When Company Stock Funds Lose Value
Prepared by:
Mary Ellen Kazimer
Submitted by:
Mark Stasch
Financial
Engines, Inc.
Atlanta,
Georgia
It’s no news to benefits
professionals that most employees are seeing declining values on their 401(k)
statements, probably for the first time in their working lives. For employers offering a company stock fund
in the plan, the decline may be extreme, particularly for employees who have
invested a large percentage of their plan balances in the company stock
fund. And employees who were planning
to retire soon or who are facing layoffs may have to change their plans or
standard of living if there have been significant declines in their company
stock funds.
Recently Lucent employees have filed suit against Lucent, claiming
it is a breach of fiduciary duty for the company to have retained Lucent stock
as a 401(k) plan investment, in light of the stock's extreme drop in value over
the last year or so. Several months
before, a similar employee class action lawsuit was filed against Ikon.
Is any legal precedent that
would indicate whether Lucent is likely to win or lose this high-stakes
lawsuit? In other words, can it be a
breach of fiduciary duty to maintain company stock as an investment choice in a
company-sponsored plan?
There is not a definitive
legal answer to this question. However,
at least one court (the federal Third Circuit Court of Appeal in 1995 in the
case Moench v. Robertson) has said
that it could be a breach of fiduciary duty to continue holding a company stock
investment if a prudent expert would not have done so. This would be the case if the stock price
and prospects for the stock are so dismal that the plan fiduciary could not
reasonably believe that the original establishers of the plan would have intended
continued investment in the circumstances.
Looking back to what the original establishers of the trust (or
“settlors,” in the court’s terminology) would have wanted is a principle that
comes from traditional trust law, where the settlor is generally an individual
who is establishing a trust fund, usually for other individuals. As a practical matter, this principle
doesn’t easily translate to a situation in which the settlor of the trust is a
corporation, the investment at issue is the corporation’s own stock and the
trust fund is intended to provide for employees of that corporation for an
indefinite, but presumably very lengthy, period of time.
Despite the difficulty of
applying the Moench principle to the
company stock fund situation, a court hearing a case like the Lucent case would
more likely than not apply the Moench
principle. That doesn't mean that a
company would actually be found to have breached its fiduciary duty in a
particular case. Most courts would be
reluctant to find an actual breach unless the facts are egregious. But it will not help Lucent’s case that its
stock has lost over 90% of its value over the last two years and many analysts
are and have been pessimistic about the company's prospects.
The Lucent case should be a
signal to employers to think about the role of company stock in their defined
contribution plans and whether design changes may be appropriate. In addition, now is a good time to remind
employees of the volatility of single-stock investments and the important role
of diversification in mitigating the portfolio risk presented by company stock
investments. If employees do manage
their risks better, they are less likely to find themselves severely punished
by a downturn in company stock values.
The result? The company reduces
its risk of employee relations problems—maybe even litigation problems—for the
employer. And avoiding litigation beats
winning litigation any day.