Incentives to invest in Company stock under 401(k) plans?

[Guest KevinGordon]

How do Companies incent employees to invest 401(k) contributions in Company Stock? How do they keep employees from diversifying into other funds after getting the incentive? Is it easy to administer/communicate? Any survey info available?

Thanks for any info...

[Kirk Maldonado]

One technique is to have a higher matching contribution made with respect to employee contributions invested in company stock. For example, you could have a 150% match if the amounts are invested in company stock and 100% if the amounts are invested elsewhere.

Because this is a plan design issue, it is outside of the fiduiary responsibility rules of ERISA.

[Guest KevinGordon]

Thanks... but if the employee can turn around a month from now or a year from now, and move the money from the Company stock fund into another fund under the plan, what have you achieved? How do you lock the employee into the Company stock?

Do you know of any companies that give incentives as described?

[Guest RJM]

Can specify in Plan document which source the Participant has investment control over.

Just so happens my Employer amended our 401(k) plan effective 1/01 for this feature. Company Match investment restricted to Company Stock fund. Match Rate is pretty good: 150% for Participants with 1-5 years of Service, 175% for those with 6-9yrs, 200% for those having 10 or more yrs. Deferrals in excess of 3% are not matched.

[QDROphile]

You should question the wisdom of anything that directly or indirectly encourages employees to be invested in Company stock. Company stock in a retirement plan is generally a bad idea.

[RCK]

I agree that too much of a retirement portfolio in company stock is questionable risk management. But I would be thrilled if my employer matched 150/175/200% of the first 3% of my contribution in any kind of stock.

So I think that Company Stock in a retirement plan is much better than no stock in a retirement plan.

[Guest JCatt]

I've seen plans where the company match was made into employer stock only, with a 12 month waiting period before it would be eligible to be transferred into an alternate investment. Not a lot of fun to track, but virtually guarantees that a certain amount will be deposited.

Personally, I think that having company stock as an available investment is a bad idea, as studies have shown that it is typically misused. Encouraging it's use through an accelerated match or exchange freeze strikes me as foolhardy at best, and basically asking for a lawsuit when the stock drops. I'm admittedly very conservative, however.

- JCatt

[Kirk Maldonado]

I disagree that it is a bad idea, if the plan is drafted so that the employee can elect how to invest the money. If they make the decision, they have to live with it, and nobody else will have any liability for their own investment decisions. I disagree completely with the paternalistic attitude that participants can't make their own investment decisions; you have to protect them from themselves.

[Guest KGibson]

I worked for a retail company that had company stock as an investment option in the 401(k) plan. The IPO of the stock was $22.50 / share. It went up to $32.00 at one point. The company execs preached to the employees to invest their 401(k) money in the company stock. That was great until they quickly and quietly positioned themselves for a sale, and at that time, the stock fell like a lead balloon to $1.87 / share, and to this day, (4 years later)never has gone above $3.00. Needless to say, a lot of money was lost some of which had been rolled out of other funds and from other 401(k) plans, so the losses were very substantial. One lady lost $75,000 from her 401(k) she had rolled out of her previous employers plan, then her husband was diagnosed with terminal cancer, and she was 60 years old. Additionally, she was the secretary for the CFO, and it was his encouragement to invest there, and his continued support to leave it there, that contributed to her financial devistation.

Use caution, and good luck!

[RCK]

Back to Kevin's original question: A large percentage (I think that it's in the 65% range)of Fortune 100 companies use company stock for at least a portion of the company match or Profit Sharing contribution in their 401(k) plan. And if you need an audit, your audit cost will go up because you will need a full scope audit instead of a limited scope audit.

[Guest JCatt]

Kirk - Do you remember the Executive Life fiasco a few years ago? When they went bankrupt and paid cents on the dollar on their GIC's, at least one employer was successfully sued for allowing an E.L. GIC to be an investment option in the plan, even though the participants were the ones directing their assets. The prudent man rule still applies, and the potential for liability still exists. If the employer is actively encouraging a certain investment through accelerated match incentives, I'd have to believe the potential liability is even higher.

[Kirk Maldonado]

JCatt:

I'm aware of a lot of litigation involving annuity contracts issued by EL with respect to terminating DB plans, but I hadn't heard about anything involving participant-directed DC plans. Do you have a cite to that case.

P.S. A few years ago, I did a fair amount of research, and found a paucity of cases imposing liabilitly upon DC plans that offered investments that went sour.

[Guest JCatt]

Kirk - You know, I've looked, and I can't find one. I'm familiar with the situation primarily through my prior job, where we performed recordkeeping and administration services for two plans with Executive Life or Confederated Life GIC's. In each case, the plans eventually made the participants whole after a few years of receiving partial payments from the excecutors. On the other hand, Unisys successfully defended themselves against participants' claims, so who knows . . .

[Guest KevinGordon]

My original question dealt with the issues of incenting employees to put their 401(k) deferrals into Company stock. Our plan has always provided that the matching contribution had to be invested in Company stock. But if we were to offer 6 investment choices to employees, and wanted to encourage employees to put their own money into Company stock, how would we do it? How do other companies do it, if they do?

