Many Corporations have
learned from the fraud cases of Enron and WorldCom that
they have to minimize their risk when most of their employees'
retirement savings are invested in company stock. What
happens when the stock takes a deep plunge and employees
lose a big chunk of their retirement savings? Million
dollar lawsuits!
The fraud case of Enron
is a big mind opener for companies that have too much
of their employees' 401k retirement savings invested in
company stock. About 57.3% of all Enron employees (11000
employees in total) had their retirement savings invested
in the company's stock, which lost 99% of its value in
2001. The value of their 401k retirement savings plunged
by $1 billion in just six weeks!
Michael Weddell, Retirement
Consultant with Watson Wyatt WorldWide quotes, "There
is substantial risk associated with offering company stock
as a 401(k) plan investment. A company can expect a lawsuit
every time the stock price drops significantly—not
just when there is criminal activity."
So what can be done to prevent
employees from losing their retirement savings due to
declining company stock? There are 3 possible solutions:
Firms should check whether
their stock is an appropriate investment for 401k investors.
These checks should be done every quarter using the 401k
Plan's Investment Policy Statement.
Investing 50% in your own
company's stock is a major risk and there is no diversification
of investments to reduce the unsystematic risk. What is
the solution to this problem? Eliminate company stock
as a 401k investment option entirely! However, this is
not as easy as it sounds. Why?
Lori Lucas, Research Director
at Hewitt Associates quotes, "Removing company stock
from a 401(k) plan can be a challenge." This is because
if the stock is going up in value, the employees may object
to the total elimination of company stock as a 401k investment
option. If the stock however is NOT going up, the employees
might object because they will not be able to recover
their losses should the company stock go back up in value.
Furthermore, if a firm eliminates
company stock as a 401k investment option, this is negative
publicity. This is because the shareholders will wonder
why the company had such a move? Doesn't the company believe
and have faith in the performance of its own stock? This
could have the negative effect of driving the stock price
down. It's all about speculation baby!
If a company really wants
to offer its stock as a 401k investment option, it needs
to modify the plan by limiting liability and responsibility
of the firm, with respect to declining stock value.
Instead of making Match Up
contributions in the form of company stock (which most
companies do), firms can offer cash as a 401k match up
contribution. This cash offering will force the employee
to diversify his investment portfolio, and not put all
the cash into his company's stock.
Firms can also enforce a
maximum amount that an employee can invest into his company's
stock. For example, a rule stating that ONLY 30% of an
employee's total 401k retirement savings may be invested
in company stock is a good one. This forces the employee
to diversify the other 70% of his retirement assets into
other investments.
Companies need to educate
their employees on topics such as investment diversification
and the elimination or minimization of as much risk as
possible. Investment diversification is as simple as diversifying
your stock portfolio across many different industries
and companies, as opposed to investing in 1 single corporation.
Should that corporation fail to deliver, atleast the employee
holds many other stock investments that will deliver results.
When employees self direct
their 401k retirement assets, it is very easy to make
the wrong investment decisions and hold their employers
liable for their losses. Classes on investment diversification
and minimization of risk can remove the liability from
the employer's head, and pass it on to the employee, who
then solely becomes responsible for his investment decisions.
David Marberger, CFO of Tasty
Baking Corporation further quotes, "During this process,
we asked whether employees really understood where their
retirement money was being invested. he issue is not just
how much to invest in company stock, but how much risk
they are willing to take and what their goals are. We
want employees to understand that putting all of their
retirement savings into a single money market fund can
be just as bad as investing all of it in company stock.
"
