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After the collapse of the Enron Corporation, employees and employers alike have cast a wary eye on company stock held in 401(k) accounts.  From a peak of almost $90 a share in mid-2000, Enron’s stock plummeted to less than 10 cents at the end of June 2002 as the company restated earnings amid allegations of financial mismanagement.  Lawsuits filed by employees complain that more than $1 billion in retirement savings evaporated with the company’s deterioration, culminating in a bankruptcy filing on December 2, 2001.  Many Enron employees and retirees lost 70 to 90 percent of their retirement assets after the company restated profits.  

Employees’ holdings in Enron stock represented more than 60 percent of total retirement assets in the plan.  If accurate, this figure is quite a bit higher than the industry norm.  Data on 35,367 401(k) plans with 11.8 million participants found that company stock represented 32 percent of 2000 year-end account balances in plans that offered it as an option. 

Many experts agree that investing in company stock as part of 401(k) assets is not inherently bad or a risky practice.  Holding company stock can encourage emotional satisfaction in knowing that you own part of the company you work for.  The problem comes when participants hold too much of their retirement nest egg in their company’s stock, without diversifying across other investments.  There is no rule of thumb for capping the amount of 401(k) assets represented by company stock.  Deciding what is an appropriate level is a question that cannot be answered easily. 

The Employee Retirement Income Security Act (ERISA) does set a 10 percent limit on the amount that a company’s defined benefit pension plan can invest in company stock, but the cap does not apply to defined contribution plans such as the 401(k).

There is also no industry norm when it comes to a lockdown period.  It is not uncommon for companies to have a lockdown when shifting from one third-party administrator to another.

For Enron, this blackout period has been a focal point of lawsuits and congressional oversight hearings, in part because it overlapped the release of negative financial news that hammered the stock. 

Employers should be wary of blackout periods because of the ERISA imperative for fiduciaries to act in the interest of participants, not the employer.  Because individual investors cannot switch investments during a blackout, a court could find that a fiduciary had the duty to actively manage accounts during that period.

Don’t think for a moment that the Enron crisis doesn’t affect you.  Scores of pension funds, endowments, and mutual funds had substantial investments in Enron.  In addition, hundreds of thousands of workers are invested in 401(k) plans and company retirement programs structured like Enron. 

Sponsors of 401(k) plans can learn some lessons from the controversy surrounding Enron and its retirement plan.

Investors and plan participants should take careful look at the structure of their own retirement plans if they offer company stock as investment options.  Employees are so concerned, that one-third (33 percent) would consider purchasing some type of retirement insurance to protect them from “Enron-like” situations.  Additionally, 4 out of 10 employees would welcome some form of reassurance from their employer about the security of their 401(k) retirement fund.

In a recent survey, of nearly 300 companies with an average of 22,000 employees, found that more than a third (38 percent) are matching contributions in company stock.  Of that number, 86 percent place some type of restriction on diversification of the matching amount of company stock.  However, 62 percent indicate they have, or are somewhat likely to ease existing restrictions in 2002.

Almost one-quarter (24 percent) of plans report that their major priorities have changed since a year ago.  When asked to rank their three most important 401(k) priorities, companies most often cited “improving employee participation in the plans” (32 percent).  More than one-quarter (26 percent) of companies ranked “improving employee understanding of the plan through communication efforts” as their second most important priority, and 21 percent ranked “encouraging participants to diversify assets more optimally” as their third most important priority.

While issues such as poor understanding of 401(k) plans are not new, the current market environment has made it more important than ever for plan sponsors to help their employees set realistic investment goals, and pay attention to important concepts such as investment risk.

Nearly one-half of employees (45 percent) are more concerned about the security of their own retirement plan since hearing about Enron’s 401(k) situation.  Merely one percent of employees trust employers to provide sound financial guidance.  However, most employees have high expectations for plan providers and financial advisors to do the right thing when it comes to making investors feel more secure.  Specifically, employees want 401(k)/retirement fund providers to: 

• Be held responsible for their investment recommendations

• Quickly communicate potential issues and risks regarding investment opportunities

• Report suspicious practices of companies to the government

• Conduct due diligence on their recommendations

• Have no involvement in the investment opportunities they recommend

ERISA does not provide a detailed guideline on what is acceptable and what is not when employers match contributions with company stock and when employees invest in company stock via 401(k) plans.

As such, here are key questions for plan sponsors:

• What’s an appropriate percentage of 401(k) plan assets to be held in a nondiversified asset, such as employer stock?

• Should employers be able to impose age-based restrictions that limit employees’ freedom to divest themselves of company stock?

• Is a plan sponsor liable in some way if plan participants are barred from switching investments during a “lockdown” period?

What can you do?

Even though you may have no choice about how much builds up through employer contributions, most employers let you begin to shift your money out of company stock and into other plan options beginning at age 55.  A growing number of plans are offering even greater flexibility, allowing you to cash out of employer stock at a younger age.

Once you have freedom to control how much company stock is in your 401(k), consider all your retirement investments, including IRAs and other 401(k) accounts, when calculating what proportion employer shares represent.  Setting a maximum limit that you feel comfortable with depends in part on your assessment of your employer’s prospects, but no matter how rosy the outlook, for diversification sake, don’t exceed 20 percent.

If you reduce the amount of company stock, avoid reallocating that money to any company or fund in the same business category as your employer so that you are truly diversifying and not just reshuffling the same cards.

Here’s how to protect your retirement plan: 

• Diversify

• Limit single investments

• Evaluate your mutual funds

• Understand the companies you purchase

• Talk to your plan administrator to find out when you can begin to shift money out of company stock

As with any investment decision, your investment professional can assist you in analyzing opportunities objectively.

This article was published in The Network Journal. Jodye Deal is a contributing writer for the New York-based magazine.  If you have questions on investing, please send them to Investing@GazelleAssociates.com.

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