Owners and managers of many businesses, large and small, believe that holding employer securities in the firm’s 401(k) or other retirement plan is good business. Recent years’ experience, however, make it clear that the practice of investing a company’s retirement plan assets in the company’s own stock can cause problems.
Shock waves caused by recent financial disasters have resulted in turmoil far beyond the burdensome rules of Sarbanes-Oxley. One example is the increasingly hostile legal climate related to holding company stock in a company’s retirement plan.
Lawyers assert claims of breach of fiduciary duty where retirement plan trustees, corporate officers and firm directors allow retirement plans to continue investing in company stock in the face of bad corporate news that causes the stock’s price to fall.
Employees look to their retirement plans as a key nest egg. Any adversity to those precious assets will be important to employees and can trigger controversy.
These disputes normally arise under ERISA, the federal employee benefits law whose definition of fiduciary can extend to officers, directors, retirement committee members and trustees — even directed trustees who simply follow the investment directions of management.
A few examples of the many lawsuits brought in the last few years against large companies are as follows.
- Merck. The company recalled Vioxx and saw a 27 percent drop in stock price. Retirement plan participants sued the company and its officers, alleging the company promoted the drug while overloading the plan with Merck stock, knowing that stock prices were artificially inflated and inherently unsustainable.
- BellSouth. The company disclosed accounting errors that overstated revenue by $163 million. Retirement plan participants sued, alleging that savings plan and ESOP fiduciaries breached their duties by failing to remove company stock as an investment option and that officers had a conflict due to their interest in incentive awards.
- ADC Telecommunications. It’s stock price plummeted. Plan participants sued the company and its officers for allowing employees to invest 401(k) assets in company stock when, despite a general downturn in telecom industry, defendants disseminated optimistic and unrealistic predictions that concealed the company’s true financial condition.
Pros and cons If your firm wishes to revisit the policy of investing plan assets in the company’s stock, what are the pros and cons of that assessment? We’ll begin with the pros.
Holding company stock in your retirement plan can:
- Generate tax deductions based on the value of employer-contributed stock
- Create a block of votes that is likely to be friendly to management’s business goals
- Have a favorable impact on the price of shares
- Create a market for the stock when it is not widely held (e.g. small company ESOPs)
- Enhance employees’ interest in the performance of their employer
- Provide a corporate financial tool
- Aid in small firm ownership transition or succession
On the negative side, holding company stock in your plan can:
- Create an overconcentration of the average employee’s financial security in the employer’s fortunes, a double-barreled risk in a business downturn. Not only is the paycheck vulnerable, but retirement assets are, too.
- Intensify criticism of management when employees react negatively to the company’s business fortunes
- Impact work force morale negatively in the face of bad business news
- Expose management to charges that it knew more about problems than outsiders but did nothing to stop the plan’s bad investments in company stock (The superior knowledge of officers and directors is a powerful plaintiffs’ issue.)
Retirement plan assets must be dealt with carefully, and the investment of those assets, whether in company stock or otherwise, calls for special attention.
Lee T. Polk is a partner in the Chicago office of Barnes & Thornburg LLP. He regularly represents clients in employee benefits law. Reach him at (312) 214-8300 or [email protected].
