The Employee Ownership Update
November 15, 2002
Tech Companies Propose Alternative to Expensing OptionsThirty-three technology companies have proposed an alternative to stock options expensing. The companies, including Cisco, Siebel, Sun Microsystems, and Intel, propose to tell investors how many options have been granted to executives and employees and detail how those grants will affect the total number of shares outstanding. Disclosure would be made on a quarterly basis. The proposal is seen as an effort to create an alternative to expensing options.
Court Ruling Gives ESOP Fiduciaries Wide Leeway in Holding Onto Employer StockIn a decision that seems to provide considerable leeway for ESOP fiduciaries to hold onto employer stock even in the face of information that seems to argue for selling shares, a U.S. District Court has found that fiduciaries of the ESOP at McKesson Corporation did not violate ERISA when they failed to diversify the ESOP's holdings even after they had learned that accounting irregularities at a company they were merging with would likely have a seriously negative impact on stock prices. In In re McKesson HBOC Inc. ERISA Litigation, N.D. Calif. No. COO-20030 RMW, 10/1/02), the court found that the law does not require ESOP fiduciaries to diversify assets. Claims against them must be made on a more detailed facts and circumstances argument than the plaintiffs provided, not just legal theory.
McKesson, a publicly traded company, has a 401(k) plan and an ESOP; ESOP contributions are made in the form of stock or cash to buy stock and are used to match employee deferrals. The ESOP trustee is directed by the board. In 1999, McKesson merged with HBO & Co., Inc. (HBOC). HBOC also had a 401(k) plan, but participants could direct all of the assets in their accounts. The two plans were merged several months after the companies merged. Soon after that, the merged company announced that HBOC had engaged in improper and illegal accounting practices, causing a drop in the stock price that cost the McKesson plan alone $800 million. Three employees of McKesson sued both McKesson and HBOC.
The court dismissed the claims against McKesson's fiduciaries. The first claim was that the fiduciaries should not have invested all the assets in McKesson's stock. While the court noted that ESOP fiduciaries cannot "blindly follow an ESOP plan's directive to invest in company stock," the court said that the plaintiffs needed to revise their claim to demonstrate on a factual basis that the fiduciaries abused their discretion in continuing to hold such a high percentage. Simply investing in employer stock per se was not a violation. Similarly, the court rejected the claim that fiduciaries should not have continued to invest in company stock after they knew of the accounting issues. Here too the court said the plaintiff's claims lacked factual justification, and allowed the plaintiffs an opportunity to resubmit this part of their claim.
Second, the fiduciaries did not violate ERISA by failing to sell after the merger. If they had sold, they would have violated federal securities laws unless they also (and previously) disclosed the accounting irregularities that had been discovered. But disclosing the information prior to the sale would have had the same damaging effect on share prices that it had subsequently, so nothing would have been gained in the process.
Third, the court rejected the plaintiff's claim that McKesson itself should have repurchased shares from the ESOP. The court said this would have hurt public shareholders because they would be knowingly acquiring an asset even though they knew that they were overpaying for it (because they knew of the disclosure they would be making).
The court also dismissed claim's against the trustee, Chase Manhattan Bank because it was a directed trustee. This automatic exemption for a directed trustee is much broader than other courts have ruled; these courts have said that even a directed trustee cannot engage in acts that violate ERISA.
The claims against HBOC were also dismissed. First, the plaintiffs, as McKesson employees, did not have standing to sue HBOC. Second, HBOC had no authority over the operation of the merged plan.