Taking stock of the Boxer bill.
Sen. Barbara Boxer (D-Calif.) touched a nerve this summer by introducing a bill (S. 1837) to restrict 401(k) plans' investments in employer securities. Boxer has been appointed by the Democratic leadership to its retirement security task force, with particular responsibility for examining 401(k) plans. Her initial foray into pension reform alarmed many in the business community. An attempt to attach the bill to the Small Business Job Protection Act in the closing days of the 1996 Congress failed after intense lobbying by business-community representatives, but we haven't seen the last of it - Boxer reportedly plans to reintroduce a modified version of the bill in the 1997 Congress.
Specifically, Boxer's bill would extend a limitation in the Employee Retirement Income Security Act on investing in employer securities to 401(k)s. Only 10 percent of a defined-benefit plan's assets may be invested in employer stock. The bill would extend that limit to 401(k) plans where the aggregate value of all defined-contribution assets that aren't participant-directed, as defined under ERISA section 404(c), represents more than 10 percent of the aggregate asset value of all the employer's defined-contribution and defined-benefit plans. If the bill passes, plans that exceed the limit on the date of enactment could continue holding existing investments but would be prohibited from acquiring any more employer securities.
A real-world example helped give this bill legs. On the day Boxer introduced her bill, the Wall Street Journal featured a story on 401(k) investments gone sour. According to the article, Color Tile invested 82 percent of its 401(k) plan's assets in Color Tile stores, which were then leased back to the company. Color Tile filed for bankruptcy in January 1996, and 40 percent of its work force was laid off. Meanwhile, withdrawals or transfers of any assets from the 401(k) plan have been prohibited until the stores are sold and their value has been ascertained. (Note: The Boxer bill also would limit investments in employer real property.)
AGAINST THE GRAIN
Clearly, the intent of the bill is to protect employees from situations like this one, but many employers feel the bill runs counter to the philosophy of profit-sharing and stock bonus plans. Traditionally, employers have viewed these plans as incentive and savings vehicles designed to supplement Social Security and defined-benefit plans. They often funded the plans with company securities to align the employees' interests with the firm's.
Today, many of these savings plans have been converted to 401(k) plans. To most large employers, however, they remain supplemental plans, and it's very common for matching contributions to a 401(k) plan to be invested in employer stock as a motivating tool and a way to link pay to performance. Contributing stock to a plan in lieu of cash also is a cost-effective way of funding the plan, because of the positive cash-flow consequences. And many employers prefer to have their stock held in friendly hands.
If only 10 percent of the assets held in a 401(k) plan could be invested in employer securities, matching contributions in employer securities would no longer be feasible. As a result, some employers would decrease their matching contributions. If that happens, employees may reduce their own contributions. The bill's long-term effect could be to discourage employers and employees from investing in 401(k)s, thus reducing overall retirement income.
The bill does exempt plan assets subject to participant control, as defined in section 404(c) of ERISA. But requiring technical compliance with the regulation would be very problematic and could make the exemption illusory. Complying with the 404(c) regulation is optional, and many plans don't satisfy every technical requirement. For example, a plan may offer the required number of investment options but not meet the regulation's specific disclosure requirements.
The bill also is replete with administrative difficulties. The trigger mechanism requires an employer to test its plans each year to determine whether the assets held in its defined-contribution plans exceed 10 percent of the asset value of all its plans combined. Because of asset fluctuation, an employer could be subject to the limit one year but not the next. Similarly, appreciation in the value of the employer's securities could trigger the limit.
Finally, the bill inevitably would increase administrative costs. All 401(k) plans would incur annual costs to determine whether they'd be subject to the 10-percent limitation. In addition, introducing or enhancing participant direction would increase recordkeeping, communication and investment education expenses. In all likelihood, employers would pass these costs on to plan participants, further reducing their savings.
