Joint Tax Committee Calls for Changes in Policies on Employee Ownership in Retirement Plans

The Joint Tax Committee (JTC) of the Congress has urged that employee retirement plans rely less on investments in employer stock. In its February 3, 2003, "Report of Investigation of Enron Corporation and Related Entities," the JTC urged that retirement laws be changed so that:

• Plans should provide participants with investment education on the importance of diversification, including notices to individuals whose assets are overconcentrated in a single investment.
• Plans should not be allowed to require employee elective deferrals or after-tax contributions be in employer stock (something that is already hard to under existing law).
• Plans should required to allow employees to diversify out of employer contributed investments in employer stock.
• Statements of executives concerning plan investments should be subject to fiduciary rules, even if the executives are not fiduciaries of the plan.

The JTC noted, however, that "because of the strong corporate culture that encouraged Enron stock ownership by Enron employees, it is not clear that the outcome would have been any different if these measures has been in place prior to the bankruptcy. Further, Enron is not alone in its high concentration of investment in employer stock. A recent study of 219 large 401(k) plans found 25 plans that had over 60% of their assets in employer securities. Given these factors, the Joint Committee staff is concerned that, absent legal restrictions on the amount of employer securities that can be held in defined contribution plans, situations such as Enron's may occur again. Such restrictions would involve a major policy change from present law."

The committee also noted that Enron relied heavily on options, both for executives and in broad-based plans. It noted that different treatments of options for tax and accounting purposes contributed to the problems at the company. In addition, the report criticized the excessive reliance on stock-based compensation for executives, saying it led to an overemphasis on stock price.

As is widely known, Enron's 401(k) plan was heavily invested in Enron stock. Less well known is that Enron also had an ESOP, as well as a pension plan with an ESOP floor-offset arrangement. These kinds of plans are no longer allowed, but Enron's was grandfathered. The complicated arrangement tied Enron's pension plan value to Enron stock in a way that ultimately was very harmful to many of the plan's participants.

It is not clear from the report whether the JTC is recommending changes only for 401(k) and other plans allowing for employee investments or would recommend limits on ESOPs as well. The recommendations are from the JTC staff, not the committee members. Congress has already shown it is not ready to go as far as the JTC would suggest in placing absolute limits on employer stock in defined contribution plans, and it has specifically exempted conventional ESOPs from any legislative reform efforts. Although the JTC report shows that there is strong sentiment among many professionals that employer stock be limited in retirement plans, it appears very unlikely that ESOPs will be affected, in part because research shows that ESOP companies are actually much more likely than non-ESOP companies to have diversified retirement plans.