I'm aware of the "eggs in one basket" debate and am convinced that proper communication and sufficient choice overcomes most of the evils. What I am concerned about is that I might provide a bigger match on $ contributed to Company stock fund than to other funds, and find that employees moved funds out of Company stock (after reaping the match). Are there other incentives that keep the employee's funds locked up in Company stock, once they have taken the incentive? One correspondent suggested that we can write the plan to prevent reallocation of funds that were contributed to Company stock in return for an incentive. So far, that seems to be the best idea. Are there others that anybody is aware of?

Thanks to all for taking the time to reply.

Kevin Gordon

[BeckyMiller]

Kevin - I suggest that you go to the web page for the National Center for Employee Ownership. It is simply http://www.nceo.org. They have lots of information about company stock in retirement plans, including 401(k) plans.

You can do creative stuff with matching formulas, etc. you need to watch out for discrimination testing concerns for some of these ideas.

But, that is not what triggered my response. First, I don't think company stock in a retirement plan is something to be avoided. It can be a fantastic benefit for employees. As noted in earlier remarks, it can also be a nightmare. I tell my clients to remember that if they are putting company stock in their 401(k), their employees are going to watch it, closely. And, if it doesn't perform, they have to remember that rather than seeing their shareholders at an annual meeting, they are going to see them EVERY DAY!

Second, adding company stock to a retirement plan does not per se trigger the need for a full scope audit. If the trustee or custodian is willing to certify the company stock portfolio, you can still get a limited scope audit. This is nearly always true where the plan holds an actively traded stock. I have seen a few cases where private companies get certifications on the company stock portion of the portfolio.

If the addition of the company stock creates an obligation for the plan to register with the SEC, then the limited scope audit is no longer available. SEC filings require a full scope audit.

[Greg Judd]

Looks like the consensus here is 'if you must proceed, do so with caution'; yet our colleague Kevin seems ready to tie a millstone made of company stock certificates around his neck.

Kevin, can you elaborate on your firm's enthusiasm for this idea?

[Guest KevinGordon]

Becky: Thanks for the link to http://www.nceo.org. It was an interesting site, but didn't focus on 401(k) plans (more ESOP oriented).

We are a publically traded company, so the audit issue is not important to us...

Kevin

[Guest KevinGordon]

Gregg:

Our plan is currently a 401(k)/ESOP, on which the 10-year leveraging aspects of the ESOP expired about a year ago. Unallocated shares held by the plan have now all been allocated to the 401(k) accounts of participants, and the ESOP loan has been paid off.

Since late 1980s all (employee and employer) contributions have been required to be made in Company stock. Company has

guaranteed that employees will get no less a return than 5% on their own contributions, plus their vested share in the Company match. So they have the protection of a fixed income investment on their own contributions (but not on the company match), and can participate in any gains on the value of the company stock. Company match is 50% of 1st 6% of employee deferral.

Stock has been up and down. Currently about 53% of its highest, and actually about 50% above its lowest, which occurred about a year ago.

I am starting to look for ways to change the plan design (from forcing employees to invest in Co. stock) to create

incentive(s) for employees to continue to invest in company stock. It would make employees happier, I think.

About 80% participation (some 1800 employees in plan). About 3 million shares of Company stock in plan. Three other funds available for diversification rules, and for old 401(k) monies (pre-1988) that were not moved into the

401(k)/ESOP.

The plan currently owns about 15-17% of the company. And for most employees is not the only plan that we have: most have a final average pay DB plan, or a PS plan, as well as this 401(k)/ESOP plan. So in many ways it is not an "all eggs in one basket" issue.

I hope that gives a better picture of the world that I am operating in.

[Greg Judd]

Originally posted by KevinGordon

I hope that gives a better picture of the world that I am operating in.

Much much better. Yours isn't the garden variety 401k, to put it mildly, but in the context you've described it's clear some sharp minds have been at work. Based on your description of the plan, & the location you've provided in your profile, I might even hazard a guess at the company - but won't here.

Now that you've done the hard work, I'll add my easy suggestion; place your 'sale' of the 401k in the same context you have here--its role in employees' overall financial reward from your firm. The history's helpful, the guarantee's helpful, the other legs of the financial stool are helpful to employee understanding.

I'm sold based on your description alone - where do I sign up?

[Wessex]

I had always thought that DC plans were not permitted to pay interest, that is, guarantee a benefit. That's what a DB plan does. How does the plan avoid this issue? Obviously the Service hasn't made it an issue; I'm assuming that the plan has a favorable determination letter on this aspect of the plan.

[Guest KevinGordon]

The plan is qualified, and has the necessary IRS determination letter.

The guarantee of interest only becomes effective when the

stock is worth less than what the interest guarantee would have paid. It is paid out of the plan (necessitating an

additional contribution if it becomes payable), except for Highly Compensated Employees (in which case it is paid directly by the Company and can't be rolled over, etc. since

it is non-qualified money).