HOVERING OVER THE HOT BUTTON
Despite these difficulties, the Boxer bill has lots of momentum. Congress is acutely aware that retirement-security issues are a hot button with the public, and 401(k) plans are becoming more important in retirement income. These facts, buttressed by horror stories like Color Tile, have generated bipartisan interest in considering some restrictions on employer securities.
The Boxer bill is part of the Democrats' "Families First" agenda and has been incorporated into the Comprehensive Women's Pension Protection Act, a sweeping bill introduced at the end of the last session by Democratic women members in the House and the Senate. Pension reform, including the Boxer bill, is at the top of the Democratic agenda.
Republicans haven't been pushing pension issues as aggressively, but COP members are sensitive to the public's interest in the area. Republicans are trying to improve the Boxer bill, but they aren't committed to rejecting it outright, because they were burned by their attempt to give employers limited access to excess pension assets in the last Congress. They want to be on the workers' side in this debate.
Undoubtedly the bill will be hotly debated and substantially modified. Some in the business community have suggested exempting 401(k) plans that supplement defined-benefit plans. The danger is regulators inevitably will attempt to define a "primary" defined-benefit plan. Does it cover enough of the work force? Is its formula generous enough? An alternative would be to raise the 10-percent threshold in the trigger mechanism so fewer 401(k) plans would be affected.
Another approach would be to include only employee contributions in the trigger calculation and to apply the limit only to employee contributions. Alternatively, the 10-percent limit could be applied only to employee contributions, and the trigger mechanism could be dropped entirely. The bill then would apply to all 401(k) plans, but employer matching contributions in stock would be preserved. Excluding employer matching contributions entirely from the scope of the bill would narrow its application substantially.
However, this approach wouldn't preserve 401(k) plans that require employee contributions to be invested in employer securities. These arrangements seem to particularly trouble Boxer and her allies and aren't likely to survive if a bill is passed. Finally, compliance with 404(c) may be the wrong test of participant control, but bill proponents continue to seek a way to ensure plan participants can choose among legitimate investment alternatives before the assets are exempted from the 10-percent limit.
The Boxer bill is extremely controversial, but the chances of a watered-down version eventually being enacted are better than even. It's unlikely employers will be able to avoid having any limitations on 401(k) plans' investment in company stock. With some significant revisions and clarifications, however, the bill could be more palatable to most businesses.
* The Boxer bill, part of the Democrats' pension reform agenda, would restrict 401(k) plans' investments in employer securities to 10 percent of total assets.
* A Merck executive says the bill would spell huge administrative costs.
* The bill may reach beyond 401(k)s. Limits on employee stock ownership could spell disaster for Procter & Gamble's ESOP, says a company executive.
RELATED ARTICLE: WHAT'S IT GONNA COST YOU?
Three executives explain what the Boxer bill would mean to their 401(k) plans.
THE ESOP QUESTION
John Smith Director, pension investment and administration Procter & Gamble Cincinnati (513) 983-8337
We're extremely concerned about the Boxer bill, because most of our employees belong to an employee stock ownership plan rather than a 401(k) plan. We do have 401(k) plans, most of them participant-directed, for 12 subsidiaries. But the vast majority of employees - about 36,000 - belong to the ESOP. The plan offers two other fixed-income vehicles and an annuity option, but most people opt to invest in company stock.
If the bill were enacted as it was first written, it would wreck our plan - 95 percent of its approximately $11 billion in assets are company stock. That would be very traumatic for our employees, because profit sharing has been part of Procter & Gamble's culture since 1890. We take pride in offering employees ownership of and a stake in the company. In fact, our CEO wants to expand stock ownership overseas.
We're afraid the Boxer bill would be the proverbial camel's nose under the tent in terms of regulating how much company stock employees can own. What's more, the bill overlooks the real advantages of stock ownership to thousands of working people.
