Investing Your Retirement Account Assets in Employer Stock–Silly or Smart?

Many employers in Chicago seek for ways to add incentive to their executives and managers. Some accomplish this through Incentive Stock Options (“ISOs”), or Nonqualified Stock Options (“NSOs”) depending on the structure of the options package. Other employers may provide a Supplemental Executive Retirement Plan (“SERP”), also commonly referred to in the benefits community as a “top hat” plan, that vests upon a certain number of years of service and/or attainment of certain goals. Yet other employers seek a more direct investment of the executive or manager’s “skin in the game” by either providing a bonus that is equity based compensation, or asking the new executive to directly invest in employer stock. Occasionally, the only source of funds the executive will have liquid for such a purchase of stock will be a retirement account that he or she may rollover into the new employer’s plan and then buy the stock with the plan assets.

Ever since the implosion of Enron, and decimation of participants’ 401(k) accounts that were invested in Enron stock, many people wonder and ask me what the dangers are to the employee of investing plan assets in employer stock, and what the risks are to the employer of offering the employer stock on the menu of investment options. The answers to those questions could consume enough pages to fill a book, to say the least. Nevertheless, you should be careful about investing your nest egg in employer stock, especially anything more than a small percentage.

Recently, such an executive had been hired by a securities brokerage firm, and its bonuses were typically paid in employer stock. Peabody v. Davis, 2011 U.S. App. LEXIS 7449 (7th Cir. Apr. 12, 2011). In order to receive a bonus payment in cash, rather than in stock, the vice president had to invest funds in the stock. The only funds the VP had were in his IRA, which he rolled over into the employer’s ERISA covered defined contribution retirement plan, and then used those plan assets to buy the employer stock. Several years thereafter, as a result of the changes of markets’ pricing securities to the penny rather than in eighths of a dollar, commissions at such brokerages tumbled and the employer’s stock significantly declined in value.

A question arises whether the fiduciaries of the plan breach their duty of prudence by offering employer stock on the menu of investment options, but generally the choice is presumed to be prudent under Moench v. Robertson, 62 F.3d 553, 571 (3d Cir. 1995). Allowing even a heavy investment in employer stock generally will not violate the fiduciaries’ duty to diversify the plan assets in the case of Eligible Individual Account Plans, such as that in Peabody. But where there is a significant decline in the value of the employer stock, there will likely be a decision of questionable prudence by the fiduciaries to continue offering employer stock on the menu of investment alternatives.

If you with equity based compensation, or are investing retirement assets in employer stock, consult an ERISA lawyer.