Hello Nilesh,
A-ha, I think I know what helps motivate the Compaq
employees! (saving any commentary for others....)
--
From Barron's
A Tisket, A Tasket
Beware too much company stock in your 401(k) basket
By JACQUELINE DOHERTY
Coca-Cola shares have fallen 44% from their all-time high of 88 15/16.
Abbott Labs stock is 38% lower than where it traded last April.
Sherwin-Williams shares haven't fared much better: down to 19 from a
52-week high of 32. But these companies are linked by more than dismal
stock performance. In each case, more than 80% of the assets in their
employees' 401(k) plans were invested in company stock at the end of
September, according to a survey by the Institute of Management &
Administration. And given that 401(k)s have become the primary savings
vehicle for many Americans, a lot of people at these companies watched a big
chunk of their retirement savings go up in smoke.
Most financial advisers caution against having more than 5%, or at most 10%,
of one's assets invested in a single stock. Yet some very large, very
sophisticated companies blatantly ignore this basic tenet of investing when it
comes to 401(k)s. IOMA surveyed 208 companies with employer stock in
their defined-contribution plans. Of the total, 91, or 44%, had more than 40%
of their defined-contribution assets invested in company stocks. And 113, or
54%, had more than 30% of the assets in company stock.
One reasons for these outsized holdings is that
many companies match their employees'
contributions with company stock. When employer stock is offered in a
pension plan, a Hewitt Associates survey found that 41% of the assets went
into that stock. And the concentration may increase if employees are
restricted from selling the shares until retirement.
This is no small issue. About 15 million of the 30.8 million current 401(k)
participants work for organizations that offer their own shares as an
investment option or as a company contribution. So why do companies shun
such an important investing principle? For one thing, they view employee
ownership through 401(k)s as a way to align company and employee
interests. That's fine when it comes to incentive stock options. But the federal
rules governing 401(k) plans say that the plans must be managed in the best
interest of the employee, with the company acting as fiduciary. And having so
many eggs in a single basket, as demonstrated above, is often not in the
employees' best interests.
So far, however, diversification hasn't become a hot issue, mainly because
company stock has made most employees very wealthy in this bull market.
Despite its lackluster performance in the past year or so, Coca-Cola has risen
450% in the past 10 years. During the same period, Dell Computer rocketed
upward by 67,320% and Pfizer soared 1,164%. So the fact that 85% of
Pfizer's 401(k) plan is invested in company stock hasn't been an issue.
"We have a lot of lower-to-middle-level people with over $1 million in the
401(k) plans," boasts William J. Robison, Pfizer's executive vice president for
employee resources. However, since hitting a high last April, the stock has
fallen 34%. That means the company has a lot of ex-millionaires as well.
Pfizer isn't alone. With the Dow Jones Industrial Average down 13.5% from
its peak, many large stocks have come under pressure. For the year ended
last September 30, the average large-company stock in defined-contribution
plans lagged the S&P 500 Index by more than 10 percentage points,
according to IOMA's survey. And in the third quarter, these stocks, on
average, fell 23.2%, versus a loss of 6.25% in the S&P.
True, the negative trend may be short-lived. But, according to a study by
Sanford C. Bernstein & Co., the average large-cap growth company keeps
its momentum for four years. Less than one-fifth of large-cap growth
companies can sustain their momentum for 10 years. And only 5% hang on to
it for 20 years. In other words, the risk stays the same, but the rewards
diminish over time.
The structure of 401(k)s differs from company to company. At one end of the
spectrum are outfits like Kroger, the grocery-store operator. Employees have
five mutual funds in which they can invest their 401(k) contributions. But if
they opt to buy Kroger stock, the company will match up to 10% of that
contribution with additional shares. The stock must be held until the employee
turns 55. So, not surprisingly, 77% of Kroger's defined-contribution assets
were in company stock at yearend. "We encourage employees to invest in the
company," said Gary Rhodes, a Kroger spokesman.
Pfizer's plan falls more in the middle of the road. If an employee contributes
6% of salary to the 401(k), then Pfizer will match 4% in stock, which must be
held until retirement. The company also has a defined-benefit plan. "We go
out of our way to show employees the value of diversification," says Pfizer's
Robison. Perhaps so. But Pfizer officials have been heard extolling the virtues
of employee ownership at 401(k) industry conferences.
Progressive's program became more flexible in early 1999. The property and
casualty insurer matches employee contributions to 401(k)s with its own
stock. Employees used to have to hold the matching shares until they left
Progressive. But now, after the company match vests over four years,
employees can opt to sell the stock and invest the proceeds in other options.