AN ADMINISTRATIVE NIGHTMARE
Sarah B. Brunner Legislative Consultant DuPont Wilmington, Del. (302) 774-8224
DuPont employees enrolled in the 401(k) portion of our savings plan choose from among eight funds, one of which is company stock, to invest their contributions. We have a 50-percent match up to 6 percent of pay. Employees aren't required to invest in DuPont stock at any time, and they can transfer their plan assets into and out of the company stock fund daily.
If the Boxer bill were passed in its current form, it would present huge problems for DuPont. First, we'd incur substantial costs to tell employees the plan administrator could no longer accept their instructions to invest their new contributions or transfer existing assets to the company stock fund until the total stock portion of the plan assets dropped below 10 per cent (it's currently 14 percent). We'd also incur costs to find out where these employees would want to invest the assets that couldn't be invested in company stock.
After the assets fell below 10 percent, we'd have to continually monitor them to be sure the stock fund doesn't increase above that level. If it did, we'd once again have to tell employees not to contribute to company stock until further notice. You can see how quickly this turns into an administrative nightmare.
One question we have is why the 404(c) regulations are the only test in the Boxer bill to determine whether a plan is participant-directed. Of course, all 404(c) plans are participant-directed, but a plan can fulfill that objective in other ways, too. Companies' plans may be participant-directed and comply with the essence of the 404(c) regulations without officially being 404(c) plans, because of the administrative burden of fulfilling the requirements. The definition of a self-directed plan should be broadened to include any plan where the investment of assets is totally at the discretion of employees. The bill could use the 404(c) regulations as a safe harbor rather than as the only test.
Melissa King Director of benefits financing Merck Whitehouse Station, N.J. (908) 423-3743
More than half of our 401(k) assets are invested in company stock, a proportion party attributable to the recent appreciation of Merck stock and to our employees' decision to invest their own funds in the company. For participants age 50 and older, all employee and company matching contributions are in participant-directed investments. For those under age 50, all employee contributions and 50 percent of company matching contributions are in participant-directed investments, and the other 50 percent of the match is in Merck stock. Our 401(k) plan also offers 12 investment options in a range of assets classes.
One of our major concerns about the Boxer bill is whether we'll have to respond to fluctuations in company stock investment levels. If we do, we'll have to manage plan assets much more actively - a significant departure from current practice and certainly a resource issue. Presumably, we'd have to establish systems to calculate the market appreciation impact on asset allocations and override routine payroll designations. Not only would this be costly to implement, it could significantly complicate and delay the processing of contributions. Our 401(k) contributions must be allocated to investments as soon as they're contributed. Delays in determining where they go mean delays in depositing contributions - and lost earnings to participants.
Also, who decides when and how the excess stock holdings are liquidated and where they should be invested? Retirement investing should have a long-term focus. Selling company stock because its value exceeds arbitrarily set limits exposes plan participants to short-term market risk - precisely what we encourage employees to avoid.
Companies do have a responsibility to educate employees to treat the company stock objectively, but most employees believe they understand their employer and its prospects far better than the companies driving mutual fund prices and market indices, let alone the economic factors that drive interest rates. Our participant education program emphasizes the relatively high volatility of any single stock - including our own stock - compared to other investment options, and we encourage diversification out of our stock. Our efforts have modestly reduced employee allocations to company stock, but because Merck stock has tended to outperform other investments recently, the plan's total asset holdings remain concentrated in the stock fund.
The Boxer bill complicates rather than clarifies the issues surrounding investment education and employer responsibility. Employees should be encouraged to diversify all their savings and investments. Forcing diversification of only one potential savings component through an arbitrary legal mandate ignores the realities of individual saving patterns, and penalizes not just employers, but employees whose company stock is a good investment.
Ms. Combs is a principal at the Washington Resource Group of Mercer Consulting in Washington, D.C. You can reach her at (202) 778-7820.
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|Title Annotation:||Sen. Barbara Boxer|
|Author:||Combs, Ann L.|
|Article Type:||Cover Story|
|Date:||Jan 1, 1997|
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