 when he agreed, with his colleagues, to give up $25,000 annually over five years, plus certain benefits, in exchange for 5,000 shares in the ESOP. By 1999, when the shares were trading at $80, Hunter's account was worth $400,000. Last week it was worth $4,600.

For all the dashed dreams, the United employees have behaved very much like owners - with a great deal at stake - as they faced the prospect of bankruptcy over the past several weeks. In late October, when State Street Bank and Trust Co., the ESOP's trustee, took the unusual step of selling off a chunk of shares in the plan for around $3 a share, the United pilots wrote a letter urging the Boston financial services firm to stop selling, and to repurchase shares in the open market to replace any shares that had been sold. State Street filed with regulators its intention to sell up to 11 million shares. At the same time, United's 401(k) trustee, Aon Fiduciary Counselors, filed plans to sell 10.6 million additional shares from company retirement plans.

''You are giving away the economic value of our ESOP stock for next to nothing,'' said the letter, signed by Paul R. Whiteford, a pilot and chairman of the United pilot's local. ''And you are limiting our ability to participate in a successful recovery program through any subsequent increase in the value of our stock.''

ESOP trustees are normally passive holders and record keepers of shares. Under federal law, ESOPs are required to be predominantly invested in the stock of the employer that sponsors the plan. A few plans permit limited cash holdings or investments to diversify the plan. There's one chief exception to the single-stock rule: when holding the stock is not in the best interests of the plan participants.

State Street, which declined to discuss United because it's a client, has been down this road before. A year ago, as trustee of the Polaroid ESOP, State Street waited to sell stock until after the photo company went bankrupt - at 9.4 cents a share. Some employees objected to the sale even then, saying State Street should have protected what leverage the employees had left for the bankruptcy proceedings, rather than selling the shares for so little.

Nevin Adams, executive editor of the investment industry Web site PlanSponsor.com, based in Greenwich, Conn., said it's historically rare for trustees to sell shares in an ESOP. But, he noted, ''Everything's different after Enron.''

Indeed, in the wake of Enron's collapse, trustees are on notice that they have a fiduciary duty to plan participants, as defined by the Employee Retirement Income Security Act of 1974. If it's widely known that a company is at risk of heading into bankruptcy, ''One could argue that as a trustee, you couldn't turn a blind eye to that,'' said Kenneth Werner, a partner at the law firm Day, Berry & Howard in Boston.

For State Street, the United situation has been a tough call. Said one senior executive at the company, speaking on condition of anonymity, ''You don't go out and sell the shares lightly.'' If the airline files for bankruptcy by the end of this weekend, as expected, State Street will look smart for having sold some of the shares. If United avoids a Chapter 11 filing, employees will remain angry that State Street sold off several millions of shares instead of holding out for a rebound. Either way, Werner said, someone's likely to sue. To protect itself, he said, a trustee must show that it has rules and procedures for dealing with a dilemma such as this, and that it followed them and documented its actions.

''If you made the wrong call, that's not fatal,'' Werner said, ''as long as you can prove you did your best.''

The trustee in this case is in the uncomfortable position of pulling the plug on a fading patient. But the United plan's health began to fail long ago. The troubles can be traced not only to its noninclusive design, but to its unwieldy size, specialists said. No other publicly traded company has ever had half its shares in a trust owned by its employees. Polaroid's employees owned 18 percent of their company, and in the more successful Procter & Gamble program, started in 1989, about 7 percent of the consumer products giant's shares are controlled by the ESOP. Southwest Airlines Co., famous for its entrepreneurial ways and its sway with investors, has 12 percent of its stock in an ESOP.

Most ESOPs are at small and midsized companies that are privately held, consultants said. They can be useful vehicles for sharing the wealth at family businesses or enterprises where one person controls the ownership. Of the nation's 10,500 stock-ownership plans, 90 percent are private, according to the ESOP Association. However, the other 10 percent, which are publicly traded, represent many more workers. Fifty percent of the 8 million American workers who participate in this variety of stock plan work for the public companies. Plans established at distressed companies are the exception, the association said; 95 percent of plans are launched at healthy companies.

ESOPs surged in popularity through the bull market and vigorous economy of the last decade. The number of plans more than doubled between 1987 and 2000, to 11,500, with $500 billion in assets. But the market's dive and the ensuing recession reversed the trend. In fact, the plunge in stock values has turned upside-down the US worker's love affair with stock ownership that had become so pervasive during the late 1990s, mainly in the form of stock options.

Being locked into a stock in a bear market environment would test anyone's long-term investing resolve. But United's employees may not have the chance to wait out the market's doldrums. Said Hunter, the pilot, ''The fact of the matter is, we're out of time.''

Beth Healy can be reached at mailto:%20bhealy@globe.com.

This story ran on page G1 of the Boston Globe on 12/8/2002.
© Copyright 2002 Globe Newspaper Company.

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