Order Code RS21115
Updated March 11, 2002
CRS Report for Congress
Received through the CRS Web
The Enron Bankruptcy and Employer Stock
in Retirement Plans
Patrick J. Purcell
Specialist in Social Legislation
Domestic Social Policy Division
On December 2, 2001 the Enron Corporation filed for Chapter 11 bankruptcy
protection in federal court in New York. Enron sponsors a retirement plan – a “401(k)”
– for its employees to which they can contribute a portion of their pay on a tax-deferred
basis. As of December 31, 2000, 62% of the assets held in the corporation’s 401(k)
retirement plan consisted of shares of Enron stock. Some Enron employees held even
larger percentages of Enron stock in their 401(k) accounts. The company’s bankruptcy
substantially reduced the value of many of its employees’ retirement accounts. Shares of
Enron, which in January 2001 traded for more than $80 per share, were in January 2002
worth less than 70 cents each. The financial losses suffered by participants in Enron’s
401(k) plan have prompted questions about the laws and regulations that govern these
plans. This CRS Report describes the current laws governing the holding of employer
stock in employee retirement plans and summarizes some key policy questions that
pension analysts have raised about holding such stock in defined contribution retirement
plans. This report will be updated as further legislative developments occur.
The two kinds of retirement plans. Sponsorship of retirement plans by
employers is voluntary, but any firm that sponsors a plan for its employees must abide by
the standards established under the Employee Retirement Income Security Act of 1974
(P.L. 93-406), popularly known as ERISA. In order for a plan to be tax-qualified – that
is for contributions to the plan and investment earnings on those contributions to be
eligible for deferral of federal income taxes – the plan must also comply with the relevant
sections of the Internal Revenue Code of 1986. Retirement plans are legally classified as
either defined benefit plans or defined contribution plans. In a defined benefit plan, an
employer pays retired workers a pension benefit based on a pre-determined formula,
usually related to the employee’s length of service and average salary in the years
immediately preceding retirement. Each year, the employer must contribute money to a
pension trust to fund the retirement benefits that the firm’s employees earned that year.
A trustee or other fiduciary appointed by the employer determines how to invest those
funds. (A fiduciary is an individual, company, or association responsible for managing
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another’s assets). Broad guidelines prescribed by federal law require the funds to be
invested solely in the best interests of the workers and retirees covered by the plan.
A defined contribution plan is much like a savings account maintained by the
employer on behalf of each participating employee. The most common defined
contribution plan, is the “401(k)” plan, named for a section of the Internal Revenue Code
that was added by the Revenue Act of 1978 (P.L. 95-600). In a 401(k) plan, the employee
can make pre-tax contributions to a retirement account. These contributions are often
matched by the employer in whole or in part up to some percentage of the employee’s base
salary. Typically, participants can allocate the investment of their account balances among
a menu of investment options selected by the employer and/or fiduciaries appointed by the
employer. Employer stock is frequently one of those options. The value of the retirement
benefit that the worker receives will depend on the balance in the account, which is the
sum of all the contributions that have been made plus interest, dividends, and capital gains
(or losses). The worker usually has the choice of receiving these funds in the form of a
life-long annuity, as a series of fixed payments over a period of years, or as a lump sum.
In recent years, some employers have converted their traditional pensions to hybrid
plans that have characteristics of both defined benefit and defined contribution plans. The
most popular of these hybrids has been the cash balance plan. A cash balance plan looks
like a defined contribution plan in that the accrued benefit is defined in terms of an account
balance. The employer makes contributions to the plan and pays interest on the
accumulated balance. However, in a cash balance plan, the account balances are merely
a record of the participant’s accrued benefit. They are not individual accounts owned by
the participants. Legally, therefore, a cash balance plan is a defined benefit plan.
