Company Stock Decision Requires Two Hats

Giving a workforce the chance to buy company stock can instill in employees a sense of ownership, says Krista D’Aloia, vice president of Fidelity Investments, and it may increase their incentive. “Employee ownership of company stock may contribute to improved employee morale, and financial benefits for both employees and employers,” D’Aloia tells PLANADVISER.

But recent lawsuits—among them, Fifth Third Bancorp v. Dudenhoeffer—may make retirement plan sponsors leery. “The Fifth Third Bancorp v. Dudenhoeffer ruling last year is certainly causing sponsors to evaluate whether or not they want to continue to offer company stock in their DC plan,” Stephen Moser, a retirement consultant for RetireAdvisers Services at Pension Consultants, tells PLANADVISER.

A presupposition of prudence once protected plan sponsors when they hard-wired company stock into the plan by mandating the investments in the plan documents. “That’s no longer the case,” Moser says. “Now sponsors must show actual prudence and regularly examine the company stock to make sure it’s appropriate for their participants, just like they do with other investment offerings in the plan.” Understandably, plan sponsors have a stark reaction to the removal of that protection. “It scares many plan sponsors,” Moser says.

Company stock continues to be an important part of the U.S. DC market, according to Fredrik Axsater, global head of State Street Global Advisors in defined contribution—constituting about 10% of all DC assets. “What is changing is that plan sponsors are increasingly reviewing their company stock plan,” he tells PLANADVISER. Of SSgA’s retirement plan clients, only one is eliminating company stock, Axsater says, and many others are reviewing the option and considering the use of a third-party fiduciary.

Recent court cases have brought to life the additional layer of risk—on top of what is already a fairly risk-laden landscape—that can come from offering company stock as a DC investment option, says attorney Kyle Halberg, a research analyst in ERISA services at Pension Consultants.

Citing the Supreme Court decision in Tibble v. Edison, Halberg points out that the fiduciary to a retirement plan has more than just a duty to ensure that the investment decisions are prudent at the time that an investment option is added to the plan’s lineup. “The fiduciary also has a duty to continually monitor the investment lineup to ensure that those investment options are prudent on an ongoing basis,” he tells PLANADVISER. “Before deciding to add company stock to your DC plan’s investment lineup, ask yourself whether you will be able to fulfill that ongoing duty to monitor the investment, and in the event that its performance is suffering, replace it with a more prudent alternative.”

Halberg says it can be hard for a company official to separate the two functions, as the same person is likely both an employee of the company, whose stock is in the plan’s lineup, and fiduciary to that same retirement plan.

As questions mushroom around how companies evaluate their company stock option, Axsater emphasizes that the third-party fiduciary always has a process, so outsourcing this function can be a boon to the plan sponsor. This division at State Street Global Advisors has expanded over the last year and a half, and now oversees $60 billion in company stock assets as the third-party fiduciary.

Plan advisers and consultants are also growing more concerned about their own fiduciary role in the plan, Axsater says. Recently, a consultant working on behalf of a very large DC plan, with about a third of its assets in company stock, expressed alarm about the potential risk. “What if something happens to that company stock?” Axsater asks. With such a large exposure to company stock, it’s natural and sensible to imagine looking back, after an adverse event, and ask, “Why didn’t we have restrictions or controls around the company stock?”

The plan fiduciary’s paramount consideration, when weighing the offer of company stock, is the Employee Retirement Income Security Act (ERISA) duty of prudence and the duty of loyalty, Halberg says. The fiduciary must act as a prudent person would act in the same situation, and answering whether allowing company stock in the investment lineup is a prudent decision is not easy, “especially as someone who is going to be inherently biased toward an optimistic outlook on your company’s future,” Halberg says.

Halberg cites the recent appeals court case, Tatum v. RJR Pension Investment Committee, to highlight the complexity and potential liability of using company stock in a DC plan. The company chose to divest the stock of the recently spun-off Nabisco company, a decision that “seemed reasonable on the surface,” Halberg observes. “After all, isn’t it inherently risky to be offering an individual company’s stock in your investment lineup? The committee thought so, and decided to divest without giving it much more thought.”

But after the stock was removed, it increased in value by nearly 250%, moving some very unhappy participants to sue the plan. The 4^th Circuit held that the prudence test requires a determination that a prudent person in the same situation would have made the same decision, rather than that they merely could have made the same decision, Halberg says, a decision that raised the bar with respect to the fiduciary duty of prudence. “It should give pause to any fiduciary who is considering adding company stock to their plan,” he says. “Again, it’s hard to take off those rose-colored glasses that led to that initial reaction, saying, ‘Of course my company’s stock is a prudent investment.’”

If there are any silver linings to some of the court decisions, Moser says the Fifth Third ruling adds some protection for plan sponsors. Regarding publicly traded stocks, it says that “allegations that a fiduciary should have recognized from publicly available information alone that the market was over- or undervaluing the stock are implausible as a general rule, at least in the absence of special circumstances,” he points out.

A plan committee that takes no action based on inside information about company stock in the plan is also afforded some protection by the Fifth Third ruling, Moser says. “A plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.”

The process for deciding whether to keep company stock in the plan or not resembles the way individual participants decide how to allocate investments in their accounts: it’s all about risk versus reward. “On the reward side, providing participants with company stock aligns their goals with those of the company, provides them with a sense of ownership, and helps increase loyalty and decrease turnover,” Moser says. “On the risk side, perceived exposure to fiduciary liability due to stricter standards for loyalty, prudence and diversification can be a powerful deterrent.” 

The recent court cases haven’t actually increased the overall risk of liability for most plans, Moser says, “but they have made it more important to pay attention to the policies, procedures and investments in the plan,” he observes. “Deciding what level of risk is acceptable in order to gain the rewards of company stock ownership by participants is an individual decision for each plan sponsor.”