Company stock in 401(k) plans should lose its exemption from ERISA's diversification requirements because its higher risk and mediocre returns don't merit preferential treatment, four academics say.
"The preferable tax and fiduciary law treatment of company stock in 401(k) plans should be eliminated," according to a white paper, "Company Stock, Market Rationality and Legal Reform," to be published in the Journal of Law & Economics. "It is most unclear why government should grant that preferable treatment, which leads to distortions in the current system of compensation."
The authors are Shlomo Benartzi of The Anderson School of Management at the University of California, Los Angeles; Richard H. Thaler, director of the Center for Decision Research at the University of Chicago Graduate School of Business; Stephen P. Utkus, director of the Vanguard Center for Retirement Research, Malvern, Pa.; and Cass R. Sunstein, professor at the University of Chicago Law School.
The white paper says that 11 million 401(k) plan participants have more than 20% of the balance of their holdings in their employers' company stock. And for those who expect to work for a company for many years, $1 in company stock — whether bought by the participant or in a company match — is worth less than 50 cents to the worker when accounting for risks such as lack of investment diversification and market volatility.
David Wray, president of the Profit Sharing/401(k) Council of America, Chicago, disagrees strongly with the notion that company stock is not a good investment for 401(k) plan participants.
"Companies that contribute company stock as a match make larger contributions (dollar-wise) than companies that match in cash," he said. Moreover, "companies that have company stock cultures outperform other companies in terms of their earnings and stock price."
He said his organization "would be opposed to any government involvement in how employees (in 401(k) plans) manage their money."
William F. Quinn is president of AMR Investment Services, Fort Worth, which oversees American Airlines' retirement plans, including $8.3 billion in several defined contribution plans. "Some companies make their match in company stock and would not make a match if they couldn't use company stock. So the participant would lose the match if the law was changed," Mr. Quinn said. This isn't an issue at American Airlines, which has very little company stock in its defined contribution plans and makes its match in cash.
Mr. Benartzi, in an interview, said," "People would like to believe that companies that give employees stock perform better, but I've never seen an academic report that proved that." Mr. Benartzi said he had done a report several years ago in which he followed the companies in the Standard & Poor's 500 index that offered company stock to employees. "My evidence showed that company stock doesn't perform any better or worse than an index fund," he said.
The white paper pointed to the collapse of Enron Corp., Houston — whose $1 billion plunge in the value of the company's stock in 2000 caused 401(k) plan participants to lose millions of dollars — as a case in which employees lost both their jobs and their retirement savings. It clearly makes the case for having defined contribution plans in diversified investments, without a large allocation to company stock, according to the authors.
Other companies whose employees have learned the lesson the hard way about the downside of holding a large amount of stock in defined contribution plans include Pfizer Inc., New York, where 56% of assets were in company stock as of Sept. 30. The stock fell to $24.29 a share on Dec. 20, three days after reports became public that patients who took the company's Celebrex arthritis drug had a higher risk of heart problems. Pfizer's stock was valued at $28.98 on Dec. 17. Several lawsuits have been filed against the company on behalf of its 401(k) plan participants.
Paul Fitzhenry, a spokesman for Pfizer, wrote in an e-mail to Pensions & Investments that the company match is in Pfizer stock and that plan participants cannot diversify out of that stock until age 55, when they are allowed to move 50% of their balance in the fund. He added that plan participants can also buy Pfizer stock on their own through the Pfizer Stock Fund; assets in that fund can be bought or sold at the participant's discretion. He declined to comment on whether Pfizer has any plans to try to get employees to lower their allocation to company stock or whether the company thinks the holdings of company stock are good for participants.
General Electric Co., Stamford, Conn., has 69% of its $22.47 billion 401(k) plan's assets in company stock, but "GE has no requirement that any of the assets in the 401(k) plan be invested in company stock," said David Frail, spokesman.
"The large percentage of GE stock in its 401(k) plan is the result of separate choices made by thousands of individuals (who work for GE) who have chosen to put a lot of their 401(k) plan assets into GE stock."
Ted Disabato, chief investment officer of Clark Investment Consulting Group, North Barrington, Ill., said he thinks the problem can be solved with better employee communications.
"It's an education challenge all around; company stock should get the same education focus as other investments (in the defined contribution plan)," he said.
Mr. Disabato thinks the Department of Labor should focus on "fair disclosure" to educate plan participants about the risks of holding company stock in defined contribution plans.
Gloria Della, spokeswoman for the Labor Department, said the DOL would have no comment on the white paper.
Mr. Disabato said "it would be a complicated solution to solve the problem" to restrict the amount of company stock a participant can hold in defined contribution plans because there are some plans where company stock represents 60% or more of the total assets. Diversifying out of the stock could cause major problems for the company in terms of the value of both the stock and the defined contribution plan, he believes.
One way to solve the problem, according to white paper, would be what the four academics termed a "Sell More Tomorrow" program, which Messrs. Benartzi and Thaler came up with before they wrote the paper.
A company would establish a cap on the percentage of retirement assets that could be invested in company stock (perhaps 10%). Then, small portions of a participant's employer stock would be sold, automatically, each month if the participant's company stock holdings exceed the cap. Proceeds would be invested in a diversified mutual fund selected by the participant.
The selling would occur gradually, perhaps over two or three years, serving as a reverse dollar-cost averaging program out of company stock, according to the academics. That would reduce the regret a participant may feel if the company stock suddenly rose sharply.
"We don't want to make money off of it or sell it," Mr. Benartzi said of the program. "We'd work with a company that wanted to use it for free. So far we haven't found a plan sponsor to implement it."
Vanguard Center's Mr. Utkus said use of the Sell More Tomorrow program had been discussed with several Vanguard defined contribution plan clients, but so far all have decided to use other options to get employees to diversify their company stock holdings, such as more education and the use of managed accounts. (Participants of several plans who are clients of Vanguard's defined contribution business were surveyed for the white paper on knowledge and attitudes toward company stock.)
Although the program could be adopted without any changes in the federal Employee Retirement Income Security Act, the white paper said the government could speed up adoption by giving employers "safe harbor" designations regarding fiduciary responsibility if they offer the program, and to make the program a mandatory requirement in any plan offering company stock.