Guest Article

(Reprinted from Pension Plan Fix-it Handbook, published by Thompson Publishing Group, Inc.)

Pension Expert Analyzes Fiduciary Duties in Light of Enron

With Enron workers claiming millions of dollars against plan fiduciaries, many plan sponsors and administrators are taking a serious look at their own situations and what can be done to protect themselves as well as the plan participants. In a recent audio conference, Protecting Your Company's Retirement Plan After Enron, sponsored by Thompson Publishing Group, Inc., pension attorney Michael Melbinger shed light on the fiduciary duties associated with retirement plan investments in employer stock.

Melbinger, who heads the global pension and benefits practice of Winston & Strawn, made it clear that 401(k) plan investments in company stock are commonplace. Although the Employee Retirement Income Security Act (ERISA) places a 10-percent limit on investment in company stock for defined benefit plans, there is no limit at all for defined contribution plans, unless the plan itself places a limit. There was no such limit in the Enron 401(k) plan, just as there is none in many other plans. When company stock is doing well, plan participants naturally want in on the action, Melbinger noted. For example, Proctor and Gamble's stock has outperformed the S&P 500 over the last 10, 15, 20, 25 and 30 year periods. It is not coincidental that its workers have invested 94.7 percent of their 401(k) plan assets in its Proctor and Gamble stock. Coca-Cola's 401(k) plan holds more than 80 percent of assets in Coke; General Electric's plan has 77 percent; and Abbott Labs, a whopping 90 percent. It was the same with Enron, Melbinger said. When Enron stock was up to nearly $90 per share, no one seemed to mind the high concentration of company stock or stock matching. The energy giant made it easy for employees to own company shares through their retirement funds: Participants' contributions in Enron's 401(k) plan were matched with the company's stock, and participants were not limited in the amount of company stock they could purchase with their own elective deferrals.

But what is there to protect workers and plan fiduciaries if the company's stock price goes south? Melbinger stressed that -- without the legislated limit on 401(k) investments in the plan sponsor itself -- the protection of these 401(k) investments heavily depends on how faithfully the plan fiduciary keeps to certain fundamental duties: loyalty, prudence, diversification of investments and administration of the plan in accordance with its terms

Plan fiduciaries who comply with those duties and document that compliance at every turn will be protected, even though the participants may lose out at the end. "ERISA is about procedure," Melbinger explained, not about end results. If the fiduciary goes through a deliberate set of steps taken in line with the fundamental duties, a bad result (i.e. loss in plan investments) will not expose the fiduciary to a successful liability claim. Melbinger also noted that it would be more helpful for the company to delegate fiduciary responsibilities to an employee benefit plans committee -- appointed by the company's board of directors. As the "named fiduciary" of the plan, the committee is responsible for the approval of investment funds, the creation and implementation of rules for the plan and directing payments of benefits under the plan. All committee actions and activities should be documented, so that if problems do arise, there may be evidence that measures were taken properly, under what Melbinger termed the prudent-expert rule - which gauges what a careful expert would do in like circumstances.

ERISA Section 404(c) provides yet another layer of protection for the fiduciary, Melbinger explained. The plan may pass on to the participant the responsibility of choosing where to invest his or her 401(k) account. In order to make this safeguard work, the fiduciary must: (1) give participants the freedom to direct their retirement fund in a broad range of investments; (2) allow participants the opportunity to change their investment allocations as frequently as appropriate; and (3) provide sufficient information on investments to participants.

According to Melbinger, restricting participants from selling the company's stock until retirement or separation from service may diminish section 404(c)'s protection because the company could be viewed as exerting undue influence over participants' investment decisions. The Enron 401(k) plan did not go this far, but still prevented a participant from moving investments out of company stock unless the participant was 50 years old or over. Melbinger suggested that a plan sponsor with matching contributions in its own stock should consider making a portion of the matching contribution in cash or permit diversification after a period of time, and not locking participants into company stock as an investment that they cannot move out quickly.

The popular media and Congress itself generally associates this notion of locking down participants' investments with the so-called blackout or lockdown period, during which the plan can change its record keeper. A lockdown prevents participants from changing investments or even taking distributions. But lockdowns are common, with 24,000 plans instituting these procedures when changing record keepers last year. Reasonable lockdown periods are not usually a breach of fiduciary duty, Melbinger pointed out, unless the lockdown was done for the benefit of the employer and not the participants, or if there was so little advance notice and explanation about the imminent lockdown.

Enron fiduciaries claim that they hesitated about implementing the lockdown after Enron's prices started plummeting. Melbinger explained that if Enron fiduciaries deliberated over the issue of going through with the lockdown, and took into account appropriate plan objectives and the best interest of the participants, and if Enron fiduciaries properly documented their decision-making process, the decision to lockdown may not have been a breach of fiduciary duty, unless participants were not told in advanced. Enron officials claim that at the time Enron stock was trading at $30 a share, Enron notified participants of the coming lockdown by mail and four e-mails. When the lockdown occurred, Enron's stock had already lost 70 percent of its value. The lockdown started October 29 and ended November 12, eleven stock-trading days during which Enron's stock fell from $15.40 to $9.30. Whether there was enough advanced notice is an open question at this point.

Melbinger observed that where Enron officials may be "vulnerable"-- as he describes it -- is not so much on the timing but on the content of communications to participants. What was told or not told to the participants -- about their plan investment options, and in particular, the investments in the company itself. A fiduciary is individually liable if he or she knew of significant pending changes in the company's fortunes and said nothing.

"The risk of liability may be especially great when the company's stock price drops, as did Enron's (and Lucent's and Global Crossing's) and plan fiduciaries stand silently by while employees continue investing large amounts of their retirement funds in the employer's stock and corporate officers continue to promote and encourage investment in the Company's stock," Melbinger said. There appears to be evidence that Enron executives spread "disinformation about Enron's stock," he noted.

But providing accurate information may not be enough. The best approach, Melbinger pointed out, is to go a step further than merely providing data concerning available investment options. In fact, a report jointly released by the Department of Labor (DOL) and the Securities and Exchange Commission (SEC) stated that "merely referring participants and beneficiaries to a source of investment information is insufficient to ensure [they] are in a position to make informed investment decisions."

To minimize risk, the employer must provide investment education that clearly advises employees that a large investment in a single security is risky. If a large portion of retirement plan investment is in company stock, the employer should give plan participants a performance history of the stock, the company's earnings and expenses, the performance of companies in the same sector and the risks associated with its line of business.

"To the extent investment education programs help improve investment performance, they also serve to reduce the risk of fiduciary liability claims," Melbinger stated.

The complete audio conference on fiduciary protections, lockdowns and the impact of proposed legislation can be ordered for $199 by calling 1-800-925-1878, or by visiting our Web site at: www.thompson.com/events/401k.html.

Reprinted with permission from the April 2002 supplement to the Pension Plan Fix-it Handbook ©Thompson Publishing Group, Inc. 2002. All rights reserved.

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