Presumption of company stock

The Department of Labor's intervention seeking a U.S. Supreme Court hearing on the responsibilities of fiduciaries concerning company stock as an investment option in defined contribution plans might lead to better guidance on a long-standing exception to the diversification rules of the Employee Retirement Income Security Act.

A decision could be a game changer, leading companies to rethink offering company stock in their DC plans and upending a valued investment option for many companies and participants alike.

The court should take up the issue in question. A ruling could resolve what has become a set of fragmented decisions at the appellate and district court levels. Its overriding objective should be to provide more protection for participants because they bear all the investment risk in defined contribution plans.

Regardless of the court's decision, plan executives as well as the DOL should phase out company stock, or strictly limit its use.

Three federal appellate courts — the 2nd, 3rd and 11th circuits — have upheld a presumption that a fiduciary's decision to remain invested in company stock was reasonable.

The 2nd U.S. Circuit Court of Appeals, in a ruling in 2011, for example, upheld the notion “that the defendants were entitled to a presumption that their decision to offer the (company) stock fund as an investment option was prudent.”

But a ruling in Fifth Third Bancorp, et al. vs. Dudenhoeffer, et al. by the 6th Circuit in September triggered the DOL's petition to the Supreme Court.

The 6th Circuit's decision undermined the application of the ERISA presumption of prudence. It ruled the plaintiffs “were not required to plausibly allege in their complaint that the fiduciaries of an employee stock ownership plan abused their discretion by remaining invested in employer stock, in order to overcome the presumption that their decision to invest in employer stock was reasonable.”

The DOL petitioned the Supreme Court to hear the case to resolve the different court rulings. The DOL seeks to challenge the general presumption that a fiduciary's decision to remain invested in a sponsoring company's securities is consistent with ERISA. Under the presumption, only a critical situation at the company, not just fluctuations in the stock price, would require divesting company stock.

The key problem with company stock is that plan executives and independent fiduciaries have been reluctant to order the sale of shares, or to prevent new contributions in company stock, even as a company runs into severe financial challenges.

Had plan executives and independent fiduciaries treated company stock like any other investment in terms of due diligence, company stock might not have come under such repeated legal challenges and, in some cases, would not have ill-served participants in terms of their retirement security.

The DOL, on the frontlines of overseeing plans and protecting participants, should have decided the issue by providing its own guidance long ago. It should have determined the place of company stock in a defined contribution plan and written the enabling rules, or if necessary, sought congressional authorization to do so.

Company stock has long been a contentious issue and is not easy to resolve, even in the egregious case of Enron Corp.

In 2001, “57.73% of Enron's 401(k) plan assets were invested in the company's stock, which fell in value by 98.8%,” according to a study by the Employee Benefit Research Institute. Participants lost a significant part of their 401(k) savings from the collapse of the stock and the company's subsequent Chapter 11 bankruptcy filing.

The Pension Protection Act of 2006 limited the length of time sponsoring employers can require participants to hold company stock contributed by employers to their plans, but it placed no limits on how much stock could be contributed to, or held, in the plans. Nor did it address fiduciary responsibility with regard to selling, or encouraging participants to sell, company stock when the company came under pressure.

Plan executives should welcome a resolution. Left to stand, the decisions leave ambiguity about the presumption of prudence, encouraging more challenges as litigants seek out favorable courts for rulings.

A resolution of the issue would strengthen guidance, mitigate litigation and provide more protection for participants.

The “prudent-person standard focuses on a fiduciary's conduct in arriving at an investment decision, not on its results, and asks whether a fiduciary employed the appropriate methods to ... determine the merits of a particular investment,” according to the DOL petition, referencing other litigation.

The issue draws attention to a conflict plan sponsors face between their fiduciary duty under ERISA to protect participants' retirement savings and their goal to encourage employee ownership of company stock.

Defined contribution plans are supposed to provide a way for participants to accumulate retirement savings in a diversified set of investment options to enable balancing risk and return objectives.

Participants are gradually providing a resolution by allocating less to company stock. Company stock represented 8% of total 401(k) assets in 2011, down almost 60% from 19% in 1999, according to a 2012 EBRI study. “Recently hired 401(k) participants ... tended to be less likely to hold employer stock,” the study states.

Thirty-eight percent, or 9.2 million, of the 401(k) participants in the 2011 EBRI/Investment Company Institute 401(k) database were in plans that offered company stock as an investment option. “Among these participants, 74% held 20% or less of their account balances in company stock, including 51% who held none,” the EBRI report states. But “about 6% had more than 80% of their account balances invested in company stock.”

A Towers Watson & Co. analysis of Fortune 100 companies, released last January and based on form 5500 filings, confirms the trend among the largest defined contribution sponsors. Of the 79 companies with company stock in their plans, the aggregate allocation was 19.1% in 2011, down from 20.7% the previous year. In addition, the percentage of companies with less than 10% aggregate allocation to company stock rose to 41% from 37% over the same period.

Sponsors and independent fiduciaries overseeing defined contribution plans in which participants have large allocations to company stock are overlooking issues of prudence, diversification and risk.

For many participants, company stock is on the way out of their plans, and that's the course it should take for all participants and 401(k) sponsors. A Supreme Court ruling clarifying the responsibilities of fiduciaries overseeing company stock in defined contribution plans might accelerate the trend. n

This article originally appeared in the December 9, 2013 print issue as, "Presumption of company stock".