The July 24 Opinion Page column, "Sponsor's stock taboo in 401(k)s," expressed concern that plan sponsors are not providing adequate information to plan participants regarding the danger of investing large portions of 401(k) account balances in employer stock funds. Specifically, it urges more information be given regarding the volatility of employer stock funds. Further, it suggests that, in some cases, a conflict may exist between a plan sponsor's desire to have significant amounts of stock held by its employees and generally accepted principles of investment diversification - which might suggest that not more than 5% of a 401(k) account balance be invested in an employer stock fund.
We agree that compliance with 404(c) regulations is important because of the very factors identified in the column: Participants are, in fact, investing large portions of their 401(k) accounts in employer stock funds and could thereby suffer large losses. There are two equally important compliance issues related to the volatility of employer stock: 1) the disclosure issues that the column focused on, and 2) the investment transfer issues that I will focus on.
Many employee benefit professionals have questioned whether compliance with the 404(c) regulations provides any meaningful protection for plan fiduciaries. It may be that the most meaningful protection under the 404(c) regs is provided in the case of employer stock funds. In general, if the 404(c) regulations are complied with, plan fiduciaries are relieved from liability for losses resulting from a participant's decision to allocate his or her account balance among the investment choices offered under the plan. If large numbers of participants are allocating large portions of their 401(k) account balances to employer stock and large losses are suffered, the situation is particularly attractive to ERISA class-action plaintiff lawyers. If sued, the plan fiduciaries, in absence of 404(c) compliance, may have to make good the participant losses unless they can show a prudent fiduciary would have invested the same large portions of the participant's 401(k) account balance in employer stock. Because of the factors identified in the column, that could be a very difficult burden of proof, and, so, compliance with 404(c) is important in order to avoid having to meet that burden.
Volatility of the employer's stock is important in determining whether a plan has complied with 404(c) regulations. The "general volatility rule" requires the plan must provide for transfers between investment options with a frequency that is "appropriate in light of the market volatility to which the investment alternative may reasonably be expected to be subject."
Many 401(k) plans that include an employer stock option limit transfers between options to once a quarter or once a month. Many employee benefit professionals recommend against daily transfers because they fear participants will time the market to their disadvantage or spend inordinate amounts of their working hours making investment decisions. In some cases, providing daily transfer opportunity might be seen as too costly. These concerns all may be valid, but they also may be offset by the litigation risk of not permitting daily transfers.
It is helpful to posit the litigation risk as follows: Assume that shortly after a quarterly or monthly transfer opportunity under the plan has passed, several analysts who follow the employer's stock issue sell recommendations and these recommendations are reported in the hometown newspaper. Assume further that before the next investment option transfer opportunity under the plan, the price of the employer's stock in fact does drop significantly - and stays depressed for a long time.
Those responsible for deciding whether to provide daily investment transfer opportunity for employer stock should ask themselves how comfortable they would be defending a lawsuit by having to contend the volatility of the employer's stock was so low that daily valuations were not required under the general volatility rule.
Put another way, could credible investment professionals be found who would testify that the beta of the employer's stock and the other indication of company specific risk were so low it would have been prudent for an ERISA fiduciary to have invested 25% to 30% of a participant's 401(k) account balance in the employer's stock - even if the fiduciary's opportunity to sell that stock for the benefit of the participant's account had been restricted to four or 12 business days each year?
Hubert V. Forcier
Faegre & Benson