"We don't necessarily believe it's a good thing for our people to be overly
invested in Progressive stock," says Marilyn Muzic, director of Progressive's
financial operations. "There's too much risk to having all of your retirement
money tied up in one stock."
At the end of December 1998, 75.6% of Progressive's 401(k) assets were in
company stock. Though the shares are up 398% over the past 10 years,
they've tumbled 67% since hitting their high in January 1999. The percentage
of assets in company stock is now down to 48%, in part because of the
increased plan flexibility, but also because the stock has tanked. "From a
fiduciary standpoint, we're in a much better position, having given our people
more flexibility," says Muzic.
Among the most generous plans are those in
which the company match is made in cash and is
invested entirely at the employees' discretion. For example, Compaq
Computer matches up to the first 6% of an employee's contribution dollar for
dollar in cash. "We feel it's important for employees to have flexibility, and we
want to be a good place to work," says Alan Hodel, a Compaq spokesman.
The company does try to make employees sensitive to Compaq's stock price,
but it does so by granting stock options broadly.
Companies that limit or don't offer choices to employees might want to
consider the liability they might face if their stock ever heads south for an
extended stretch.
Consider Charles Moench, who invested in Statewide Bancorp's employee
stock ownership plan. After the New Jersey-based bank filed for Chapter 11
bankruptcy protection in 1991, Moench brought a class-action suit against the
bank's directors, benefit committee members and members of the plan
committee of the ESOP. Employees contributed to the ESOP through payroll
deductions, the company provided a match and everything was invested in
Statewide Bancorp's stock. The ESOP bought Statewide stock even as the
company approached bankruptcy protection.
Judges on the U.S. Court of Appeals
for the Third Circuit ruled that the plan's
fiduciaries were expected to act
prudently and had an obligation to take
the money out of Statewide shares and
put it into something safer. They found it
did not matter that the ESOP was
established to invest solely in Statewide
stock and employee participation in the
plan was optional. The fiduciaries hadn't
made a "reasonable" decision in the
employees' best interest when they
allowed the ESOP to hold the stock.
The judges, however, never drew the line on when the fiduciaries should have
acted, and the case was settled before the court made any further
clarifications. So, to some extent the Moench case raises more questions than
it answers: If a company thinks its stock should be sold, how does it do so
without driving down the price? Will a company have to announce that it no
longer believes its stock is a prudent investment? If a company thinks it will
survive a tough stretch, can it continue to hold on to its depressed stock? If
the fiduciaries are wrong and the company goes belly-up, will they be held
accountable? If they sell the stock and it rebounds, will they also be held
liable?
More recently there was the $36 million settlement in January between
employees and Carter Hawley Hale Stores, which had filed for bankruptcy
protection in 1991. The workers claimed that their 401(k) fiduciaries had
violated the law by buying stock in the failing company as it approached
bankruptcy. The retailer had a 401(k) in which employees could invest only in
Carter Hawley stock, and the company match was in stock as well.
"Down the road, you could see a lot more litigation in this area," predicts an
attorney involved in the field. And that could prove to be a major liability for
companies where 401(k) assets are overweighted with their own shares.
While very little guidance has so far been offered by Congress or the courts
about potential liability, the subject may be addressed as early as this spring.
Congressman John Boehner (R-Ohio), chairman of the House Education and
the Workforce Subcommittee on Employer-Employee Relations, plans to
hold hearings on ERISA, the Employee Retirement Income Security Act, the
law that governs defined contribution plans. One of the main objectives,
however, will be to consider whether employers who offer investment
education programs to workers can be let off the hook if workers' investment
decisions go bad.
David Schnittger, Boehner's press secretary, says investing in employer stock
"can be an opportunity for some and a risk for others. We'd prefer to put
more decision-making in the hands of employees, instead of putting
restrictions on what companies can and can't do."
David Wray, president of the Profit Sharing/401(k) Council of America,
agrees. "We do not want to see changes in a system that works so well.
These plans are about motivating employees to work for you."
But that may be shortsighted in a world where 401(k)s are increasingly the
main form of savings. "Saving for retirement is not about company loyalty or
motivation," argues Alan Skrainka, chief market strategist at Edward Jones.
"The government should regulate this before we have a disaster." Better yet,
companies should ease up on the restrictions regarding the selling of company
shares, which would head off the kind of harsh and potentially misguided
regulations that could come if a broad market decline jeopardizes people's
retirement savings.
What should you do if your employer matches in stock and locks you in until
retirement? Sue Stevens, director of financial planning at Morningstar
Associates, advises that you practice a little friendly coercion. "People should
be encouraged to speak up" if they're not happy with their 401(k)'s structure,
she says. "And if all else fails, you can vote with your feet."
In today's job market, that's something employers should be worried about.
|