The Locus of Risk in DB and DC Plans. In a defined benefit plan, the
employer bears the investment risk of the plan, while in a defined contribution plan the
employee bears the investment risk. In a defined benefit plan, the employer promises to
provide a retirement benefit equal to a certain dollar amount or percentage of the
employee’s pay. The employer contributes money to a pension trust that is invested in
stocks, bonds, real estate, or other assets. Retirement benefits are paid from this trust
fund. The employer is at risk for the amount of retirement benefits that have been
promised to employees and their survivors. If there are insufficient funds in the pension
trust to pay the accrued benefits, the firm that sponsors the pension plan is legally
obligated to make up the difference by paying more money into the pension fund.
In a defined contribution plan, the employer bears no risk beyond its obligation to
make the contributions it has promised to each employee’s retirement account. In these
plans, it is the employee who bears the risk that his or her retirement account will increase
in value by an amount sufficient to provide adequate income during retirement. If the
contributions made to the account by the employer and the employee are insufficient, or
if the securities in which the account is invested lose value or increase in value too slowly,
the employee risks having an income in retirement that is not sufficient to maintain his or
her desired standard of living. If this occurs, the worker might choose to delay retirement.
The Pension Benefit Guaranty Corporation. The Pension Benefit Guaranty
Corporation (PBGC) is a federal government corporation established by ERISA to insure
pension benefits in private-sector defined benefit plans. By law, the PBGC insures only
defined benefit plans. It does not insure defined contribution retirement plans, such as
profit sharing plans or 401(k) plans. The PBGC currently insures pension benefits for
more than 43 million workers in almost 38,000 private-sector defined benefit pension
plans. The insurance provided by the PBGC is financed through premiums levied on all
private-sector defined benefit pensions. This premium, set by Congress, is $19 per year
per participant. An additional premium of $9 per $1,000 of unfunded vested benefits is
levied against under-funded plans because these plans present the greatest risk of default.
When a fully funded plan terminates – perhaps because an employer chooses to end
the pension plan – the plan provides benefits either by purchasing an annuity from an
insurance company or by paying out the benefits owed to each participant in a lump-sum.
When an underfunded plan terminates – either because the employer is unable to properly
fund the plan or because the PBGC ends it to protect the interests of participants or the
PBGC – the PBGC takes over the plan as trustee and uses its own assets and any
remaining assets in the plan to make sure that participants will receive pension benefits,
within legal limits. The PBGC’s maximum benefit guarantee is set each year under
provisions of ERISA. For pension plans that end in 2002, the maximum guaranteed benefit
is $3,579 per month for a worker retiring at age 65. The guarantee is lower for payments
beginning before age 65 or if the pension includes benefits for a survivor.
Employer Stock in Retirement Plans. ERISA limits the amount of employer
stock that can be held in a defined benefit plan to 10% of plan assets to ensure that the
assets of pension trust funds are diversified beyond the assets of the company itself.1 Such
diversification reduces the risk that a pension fund would become insolvent as a result of
the company that sponsors the plan going bankrupt. Congress has generally exempted
defined contribution plans from limits on investing in employer stock,2 except for certain
plans that require salary deferrals equal to more than 1% of employee pay to be used for
purchasing employer stock.3 H.R. 3463 (Deutsch) would limit employer stock to 10% of
the total assets in a 401(k) plan that are attributable to employee contributions. Employer
contributions would not be subject to the limit. S. 1838 (Boxer) and H.R. 3640 (Pascrell)
would limit employer stock to 20% of the assets held by any individual in a 401(k) plan.
Should employee ownership of employer stock in a 401(k) be limited
to some fixed percentage of the total? As of December 31, 2000, 62% of the
assets in the Enron Corporation’s 401(k) plan consisted of shares of Enron stock.4 The
company has estimated that 89% of this stock was purchased by employees and that the
remainder represents the corporation’s matching contributions to the plan, most of which
were made in the form of shares of Enron stock.5 It is not unusual for defined contribution
plans to hold employer stock that comprises more than 10% of the plan’s assets.
According to a survey of 428 employers conducted by the benefits consulting firm Hewitt
Associates, 29.6% of the assets of these firms’ 401(k) plans was invested in the employer’s
stock as of October 31, 2001. Fifty-five percent of plans offered the employer’s stock as
an investment option. Among those plans, 45% made the employer’s matching
29 U.S.C. §1107(a).
29 U.S.C. § 1104(a)(2) and § 1107(b).
29 U.S.C. § 1107(b)(2).
S.E.C. Form 11-K for the Enron Corporation Savings Plan, Commission file number 1-13159.
