Investment Strategy

04/16/02 - Let's Get Back To The Spirit Of ERISA - Preventing Another Enron 401(k) Disaster

By: Frank Armstrong, CFP, AIF

It's time to clean up the 401(k) loopholes that threaten to destroy so many employees' retirement plans.

The Bush Administration's sudden interest in protecting worker's pensions is a transparent, self serving, hypocritical attempt to defuse some of the political fallout over the Enron debacle. However, some good may come of it.

Lets leave it to the courts to decide if there were a few bad apples at the top of Enron, and if their various political contributions tainted the oversight process. That process will undoubtedly play itself out in excruciating detail over the next few years. After all, with Monica and Gary Conduit retired from the scene, the press and politicians will need something to entertain themselves with.

What I'm concerned about is the fate of the 20,000 hard working and productive employees that had no part in the scandal. We have collectively failed them by allowing their pension plans to be so poorly administered that a lifetime's savings could vaporize almost overnight. We need to demand that Congress fix that.

The spirit and intent of the Employee Retirement Income Security Act (ERISA) holds that pension plans are for the sole and exclusive benefit of the participants. The act mandates that pension fiduciaries adhere to prudent investment practices including the duty to educate and advise employees, diversify investments, and limit risk. Pretty straightforward.

But, special interests testified that if they didn't have the right to donate company stock for all or part of their contributions, they would simply not have a retirement plan at all! So, Congress caved, establishing a loophole large enough to fly a 747 through.

Companies are routinely allowed to stuff the employee's 401(k) accounts with "funny money" employer stock. Employees may be required to purchase company stock in order to obtain the "match". But, it even gets worse. Employers actively encourage employees to purchase even more company stock inside the plan. As if that weren't bad enough, restrictions on the sale of company stock are routinely imposed on plan participants.

From the employer's side this is a wonderful opportunity.

Large employee ownership may foster loyalty and increase productivity.
The stock is held by "friendly" hands that are unlikely to vote against management.
The employees "sweat equity" funds the company's capital requirements.
The company receives a tax deduction as if they had contributed cash.

Things look entirely different from the employees side.

The fundamental investment principal of diversification is violated. The employee's human capital (employment) and investment capital (retirement plan) are subject to the same risk. When things go wrong, the employee loses his job and life savings at the same time. While it may be difficult to diversify human capital risk, specific company risk can be completely diversified away in the investment accounts. For that reason, the appropriate weighting of employer stock in the employee's account is zero!
Few employees are sophisticated enough to properly evaluate their own company. They are often too emotionally close to the company to be objective.
Employees may be deliberately mis-informed about the company's prospects and finances in an attempt to enhance morale and sustain or bolster the price of the company stock. The troops in the trenches are often the last to know when things go wrong.
There is simply no way to describe the nightmare of watching company insiders bail out of their stock and options while the rank and file workers are locked in. Being "Enroned" is now part of our vocabulary.

Various knee-jerk legislative proposals fail to rectify the problem. Most impose specific limits on company stock within a plan, which would impose a record keeping disaster while failing to insure employee security.

Solving the problem requires a far more direct approach.

Eliminate the deduction for any company's stock contribution to any qualified plan,
Prohibit any requirement to purchase company stock as a qualification for participation or matching contributions,
End any restrictions on selling company stock inside qualified plans, and
Require education for employees on the risks of owning any concentrated stock positions, including company stock.

You can anticipate the wails and groans of protest from corporate America. Some companies will threaten to terminate plans. A few might actually do so. For the most part that's a hollow threat. In today's economy a pension plan is a required employee benefit if qualified workers are to be recruited and retained.

If employers believe that employee ownership will advance the interests of the corporation, let them establish non-qualified deferred compensation plans in addition to their qualified plans.

Its time to get back to the spirit of ERISA. It's time to prohibit the contribution of "funny money" to qualified plans. It's time to insure that fiduciaries make prudent investments for the sole and exclusive benefit of the participants. Let's not see any more American workers be Enroned!