When a plan sponsor offers company stock as a 401(k) investment option to its employees, fiduciaries of the plan who also happen to be company executives can find themselves thrust into a very awkward position.

On the one hand, the SEC bars them from sharing insider information that might affect the upward or downward trajectory of company securities. Conversely, the US Department of Labor demands that fiduciaries act solely in the best interests of plan participants. If a company executive knows but declines to inform plan participants that the firm's stock is likely to plummet - or perhaps even soar - is that executive failing to act in the best interests of participants? So, what is a responsible company executive/plan fiduciary to do? Tip off participants to an impending stock downturn and risk SEC prosecution, or withhold the information and face possible litigation from plan participants?

In fact, according to ERISA attorneys and experts in the area of company stock investments, neither alternative is perfectly safe.

That is why a growing number of plan sponsors with company stock on their investment menus have turned to outside fiduciaries to handle those issues rather than expose their executives to potential legal action and/or employee rage. It’s best to have that outside fiduciary in place before the company stock has a chance to descend.

"There’s a persistent sense that this is a very sensitive area," says Lori Lucas of Hewitt Associates. “Plan sponsors should be aware of these issues when company insiders are involved.” Research by Hewitt indicates that 10% of sponsors have hired or are considering hiring an outside fiduciary to deal with their plans’ company stock. In 2005, Hewitt found that 43% of their predominantly large plan sponsors offered their participants employee stock as an investment option. That is down from 55% in 2001. More than a quarter of respondents to PLANSPONSOR’s 2005 Defined Contribution Survey, which covers a broader segment of plans, offered company stock as an option, roughly identical to the level in the 2004 survey.

The Profit Sharing/401(k) Council of America (PSCA) reports that about 40 class action suits filed by participants are pending in court today. In the majority, participants claim to have lost money on company stock investments when company officials did not advise them of an impending downslide. In a handful of cases, however, according to PSCA president David Wray, litigants claim that a stock did not go up as high as they had been led to believe.

Plan sponsors that do hire an outside fiduciary to oversee company stock investments should not assume such action is a foolproof method of avoiding litigation if trouble brews, or if participants perceive that they have been hurt because of sponsor misfeasance.

“The ultimate fiduciaries of a plan are the board of directors of the company that appoints the investment managers,” says Ian Kopelman, an ERISA attorney and chair of the Employee Benefits and Executive Compensation Practice Group of Piper Rudnick Gray Cary, a law firm. “If the insiders appoint outsiders, they are one step removed [from potential legal action], but they are still potentially liable.”

Kopelman predicts that, eventually, with all the law suits and government regulatory confusion swirling about the company stock issue, some definition will be given to the precise liability of company fiduciaries. However, for now, he says, the subject is still up in the air.

Relatively few companies actually are abandoning company stock out of fear of legal action or government restrictions, but many are encouraging participants to diversify their company stock investments if their holdings are thought to be too high. While there is no consensus, many say anything above 20% is excessive. Some plans have loosened restrictions they previously had, mandating that company stock, when it comes as a company match, be retained by a participant for a specified time period, often until the employee turns 50 or 55. In some cases, the diversification provisions carried over from a time when the company stock component was part of an employee stock ownership plan (ESOP).

The trends seem to be heading in the right direction. Some 17% of plans, says Hewitt, place a restriction on the percentage of individual account assets that participants can keep in company stock. “That’s pretty significant,” says Lucas, because it indicates that plan sponsors are getting the message that they must both educate participants and encourage them to be wary of holding too much of any one investment - particularly company stock - in their 401(k) portfolios. Eight years ago, says Wray, 28% of all plans that offered employer stock had more than 50% of their total plan assets invested in that category. Today, just 13% have more than half of all investments in company stock.

In the wake of the Enron debacle, Congress contemplated a number of alternative restrictions/notices dealing with company stock in retirement plans, but little has made it into law thus far. However, the pension reform bill passed by the Senate (S. 1783) would require plan administrators to notify participants of their right to diversify and, in fact, advise them of the value of diversification. It also would mandate that sponsors allow participants to diversify their assets in company stock, including employer matching contributions, within three years of their hiring.

“If you’re talking about company stock in today’s environment,” says Wray, “you probably want to go to a law firm that specializes in employee benefits. There are a lot of legal issues, so you probably want to start with the lawyers to lay out all of the considerations you need to know.”

Louis Berney

PS