Too much company stock risky for workers’ retirement, says US legal expert

June 23rd, 2009 - 12:00 pm ICT by ANI  

Washington, June 23 (ANI): An American legal expert is urging the Government to ban employer stock from company-sponsored retirement plans, so that workers can be prevented from the risk of putting too much of their nest eggs in one basket.

Sean Anderson, a visiting professor in the University of Illinois College of Law, says that employee stock ownership plans (ESOPs) are the biggest threat, with even heavier investment in company stock than the 401(k) plan that gobbled up workers’ savings when energy giant Enron Corp. collapsed amid scandal in 2001.

In an article, to be published in the Loyola University Chicago Law Journal, Anderson points out that workers whose employers have ESOPs typically have no choice about whether to invest in company stock.

“ESOPs have a lot of intuitive appeal - the idea of having workers own a piece of the company they’re working for. But they’re Enron on steroids. At the end of the day, they put workers at terrible risk and more often than not work as a tool that benefits the company, not employees,” he said.

According to him, ESOPs are dicey even beyond the doomsday scenario of a company bankruptcy that strips away workers’ savings along with their jobs and benefits.

Anderson says ESOPs concentrate investments in a single firm rather than diversify across a wide range of companies, industries and even geographic areas to minimize risk.

“Someone who has the bulk of their portfolio in one investment is just not going to do as well as someone who has a diversified portfolio. Over time, undiversified investments through ESOPs can be worth far less than half as much,” he said

He further says that ESOP participants generally don’t have any control over the prices at which the shares are bought.

Given that most ESOP companies are privately held, the share price for stock transactions is determined by company-hired valuation firms with an incentive to set high prices that net extra cash for the business or its insiders rather than low prices that benefit employees, says Anderson.

“These firms are hired by the company and do this over and over, so it’s not in their best interests to stick up too ferociously for ESOP participants. If they get a reputation for bucking the company, they’ll lose business,” he said.

Anderson says setting share prices is just one of several incentives that combine to make ESOPs a better deal for the company than for the employees they are supposed to help.

He says ESOPs are the only tax-qualified retirement plan that can borrow money, something that makes them an effective means of raising capital. He says companies can then deduct all of the interest on those loans, providing a much bigger tax break than comparable 401(k) or other pension plans.

Anderson says that owners of privately held firms who sell shares to the ESOP, rather than an outside buyer, can also defer capital gains taxes if they invest the proceeds in other stocks, an incentive for owners who are retiring or merely seeking to diversify their own investments.

“Because of those conflicts of interest, some people have said it’s better to think of ESOPs as instruments of corporate finance rather than retirement plans. That’s the problem. Employees think they have a pension plan, so they’re less inclined to agitate for a better one because they don’t realize what a bad position they’re in,” he said.

According to him, ESOP reforms have failed, even escaping a post-Enron federal mandate that requires 401(k) plans to give workers more freedom to diversify investments and to educate them about the importance of diversification.

He feels that an ideal solution to the problem would be to ban employer stock from both ESOPs and other retirement plans.

He says that a 5-10 per cent cap on company stock could also solve diversification concerns, but that would be cumbersome to regulate.

“I do have a glimmer of hope that the horrible things happening in the investment world will make the ground a little more fertile for arguments against ESOPs,” he said.

“Ironically, ESOP participants would be better off if the company just randomly chose the stock of a similar firm in the same industry. They’d still be radically under-diversified, but at least their pay and benefits would be in a different basket than their retirement savings,” he added. (ANI)

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