[Greg Judd]

Originally posted by KevinGordon

The guarantee of interest only becomes effective when the  

stock is worth less than what the interest guarantee would have paid

Is the 'guarantee' then more in the nature of a target than a pledge? Does the plan/company carry some kind of insurance in anticipation of the event you describe?

[Guest KevinGordon]

Guarantee is a pledge (backed by the full power of the Company - over 100 years old). Risk is self-insured. Employees know that at the end of the day, if the company were to go belly-up, the guarantee would not be worth anything. Liability is tracked on an ongoing basis, and varies as stock price changes. Payouts are small, and liability is manageable.

But all of this is getting away from my original question:

How to incent employees to invest in Company stock in a 401(k) plan.... any new ideas, information?

Thanks for any input.

Kevin

[BeckyMiller]

When you went to the NCEO web page, did you look at

http://www.nceo.org/pubs/401k.html

or

http://www.nceo.org/library/combine.html

Also, the Profit Sharing/ 401(k) Council has survey on matching contributions, etc. you have to be a full member to get the entire survey. However, I don't recall seeing anything in there to that level of detail.

We regularly get copies of the other surveys done by the big consulting houses. I do not recall seeing anything on this topic in any of those. This would be the Hewitt, Mercer, etc. folks.

[Guest KevinGordon]

Becky:

Yes.. I did, and you're right I can't find the detail that I am looking for.... so I'll have to get creative...

[Greg Judd]

Originally posted by KevinGordon

Becky:

Yes.. I did, and you're right I can't find the detail that I am looking for.... so I'll have to get creative...

Sounds like you have some well-defined goals for a) how many employees you need/want to make the investment you've outlined & b) how much you need/want them to invest. It sounds like you're bent on needing/having employees buy & hold x amount of company stock for y period, with z minimum total stock held by the plan.

If there's any way to share that info, maybe some here can zero in on the 'details' you're after. But if by 'details' you mean 'tricks', or 'gimmicks', you're facing a particularly tough 'incenting' job.

[Guest KevinGordon]

I don't think that we have any well-defined goals, except to keep active employees interested as much as we can in how the company is doing. Our 401(k) plan has done a good job of focussing employees' attention on the bottom line, and all that they can do to affect it.

However, the workforce has changed since we put this plan into effect, and I'm starting to think about allowing employees to invest in things other than company stock on a prospective basis. And I am still interested in having them

invest in Company stock (but without a guarantee for new money that they put into the plan).... so I was interested in the "gimmicks" that companies use, if any, to do this.

I thought my question was rather simple... obviously there

are many facets to it, but I really thought that there would be companies out there doing creative things in this area...

Thanks to all who have entered into the discussion.

[Jon Chambers]

Sorry I missed the start of this thread--it's been quite dynamic.

Kevin, I think the reason that you haven't received any unique suggestions is that there really aren't any out there. This stems from how fiduciary issues regarding investment selection come into play. When employees have no choice regarding investing in employer stock, the regulatory framework provides the employer with broad latitude regarding fiduciary responsibility for offering employer stock. Briefly, unless the fiduciaries have knowledge of some huge impending event (such as bankruptcy) that clearly makes the company stock an imprudent investment, they can offer the stock without facing much liability. I recall a case 10-15 years ago involving the department store chain Carter-Hawley-Hale where fiduciaries were sued for continuing to mandate that company stock was the only investment choice, even as the company went into bankruptcy. Not sure as to the resolution of the case.

The issue becomes more complex as company stock is one choice among many. Now, any action by the employer to influence employees investment decision may be perceived to be:

a) investment advice--generally impermissible, if it comes from employer

b) conflict of interest--as the rationale behind the stock purchase recommendation may be perceived as primarily intended to support company's stock price, by increasing demand for stock, rather than helping employees manage investment process and maximizing plan benefit (see claims in Air Touch/SBC litigation, where plaintiffs claim that mapping of proceeds from Air Touch stock sales into SBC stock were designed to artificially inflate price of SBC stock, hence creating a prohibited transaction).

As another thing to consider, the 404© regs have some very specific reference to how company stock must be handled as an investment option if the sponsor seeks 404© protection for fiduciaries. Briefly, the plan must be structured in a way that sponsor cannot influence employee's decision regarding investment in company stock.

Finally, when the plan transitions from employer directed (into company stock) to employee directed, a host of SEC issues arise. Don't have time to go into these here. Kirk Maldonado is an expert on these.

In conclusion, I think that most companies conclude that it would be imprudent to design plan features that permit employees to choose whether or not to invest in company stock, but then attempt to influence the decision. The only suggestion that I might make is that the company could elect to pay all administrative expenses for the portion of the plan invested in company stock, while passing through costs for the portion of the plan invested in other funds. I know it's not much, but it's something.

Hope this helps!

[Guest KevinGordon]

Thanks for the interesting discussion, for the hints of where else to look, and for the various cautions that you have all thrown my way. I appreciate the help and input!

Kevin