A downturn in the stock market, economic recession and a new flow of bankruptcies, are dramatically changing American public perceptions of 401(k) plans. Personal retirement accounts have been very popular in the US during the last 10 years – so popular that they’ve become the core of President George Bush’s proposals to reform the social security system. But they are currently under strict scrutiny and some critics are pressing for new rules and limits on investment options available to employees.
The change in attitude has been triggered by the Enron case: one of the biggest potential bankruptcies in US corporate history. The problem is most Enron employees’ retirement savings were invested in their own company’s stock, which plunged from a high of $84 to less than $1 a share. Besides, Enron’s rules – the so-called “lock-down” – forced employers not to sell the shares until they reached the age of 54 (while, by the way, managers were able to cash their own stock options with no restrictions).
Now the employees of the Texas energy company have initiated a few lawsuits: first of all against the company itself; then against Andersen. They allege the accountancy firm “knowingly participated in Enron’s breaches of fiduciary duty” by helping the firm to hide its huge debts. The grounds for accusing Enron’s managers are interesting: they encouraged the employees to overcommit themselves to the company’s stocks, instead of urging them to follow a sensible diversification of risks.
Eli Gottesdiener, at the Gottesdiener law firm in Washington, is the lawyer who filed the suit on behalf of Enron’s employees. He wants to draw the attention to Enron as a “typical” situation in the 401(k) plans’ universe and calls for a public action: “We all know you are not supposed to put all your eggs in one basket. Yet nationwide we have an average of 30% company stock held in 401(k) plans. Isn’t that evidence that something should be done to limit the amount of stock in these plans?”
As of 31 October, according to Hewitt Associates, 29.6% of 401(k) assets held in 1.5m plans were in stock of the company sponsoring the plan. Last year the proportion was lower, 28.4%. In some companies – especially in the high-tech business – employees invest even more: up to 46% at Microsoft.
These figures are confirmed by the last survey of 401(k) plan asset allocation by EBRI (Employee Benefit Research Institute) and ICI (Investment Company Institute). At the end of 2000, the average 401(k) plan asset allocation had 18.6% of assets invested in the company stock. But not all plans offer this option: if you take into account only the ones that offer it, in this case 31.8% of the assets are invested in the company stock; slightly less, 27.7%, when plans offer also GICs (Guaranteed Investment Contracts, which attract 18.9% of the employees’ assets). It’s interesting to notice that the risk tolerance doesn’t change very much with age, in plans with company stock: 20-year-old employees invest 32.8% of their assets in company stock, more or less the same as colleagues in their 30s (33.5%), 40s (34%) and 50s (31.3%). Sixty-year-old employees become more conservative and invest ‘only’ 26.1% in company stock, increasing to 22.2% the stake in bonds and money market funds.
You can explain this situation in many ways: the 10-year bull market fuelled optimism towards the future of stocks and lowered the risk aversion threshold; to be paid in stocks instead of cash was a very popular idea, altogether with the conviction that it was more profitable for employees; bonds were not fashionable. But Gottesdiener and other critics want to raise also the issue of the companies’ responsibilities for the lack of financial education of their employees, matched with the companies’ interest in paying them with stocks and transforming them into quiet, friendly shareholders.
Because there are no rules imposing a minimum diversification of 401(k) plans – and in theory employees could invest all their retirement savings in their company stock – the Congress is likely to discuss whether to introduce some sort of limits for these assets. “But I think that the companies are thinking themselves to voluntarily adopt new rules, in order to avoid bad publicity and prevent lawsuits”, observes Patricia Pou, a 401(k) plan consultant with William M Mercer.
Others will try and use the ‘Enron lesson’ to oppose Bush’s willingness to create new and voluntary personal retirement accounts. Just to mention an extreme opponent of Bush’s ideas, the Democratic economist Paul Krugman would simply liquidate the DC plans as a system “in which the unwise or unlucky can find themselves destitute in their old age”.

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