401(k)s With Company Stock Fading Fast

The practice of throwing company shares into retirement plans has been waning for some time, but a recent Supreme Court decision could hasten its demise.

In Fifth Third Bancorp vs. Dudenhoeffer, the court last month unanimously rejected the notion that fiduciaries of employee stock ownership plans are protected by a presumption of prudence known as the Moench Presumption. Instead, the justices decided that ESOP fiduciaries are bound by the same level of duty that governs other ERISA fiduciaries — with the exception that they are not required to diversify the assets of a fund.

In other words, the court stripped away a key protection that ESOP fiduciaries have used to shield themselves against suits alleging they should have known better and done more to protect employees against declines in the value of company shares in their retirement plans.

The ruling stood in direct contrast to past circuit court decisions across the country, and while it didn’t leave ESOP fiduciaries entirely vulnerable, it nonetheless opened the door for litigation that would have been more difficult to pursue were the presumption of prudence left in place.

In fact, just this week, a U.S. appeals court, citing the Fifth Third case, overruled a lower court and gave the green light to BP Plc employees to pursue their suit against managers of the company’s retirement savings plan over losses related to the 2010 Gulf of Mexico oil spill.

ERISA experts say the blow to the Moench Presumption is just one more among many reasons to leave company stock out of retirement plans.

Steven Blakely, communications director at the Employee Benefit Research Institute, notes that use of company stock in retirement plans has declined steadily since about 1990, with “Enron and PPA (the Pension Protection Act) being major factors.”

Few are likely to forget the financial disaster that ensued when Enron’s stock dropped from more than $80 per share in January of 2001 to less than 70 cents 12 months later. At the end of 2000, according to a Congressional Research Service report, the company’s 401(k) plan was made up of 62% Enron stock, with some employees holding even higher concentrations.

When the company’s financial problems began to surface, not only did the stock price plunge, but employees were barred by an administrative freeze from selling it so they could move their savings into less-risky investments. In other words, they had to stand by and watch their savings evaporate.

Thanks to the PPA, new regulations made that scenario less likely.

Among other changes, the PPA decreed that a company must allow employees to diversify their holdings away from company stock after three years of service — although many companies will now allow immediate diversification.

Also, companies must now notify employees annually of the risks inherent in focusing on company stock rather than diversifying.