“Employees’ Retirement Plan Is a Victim as Enron Tumbles,” The N.Y. Times, Nov. 22, 2001.
contribution exclusively in the company’s stock. Some employers voluntarily limit the
amount of employer stock that participants can hold in their 401(k) accounts, but most do
not. According to the survey conducted by Hewitt Associates, only 14% of the companies
surveyed restrict the amount that employees can invest in employer stock. The most
common limit is 25%. Another recent survey found that the concentration of employer
stock in some 401(k) plans is greater than 50% of total 401(k) assets. (See Table 1.)
Table 1. Employer Stock in Selected Retirement Plans
Procter & Gamble
William Wrigley, Jr.
BB&T (Branch Banking & Trust)
TXU (Texas Utilities)
Ford Motor Company
Company stock as a
percentage of defined
have a defined
contribution plan’s assets: benefit plan?
Source: S.E.C. Forms 10-K and 11-K and company spokespersons.
Should there be restrictions on employer contributions to 401(k) plans
in the form of company stock? Some employers make all or part of their
contributions to their employees’ 401(k) accounts in the form of company stock. Some
also offer company stock as an investment option that employees can purchase for their
401(k) accounts. Contributing company stock is popular with employers because, when
it consists of newly-issued shares or shares from the company’s treasury, it does not
reduce the company’s cash flow. Moreover, as with cash contributions, stock
contributions are fully deductible as a business expense for income tax purposes. Making
contributions of stock also puts shares into the hands of a group of people – the firm’s
employees – who are less likely to sell their shares either when there is a hostile tender
offer for the company or when the firm’s reported profits are less than expected. Some
observers contend that if companies were forced to contribute cash rather than stock,
many companies might stop making matching contributions to their 401(k) plans. Others
point to research suggesting that workers whose employers make matching contributions
with company stock are more likely to put their own contributions into company stock,
thus risking substantial losses from a decline in the price of their employer’s stock.6 Under
S. 1992 (Kennedy), a defined contribution plan could either (1) permit employees' elective
deferrals to be invested in employer securities or (2) make the employer's contribution in
employer securities, but not both.
Should there be limits on when and how long employers can suspend
401(k) transactions? Companies sometimes suspend transactions in their 401(k)
accounts, most commonly when they are changing plan administrators, installing new
software, or performing other routine administrative tasks that require a temporary
suspension of account activity. According to the Office of Regulations and Interpretations
of the U.S. Pension and Welfare Benefits Administration, there is no statutory or
regulatory limit on the length of time during which participants can be blocked from reallocating assets or conducting other transactions in a 401(k) plan.
Plan sponsors and administrators have certain rights and responsibilities as fiduciaries
of the plan, such as crediting each individual participant’s account with contributions and
recording investment earnings or losses. Fiduciaries therefore have the right to take
reasonable actions to ensure that these and other administrative tasks are carried out in an
orderly and efficient manner. Nevertheless, when a plan sponsor suspends transactions,
it still must act in the interest of the plan participants. ERISA § 404(c)(1) states that when
a plan “permits a participant or beneficiary to exercise control over the assets in his
account,” neither the plan sponsor nor the plan administrator are liable for investment
losses that the participant may incur. Whether the plan sponsor or administrator is relieved
of such responsibility depends in part on the ability of the participant “to exercise control
over the assets in his account.” In a lawsuit filed against the Enron Corporation, plan
participants have alleged that the company deprived plan participants of control over their
accounts by “locking down” the plan – i.e., prohibiting re-allocation of assets – during a
period of time when revelations about the company’s finances were causing the share price
of Enron stock to fall. They argue that during the lockdown, the plan assets were under
the control of the plan sponsor rather than the plan participants. Therefore, they contend,
the plan sponsor should be held legally responsible for carrying out the fiduciary duty for
diversification of plan assets defined at ERISA § 407(a)(2). H.R. 3509 (Bentsen) would
require 401(k) plan sponsors to secure permission from the Department of Labor before
suspending transactions in the plan and to provide 90 days notice of any suspension. H.R.
