Companies that offer their own stock in their 401(k) plans do so at the peril of their participants.
They, and their independent fiduciaries, face risk of litigation to account for letting plan participants accumulate any significant allocations to employer stock. It's also imprudent. Prudent diversification would not permit a high-level allocation for any other single stock in a 401(k) plan.
The 29% allocation to BP PLC American depository shares by the company's U.S. 401(k) plan participants underscores the risk of company stock. Since the company's deep-water well blowout in the Gulf of Mexico on April 20, BP shares have fallen 44%. That loss would total $1.155 billion or 14% of the $8 billion 401(k) plan.
A 401(k) plan is supposed to provide a vehicle for employees to accumulate savings for retirement, offer a diversified array of investments to provide an appropriate balance of risk and return and place allocation decisions and investment risk with participants. Plan sponsors like BP —whose participants have large percentages of their 401(k) assets in company stock — and independent fiduciaries managing those company stock investment options appear to have overlooked those key elements.
Companies should reconsider the company stock option and phase it out. They should do so to promote prudent diversification and to avoid litigation challenging fiduciary decisions in permitting company stock to reach a significant level of a participant's allocation. Participants take on too much risk when they have more than a small fraction of their 401(k) assets in their company's stock. If employees want to buy the stock, they should buy it outside of the plan.
“To be 30% in any stock is crazy,” remarked Edward A.H. “Ted” Siedle, president of Benchmark Financial Services Inc., Ocean Ridge, Fla. “But to be 30% in company stock (compounds participant risk) because (most of them) are employed by BP.” Now because of the deep-water well blowout, some participants might be at risk of losing their jobs if BP has to trim its work force, as well losing a large part of their retirement savings, if they have large allocations to company stock.
Sponsors should not permit compounding employment risk with company stock risk. That 29% aggregate allocation means many participants have well above that percentage in company stock, increasing their risk.
Company stock should be managed like any other investment portfolio, or risk accusation of breaching a sponsor's fiduciary duty to participants.
There should be no presumption that company stock belongs in a plan. The presumption should be the stock does not belong in a plan.
Under the Employee Retirement Income Security Act of 1974, defined benefit plans may not have more than 10% of assets in employer securities. It's ironic that defined benefit plans — for which there are corporate resources to draw upon to make up investment losses — have a limit on employer stock, while 401(k) or other defined contribution plans — which cannot draw more contributions from sponsors and restrict the amount participants may contribute — have no limit on the amount that can be invested in employer stock. Fiduciaries should examine such reasoning in evaluating investment prudence and employer stock in a 401(k) plan.
Last year, State Street Bank & Trust Co. was sued by several participants in General Motors Corp.'s salaried and hourly employees' 401(k) plans. According to the suit, the bank allegedly failed to sell GM stock before its price collapsed just before the company filed for bankruptcy protection, resulting in hundreds of millions of dollars of losses to plan participants. The suit, seeking class-action status, is pending in U.S. District Court in Detroit.
The good news is it appears the majority of companies do not offer an employer stock investment option.
Of the 401(k) plans Mercer Inc. administers, only 11% offer employer stock, according to Bruce Lee, principal, public relations, Mercer.
Some 47% of more than 300 midsize to large companies offer employer stock as an investment option, according to Catherine Brandt, spokeswoman for Hewitt Associates Inc., citing the firm's 2009 Trends and Experience in 401(k) Plans report. Of the companies that offer employer stock, 20% impose a restriction on the percentage of contributions a participant can invest in sponsoring company stock, up from 18% 2007, the report notes. Among the sponsors that impose limits, the overall average maximum contribution employees can invest in employer stock is 24%.
For many sponsors, company stock is on the way out of plans. And that's how it should be.
