NEW YORK - Travelers Group Inc. plans to contribute stock options this summer to participants in its $2.3 billion 401(k) plan, an industry first.
The Department of Labor is expected to issue Travelers an exemption letter from prohibited transaction regulations of the Employee Retirement Income Security Act for the proposal by the end of March.
A Labor Department spokesman said the proposal attracted no objections "of substance" during the comment period.
"It should be a fairly routine approval," he said.
Many industry experts expect other companies to quickly jump on the bandwagon.
Under the proposal, Travelers would contribute stock options annually to the plan for all eligible participants. The number of options contributed would be equal to 10% of an employee's compensation up to $40,000 in compensation - divided by the option price.
(For an employee with $30,000 in compensation, if Travelers' stock is selling for $60 at the time the option is contributed, Travelers would contribute options entitling the employee to buy 50 shares.)
Although the options would vest immediately, the term of each stock option would be 10 years and could be exercised at a rate of 20% per year. The timing of exercising the option would be up to the participant.
No employee contribution would be tied to the stock option contribution.
The stock options would be contributed and held as a separate plan option. The contribution would be made automatically each year with no action required by the participant.
The stock options are an expansion of Travelers' WealthBuilder Plan, which Chairman and Chief Executive Officer Sanford Weill created last year. Mr. Weill strongly supports increasing the numbers of shares held by employees. In WealthBuilder, options were granted to all full-time employees , but not through the 401(k).
According to Travelers' filing documents, the stock options are designed to "enhance the value of the assets" in the plan and are being contributed because executives believe that ownership of the stock by employees is "desirable."
About one-third of Travelers' 401(k) assets are Travelers' stock - about $600 million in common stock, $168 million in preferred stock and $45 million in Travelers/Aetna Property Casualty stock.
Of the Travelers Group's 60,000 employees, about 70% participate in the plan, which covers subsidiaries Smith Barney Inc., Commercial Credit Co., Primerica Financial Services, Travelers Insurance Co., and Travelers/Aetna Property Casualty Corp.
Travelers designated its trustee, Citibank, New York, to process the proposed stock option transactions.
In its filing documents, Travelers also said Smith Barney may be selected to provide brokerage services to exercise the options and the sale of stock. If Smith Barney is selected, the services would be without commission, fees or other compensation, according to Travelers.
Exemption is 'significant'
Mike Butler, a consultant with Hewitt Associates L.L.C. in Rowayton, Conn., said the details are not as significant as the Labor Department granting the exemption.
"Qualified (defined contribution) plans have not been permitted to hold options; it was uncharted territory and was considered off limits," Mr. Butler said. "This will open all kinds of new opportunities; it really will generate a good deal of excitement."
Industry experts pointed out the benefits to plan sponsors of contributing stock options to 401(k) plans. But they also warned of potential problems.
Dennis Coleman, principal at Kwasha Lipton Group, Fort Lee, N.J., said the contribution is a "low-cost way of funding benefit plans."
"Rather than contributing company stock, all you are contributing is the right to buy and it doesn't really cost you anything. And, to the extent the stock goes up and does well and participants exercise the options, the company does well, and this becomes a drop in the bucket, almost like a free lunch," said Mr. Coleman.
Mr. Butler said the Travelers' approach can conserve cash, yet is another way to promote employee ownership.
Other benefits, he said, include favorable tax and accounting treatment.
Not a free way
But options have value and "opportunity costs," he said, because the option holder receives shares of stock that cost the holder less than the appreciated market price.
"It is an innovative approach and will provide new opportunities for companies but it is not a free way of delivering value," Mr. Butler said.
Mr. Coleman said he does not support major use of employer securities - be they stock or stock options - to fund retirement programs.
"I have a problem with qualified plans investing too heavily in company securities," he said.
"Philosophically, to fund benefits with stock options goes beyond funding with company stock," Mr. Coleman said.
He said the run-up in the stock market over the past six years has contributed to the movement toward equities by 401(k) participants, and the use of options "is just adding fuel to the fire of market speculation."
But "at some point, when this bubble bursts, there will be lot of sorry people."
Mr. Coleman added: "While this is a new way of funding qualified plans, when does the employer get the deduction and what is the amount of the deduction? They are not contributing anything but a right to buy the stock."
IRS ruling also sought
The deduction question must be decided by the Internal Revenue Service, from which Travelers has requested a private letter ruling.
If other employers decide to follow Travelers and apply for an exemption, the Labor Department expects to be able to process the applications in a timely fashion.
Olena Berg, assistant secretary of labor, said the department has a relatively new program to expedite exemption applications that deal with similar issues and put them on the "fast track."
Jim Klein, principal and attorney at Towers Perrin, New York, said companies might be interested in the practice because of the longer time horizon, noting some employers increasingly are wary of participants trading in company stock funds when there are price increases.
He said companies "would not like (participants) exercising the options and then selling the stock. But if I can do this in a 401(k) - where they can't get the money out right away by giving them options which they can't use right away - it may be of interest to some."
Rich Koski, principal at Buck Consultants, Secaucus, N.J., agreed, saying options could be used to slow "profit taking" by participants because one employer aim is to retain the stock in the plan. "They don't want (participants) liquidating and taking the gains."