3657 (Miller, CA), H.R. 3762 (Boehner), S. 1919 (Wellstone), S. 1921 (Hutchison), S.
1969 (Hutchinson), S. 1971 (Grassley) and S. 1992 (Kennedy) would require plans to give
participants written notice 30 days before a lockdown begins. H.R. 3657 and S. 1919
would limit lockdowns to no more than 10 consecutive business days.
Shlomo Benartzi, “Excessive extrapolation and the allocation of 401(k) accounts to company
stock,” The Journal of Finance, Vol. 56, No. 5, October 2001.
Should employers be able to compel employees to hold on to
employer contributions of company stock until age 50 or later? Plan
sponsors can require participants to hold on to employer stock contributed by the
employer. According to the Hewitt Associates survey, 34% of 401(k) plans that match
employee contributions with employer stock require participants to reach a certain age –
typically 50 or 55 – before they can sell it. Of the firms that match with employer stock,
only 15% allow their employees to sell the stock immediately. Nineteen percent do not
permit diversification at any time. According to a study of 401(k) plans by Fidelity
Investments, only 4% of plans that match with company stock let participants immediately
sell those shares. Employees participating in Employee Stock Ownership Plans (ESOPs)
are permitted to begin diversifying their holdings of employer stock when they have
completed at least 10 years of participation under the plan and have attained age 55 (26
U.S.C. § 401(a)(28)). In 1997, a majority of the Pension and Welfare Benefits
Administration Advisory Council working group on employer assets in ERISA plans
recommended that participants in 401(k) plans should be able to sell employer stock when
they become vested in the plan.7 S. 1838 and H.R. 3640 would permit vested participants
to sell employer stock 90 days after it is credited to their 401(k) accounts. H.R. 3463
would allow participants in 401(k) plans to sell employer stock 3 years after the stock is
contributed to their accounts. H.R. 3657 would permit vested participants to sell
employer stock 30 days after it is credited to their 401(k) accounts. It also would reduce
the maximum vesting period for defined contribution plans from three years to one year.
Should 401(k) accounts be insured by the federal government? Defined
benefit pensions are insured by the Pension Benefit Guaranty Corporation, which was
established by ERISA in 1974. Insuring defined contribution plans would raise several
difficult questions about the specific kinds of risk to be insured against. (1)Would investors
be insured only against losses directly attributable to the collapse of their employer’s
shares? In that case, regulating risk by requiring diversification would be simpler and
cheaper than insuring defined contribution plans. (2) Would investors be insured against
wider investment risk, such as business failures in particular industries or sectors of the
economy in which they had invested? (3) Would investors be insured against market risk,
such as a general decline in stock prices? In any case, it would be challenging to price the
insurance appropriately. All 401(k) investors would ultimately pay for the insurance
through higher administrative fees, reduced employer contributions, or both.
In addition to defining the specific risks to be insured against, there is the potential
problem that offering insurance for 401(k)s might actually encourage workers to engage
in risky investment behavior, something that insurers call moral hazard. Investors might
choose to invest in companies that are especially risky because they would have nothing
to lose. The effects of offering insurance for 401(k) plan losses could lead to events
similar to the savings-and-loan crisis of the 1980s. Depositors were willing to place their
money with risky savings and loans – those that paid the highest interest rates – because
they knew that if the S&L failed, they would get their money back from the federal
government through federal deposit insurance. H.R. 3657 and S. 1992 would direct the
PBGC to study the feasibility of a system of insurance for defined contribution retirement
Pension and Welfare Benefits Administration Advisory Council on Employee Welfare and
Pension Benefits Plans, Report of the Working Group on Employer Assets in ERISA EmployerSponsored Plans, November 13, 1997. [http://www.dol.gov/dol/pwba/public/adcoun/acemer.htm].