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Observations on Employee Ownership

Bear Stearns and Employee Ownership

Corey Rosen

March 2008

(Corey Rosen)There have been a lot of stories about how employees are among the most hurt by the fire sale of Bear Stearns. We have tried to piece together the available facts about just what kinds of employee ownership plans exist there.

For the broad employee population, there was an employee stock ownership plan (ESOP) that held about $285 million in Bear Stearns stock in 2007. The plan was funded by the company. This was not, however, the sole, or even main, retirement plan at the company. In addition, there was a profit sharing plan funded by the company that had about $300 million in diversified investments and a 401(k) plan with $720 in diversified investments. So from a retirement plan standpoint, Bear Stearns is not at all like Enron and some other companies several years ago where employees were heavily or primarily invested in company stock, generally in their 401(k) plans, and were left with limited or no retirement assets after their companies melted down. The ESOP accounted for about 3% of total Bear Stearns Stock.

The media has widely reported, however, that employees owned about 30% of Bear Stearns. So where was the rest of that held? According to the company's SEC filings, there were three other employee plans, all aimed at "key" employees. That term was not further defined. This included a capital appreciation plan (stock options) that issued about $300 million per year, a restricted stock plan that issued about $135 million per year, and a stock award plan that issued about $100 million per year. While the filings do not break it down, these plans typically provide most of their benefits to the "C"-level employees. The company's filings do not indicate how much employees at other levels defined as "key" would get. Of course, employees could also buy Bear Stearns stock on their own, something the company apparently encouraged.

Several law firms have already announced that they are seeking clients to sue the fiduciaries of the Bear Stearns ESOP. Under federal law, ESOPs are intended to be invested "primarily" in employer stock. This generally exempts plan fiduciaries from liability if the stock does not perform well. However, this protection does not apply if the fiduciaries know or should have known that the stock was headed for an imminent and very sharp decline, in which case fiduciaries should seek to sell the shares in an orderly way if possible.

Over the years, many Bear Stearns employees would have left the ESOP and been paid out substantial benefits. For those remaining, however, the loss will be almost total. It is important to put this in the context of ESOPs overall. These plans currently hold about $925 billion in assets and cover about 11.2 million employees. Over 90% of ESOPs are in closely held companies, where they are often used as an ownership transition vehicle. About 40% of ESOP companies are now majority-owned by their plans, a percentage that is rising.

Studies by academics in Washington State and at Rutgers have shown that the typical ESOP participant has about three times the total retirement assets of a comparable non-ESOP participant in a comparable company, and has diversified assets about equal to those of the non-ESOP employee. The large majority of ESOP companies have at least one other retirement plan and, in fact, are more likely to have a diversified retirement plan (that is, a plan other than their ESOP) than comparable companies are likely to have a retirement plan at all. ESOPs also serve a different function than 401(k) plans. 401(k) plans are intended to be diversified retirement plans funded by employee deferrals and, often, employer matching contributions. While this can provide for a safe and very advantageous retirement plan for employees, employees almost always have to contribute to take advantage of the opportunity. In practice, that means that at least some percentage of the eligible employee population is not covered or gets only relatively small benefits. ESOPs are, as a rule, entirely funded by the company, and contributions are based on relative pay or a more level formula, so all eligible employees benefit in a significant way. However, ESOPs are concentrated in a single investment (the typical plan is about 80% in company stock), making them more wealth building strategies than pure retirement vehicles. That is why most ESOP companies have supplemental plans, such as 401(k), pension, or profit sharing plans.

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