Is Company Stock a Liability to Your Retirement Plan?

Recent litigation has been making plan sponsors nervous.

With a Supreme Court decision expanding fiduciary responsibility for employer stock in retirement plans, plan sponsors wonder about their own stock holdings in their retirement plans. Where the percent of plan assets in company stock has been creeping up, can that be reduced? Or should they liquidate from company stock in the plan? Does merely offering company stock as an investment option make them more prone to participant litigation?               

“We think a lot of plans have questions about company stock. That’s nothing new.” says Mark Teborek, senior consulting analyst with Russell Investments and author of a white paper “Revisiting Company Stock in Defined Contribution Plans.” “But with the aftermath of the Fifth Third [Bankcorp v. Dudenhoeffer] case, there was renewed interest in what to do next.”

Sources agree that company stock can have a valuable place in investment portfolios—some companies offer it for their match contributions, and ownership gives employees a vested interest in performing well. A corporate tax benefit can be an added bonus. Still, litigation is always a risk.

“There’s no way to avoid the litigation risks, if you’re going to have company stock in your plan,” says Jeremy Blumenfeld, an Employee Retirement Income Security Act (ERISA) attorney with Morgan, Lewis & Bockius LLP. “You can take all the right steps, you can engage in the highest level of prudence and monitoring of your investments, but that won’t prevent you from getting sued.”

NEXT: Company stock losing popularity

The typical circumstances inviting a lawsuit involve the company disappointing the market in some way, Blumenfeld says. “You have a bad quarter, or the company loses a big contract, or there is some underperformance relative to expectations.” The stock needs to only fall 10%, if “there are high allocations and high dollars in employer stock investments,” he says. “You’re not likely to see litigation with very small allocations to employer stock investments, even though the litigation issues are often the same.”

Still, even before what Blumenfeld calls the “whole line of cases [that]culminated last year in Fifth Third Bancorp,” the prevalence of company stock on plan investment menus was declining.

The Defined Contribution Institutional Investment Association (DCIIA), citing research from Vanguard, says the percentage of plans that offer company stock decreased from 11% in 2005 to 9% last year, and of participants accepting the offer, from 40% to 29% over the same 10-year period. The percentage of participants invested at 20% or more fell from 17% to 8%. Referencing statistics from Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI), DCIIA reports that, as of 2013, 7% of 401(k) account balances were invested in company stock.

One reason for the change has been automatic enrollment—a method that plan sponsors preferring to remove the stock by attrition might adopt. Because of that practice, recently hired participants are less likely to hold company stock, experts say.

Further, recognition that plan participants benefit when their holdings are diverse has prompted many sponsors to encourage broader investment—meaning reducing exposure to single stock positions, employer stock as a prime example.

Just a small percentage of the companies still offering their own stock plan to eliminate it entirely, though, says Lew Minsky, DCIIA executive director. “A much greater number are putting significant limitations on how much of somebody’s balance can be allocated to it.”

NEXT: How to limit employer stock allocations

Plan fiduciaries have, historically, chosen from several options to keep company stock allocations in check, Teborek says. Still popular is education, by which plan sponsors can stress the value of diversification—by way of current technology, plan sponsors can do that more economically than before. To overcome participant inertia, though, more proactive steps may be needed.

One, as Minsky said, is to limit, or cap, participants’ employer stock holdings to a percent of their total assets. This can address the reality that, whether a stock is their employer’s or otherwise, individuals tend to over-allocate, challenged by how to diversify appropriately, he says.

As with all important financial decisions, the cap amount should be decided with the help of the plan’s financial adviser. Variables to consider might be type and size of the company, its stability, including anticipated corporate changes over the next several years, and its work force demographics, along with how much the plan currently holds in employer stock investments and how those have performed over the long term, says Blumenfeld.

While some plan sponsors might fear a cap could be viewed as asset allocation advice, Blumenfeld sees no cause for concern. “Fiduciaries are not suggesting in that context that, if they put a limit of 25%, everybody should hold 25%. They’re … essentially saying, ‘Instead of giving you 0% to 100% for your investment options, we’re only giving you zero to 25% for this one particular investment option.’”

Where a cap can get complicated is when the stock value grows and participants’ holdings now exceed the maximum, he says. Plan sponsors typically address this by prohibiting new investment in the stocks or limiting the percentage, while letting the participants keep what they have, he says.

Potentially another complication, says Teborek, is that a cap “may send a mixed message to participants about whether the company believes company stock is a suitable investment.” Rather, he says, limits work best in tandem with what he and others may consider the most promising strategy—one many plan sponsors already have available in their plan’s design ...

NEXT: A highly effective tool

Automatic features, used strategically, can be highly effective for reducing employer stock over-load in the plan. As indicated earlier, auto-enrollment can minimize choice. And, when enrolled into the qualified default investment alternative (QDIA)—possibly a target-date fund (TDF)—participants tend to stay. “You see plans re-enrolling everyone into the target-date fund or the default, and also [participants] sticking with those asset allocations several years later,” Teborek says.

Minsky agrees, going so far as to call re-enrollment into the default investment structure a trend “that has a lot of advantages, one of which would be potentially limiting exposure to company stock.”

A common source of company stock in retirement plans has been the company match. Employers that want to continue this practice and reduce allocations might consider shortening the vesting period for company stock, says Holly Verdeyen, director, defined contribution investments at Russell. This way, “participants have more opportunity, sooner, to be able diversify themselves.” As three years is the maximum vesting period for company stock, she recommends reducing it to as little as one, so people can act before they forget the investment, exchanging it, say, for a diversified fund.

For plan sponsors that decide to eliminate the plan’s holdings entirely, it should be planned out carefully. Even plan sponsors not deciding to liquidate might prepare for the possible need to do so down the road, Teborek says. He recommends discussing with the investment committee possible scenarios under which the plan would need to take action, then putting a strategy on paper.

Blumenfeld, on the other hand, advises making any such decisions at the time, based on the circumstances then. Even if a plan is sued, he says, liquidation may be unwarranted. “The fact that somebody files a lawsuit against the plan fiduciaries is not a reason for them to change their behavior or change the investment options in a plan. If they continue to believe those are good investment options they should continue to offer them,” he says. “If they don’t, an investment shouldn’t be an option—even if there’s no litigation.”