Using employer stock in qualified plans

In the best of times, both retirement plan participants and sponsors can benefit from the inclusion of employer stock in a company's participant-directed retirement plan.

Employees share in the success of their company by using a convenient, tax-advantaged savings apparatus, often with the help of matching contributions from the company. Sponsors benefit from increased loyalty and productivity from employee-owners, as well as from added demand for company shares.

The Employee Retirement Income Security Act of 1974 explicitly recognizes these mutual benefits and encourages employee ownership of employer stock through eligible individual account plans such as employee stock options, profit sharing and 401(k) plans.

Unfortunately, in the worst of times, employer stock can be the focus of extra scrutiny, and even litigation, if plan fiduciaries aren't conscientious about fulfilling their fiduciary duty. The troubled economic conditions and turbulent markets of the past few years have generated a surge in lawsuits against plan fiduciaries when employer stock has dropped precipitously.

All these so-called stock drop cases involve alleged breaches of fiduciary responsibility for failure to sell or suspend further investments in employer stock when it would have been prudent to do so. Generally, the cases allege that plan fiduciaries had information — often nonpublic information — that would have prompted competent, independent fiduciaries to act.

Several such cases were decided late last year, and while all were decided in favor of the defendants, the expense, public relations damage and adversarial employee-employer climate incurred in these situations should provide sponsors with ample incentive to prefer prevention over a legal cure. Prevention is largely a matter of paying attention to good plan design, consistent due diligence and careful documentation.

With regard to plan design, corporate insiders must be kept out of the investment decision process.

Senior executives who have material nonpublic information that could have a bearing on the future price of employer stock shouldn't serve on a plan's investment committee.

It is acceptable for senior executives to be fiduciaries to the plan to the extent that they appoint others to fill fiduciary roles or they make non-investment decisions. However, plan documents should provide clear and complete delegation of responsibility for the investment decision-making process to competent parties who don't have access to nonpublic financial information about the company.

SAFE HARBOR

In 401(k) plans, participants shouldn't be required to have their money invested in employer stock. Moreover, plans should take advantage of the 404(c) safe harbor under ERISA that provides plan sponsors protection for the investment decisions made by plan participants.

Consistent due diligence is a matter of applying the same rigorous scrutiny to all investment options offered in the plan. The fiduciary duty of due care obligates those fiduciaries who are responsible for selecting and monitoring the investments in a plan to apply generally accepted investment procedures to establish and maintain the plan's investment menu.

A landmark 1995 stock drop case, Moench v. Robertson, established a legal precedent affording plan fiduciaries the benefit of any doubt regarding the prudence of offering employer stock in an EIAP.

Even so, if responsible plan fiduciaries determine that having an employer stock option in the plan isn't in the best interests of participants, they should exclude it from the investment lineup. As a best practice, investment committees may rely on independent advisers to do this analysis to assure rigor and objectivity.

Although good documentation is essential for all retirement plans, the inherent conflict between serving the interests of the company versus those of plan participants when employer stock is involved warrants special attention. The plan document and investment policy statement should reflect careful consideration of how the fiduciary duties of loyalty and care are fulfilled in the way that the employer stock component of the plan has been designed and how it is managed on a continuing basis.

Deliberations and actions taken by fiduciaries on matters involving the employer stock option should be recorded in investment committee minutes and should adhere to core fiduciary principles.

The flurry of stock drop litigation shouldn't cause plan sponsors to regret having employer stock in their plans. Sound fiduciary practices are necessary and sufficient to manage these plans properly.

Blaine F. Aikin is chief executive of Fiduciary360 LLC.