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Congress Takes Aim at Employer Stock in 401(k) Plans; Business Remains Leery

Pressure continues to build in Washington for legislation that would protect US workers from future Enron-like meltdowns in their 401(k) plans. While Democratic lawmakers have proposed the most drastic changes to current law, Republicans are making their voices heard, too, with President Bush himself floating a proposal that would make it easier for workers to diversify out of employer stock held in those plans.

When energy trader Enron Corp. filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code in December, it not only left many of its workers out of a job, it also left them with tattered retirement accounts. On average, those workers were reported to have held about 60% of their 401(k) assets in Enron stock, which last year fell from $83 to less than $1. Their retirement account losses alone exceeded $800 million.

On January 29, Bush proposed that participants in retirement savings plans be allowed to diversify out of company stock contributed to those plans by their employers after a maximum of three years. Bush would also preclude senior executives from selling company stock during times when rank-and-file workers can’t trade in their 401(k) accounts, and assign fiduciary responsibility for plan assets to employers during plan lockdowns. Bush also called for the Senate to pass the Retirement Security Advice Act, which has already been approved by the House and would make it easier for financial advisors to provide investment advice to plan participants.

That same day, Rep. George Miller (D-CA) floated the Employee Pension Freedom Act which would, among other things, allow participants to diversify out of employer-stock matching contributions once they are vested in their plan, limit vesting schedules to one year, require advance notice of plan “lockdowns” that prevent participants from trading in their accounts, and impose other new legal protections for plan participants.

Other proposals have gone even further. On December 18, Sen. Barbara Boxer (D-CA) and Sen. John Corzine (D-NY) introduced the Pension Protection and Diversification Act of 2001, which would limit workers to maintaining a maximum of 20% of their dc plan in their employer’s stock and also give them freedom to diversify out of company stock that had been contributed to their plan by their employer after just 90 days. The Boxer-Corzine bill also would limit to 50%, instead of the current 100%, the tax deductibility of employer contributions to retirement plans when those contributions are made in the form of employer stock. Additionally, the bill would allow employees to diversify out of company stock in an Employee Stock Ownership Plan once they have reached the age of 35 and have at least five years of participation in that plan. Currently, companies can prevent workers from diversifying their ESOP holdings until they reach age 55 and have 10 years of plan participation. Rep. Peter Deutsch (D-FL) and Rep. Gene Green (D-TX) had earlier introduced similar legislation that would limit employer stock holdings to 10% of retirement account assets, but would not restrict employers’ use of company stock in matching contributions.

The business community has not responded warmly to these proposals. “They think it’s a terrible idea,” says Janice Gregory, vice president of the ERISA Industry Committee, an organization of companies that sponsor retirement plans, when asked about the Boxer legislation. And, she adds, “Chances are their employees will agree.” Gregory says US workers were “outraged” in 1997 when Boxer was pushing similar legislation, which Gregory characterized as an attempt to prevent workers from participating in the prosperity of their employers. Although Boxer succeeded in having a bill passed at that time, the final product was considerably weaker than what she had first proposed. It merely barred companies from forcing employees to invest their voluntary contributions to a 401(k) plan in employer stock or employer real estate (with some exceptions).

In the wake of the Enron debacle, however, Boxer may find herself in a stronger negotiating position. While Gregory insists that Enron was an isolated incident that shouldn’t trigger wholesale changes in the way other companies run their retirement plans, the sheer size of Enron—it was the seventh largest company in the country prior to its downfall—has riveted Washington’s attention like few other corporate failures before it. By late January, no fewer than 10 Senate and House committees had announced inquiries into the blowup. Even President Bush had ordered his economic team to review pension rules that could put other workers at risk.

“We know there are very powerful forces arrayed against this legislation, and that they are making their voices heard loud and clear,” Boxer spokesman David Sandretti said in late January. “But we feel we have a compelling case and can make a compelling argument, given the huge amount of interest in this situation, given the really terrible losses that the Enron employees had to take, and given the fact that we’ve got a number of companies that have similarly exposed their workers to this kind of risk.”

In fact, while Enron’s implosion hopefully will be an isolated event, it is hardly the only major company that has crafted a retirement savings plans stuffed to the gills with its own stock. According to a recent report in the Washington Times, for example, workers at paint-store chain Sherwin-Williams have about 92% of their 401(k) assets in company stock, workers at Coca-Cola have about 81%, workers at pharmaceutical giant Pfizer Inc. have about 86%, and workers at McDonald’s have about 74%.

Those are, to be sure, the extremes. A recent study by the Investment Company Institute and the Employee Benefit Research Institute, which examined the 401(k) accounts of 11.8 million workers in 35,367 plans (about 11% of the nation’s total), showed that at year-end 2000 participants in those plans had about 19% of their assets invested in employer stock. In cases where employees do hold more than that, it’s often because they have elected to do so, enthused by their employer’s prospects. That was also the case at Enron, however, and it helps to explain why the environment for legislative action appears to have changed.

So does the current economic climate. “The difference between 1997 and 2002, says Karen Friedman, Director of Policy Strategies for the worker advocacy group the Pension Rights Center, “is that in 1997 we still had a bull market.” When most companies’ stocks were going up in value, few people were stopping to worry about what would happen when the party was over. The case that triggered Boxer’s 1997 legislation—the failure of flooring retailer Color Tile—really did seem like an isolated incident. (At the time that Color Tile filed for bankruptcy protection, most of its employees’ 401(k) assets were invested in real estate rented by Color Tile stores. The employees suffered huge losses in their retirement accounts.)

To some critics of the current rules governing 401(k) plans, the federal government has an obligation to step in and protect workers who are shouldering more and more of the responsibility for their own retirement security.

“We have a tax subsidized system and we’re using it to help people commit financial suicide instead of financial security,” argues plaintiff’s attorney Marc Machiz, a partner and ERISA specialist in the Washington, DC, office of Cohen Milstein Hausfeld & Toll. “If we’re going to pay for this system with our tax dollars, we ought to get what we paid for, and that requires a reasonable amount of diversification in these retirement plans. Letting people put 90% to 100% of their retirement assets into employer stock is a recipe for disaster.”

Friedman agrees, pointing out that the law already prohibits employer-sponsored defined benefit plans from holding more than 10% of their assets in employer stock. “In those plans, where all of the risk is on the employers and where we have a federal agency in place to insure those plans if they fail, we limit the exposure to company stock to 10% because of the need for diversification,” says Friedman. “Yet in 401(k) plans, where all of the risk is on the employees’ shoulders, and where there is no insurance, we’re saying, ‘Oh, let them do what they want.’ I think legislators will see the need to implement some legislative protections.”

The challenge for supporters in that camp, of course, will be to overcome what will inevitably be intense lobbying from the business community and those legislators most sympathetic to their interests. Proponents of change will also need to balance their desire to protect workers from their own risky choices with the desire to give them as much freedom as possibility for directing their own retirement accounts. Whatever the outcome, it will be a lively, and important, debate.

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