Hardier Stock
Enron Corp. employees who gambled their life savings on nearly worthless company stock stood at the end of a very long line of creditors when the Houston energy giant collapsed. Enron executives have since stood trial on charges they instituted bogus businesses that masked the company’s true condition.
Meanwhile, Enron workers and others who say their bosses swindled them with bogus, homespun stock purchase plans have been quietly trying to get their money back. After the 2001 corporate scandals rattled the financial markets, employees filed scores of lawsuits targeting the corporations, officers, directors and outside advisers. Those suits largely have gone unnoticed behind the high profile civil and criminal securities fraud cases brought by large outside investors and the government.
But the employee lawsuits are beginning to mature and move closer to trial—with enormous implications riding on the outcome. Half the nation’s private pension assets—nearly $2 trillion—reside in individual 401(k) accounts. At least 20 percent of those holdings are in company stock.
“My guess is that there have been maybe a hundred cases in the last three years,” says New Orleans based defense lawyer Howard Shapiro. “These are big numbers, big cases and big damages.”
The number of beneficiaries also could be staggering, and the cases have drawn intense interest from amici supporting both management and workers, including the 36.5 million member AARP.
“About half our members are still working,” says Mary Ellen Signorille, senior lawyer with AARP Foundation Litigation. “As baby boomers get ready for retirement, they want to know whether they’ll have a secure source of income.”
Filed as class actions under the 1974 Employee Retirement Income Security Act, the worker suits can reach corporate defendants in places the securities laws sometimes find less accessible. Those laws require plaintiffs—outside investors and the government, trying to recover money and punish the guilty—to plead their complaints in excruciating detail. But ERISA plaintiffs have the relatively simple task of alleging a breach in the fiduciary duty company executives owe when they monkey with pension money.
“In other words, they made an imprudent investment,” says Seattle plaintiffs lawyer Lynn L. Sarko.
Victory for Workers
The ERISA suits’ viability remained in doubt until late winter when the en banc 5th U.S. Circuit Court of Appeals at New Orleans reversed a panel decision and held that a group of pilots could sue their employer over its handling of their accounts. Milofsky v. American Airlines Inc., No. 03 11087 (March 2). The 3rd U.S. Circuit Court of Appeals at Philadelphia reached a similar result last summer. In re Schering Plough Corp., 420 F.3d 231 (Sept. 15).
The divided 5th Circuit panel initially had denied the workers’ standing because the class action would affect only 218 accounts and not all plan participants. Critics, including lawyers from the U.S. Department of Labor, ridiculed the initial outcome as absurd because it would be too easy for employers to dodge liability if plaintiffs had to prove damage to each and every account.
“That result would leave most participants in 401(k) plans covered by ERISA unprotected from fiduciary violations,” the Labor Department argued in an amicus brief. Financial advisers long have counseled against reliance on company stock for retirement income. While all stocks carry risks, a worker heavily steeped in employer stock can wind up both unemployed and broke should the company go down the tubes. Employers believe company stock ownership breeds worker loyalty. Besides, it’s cheaper for a company to match employee contributions with stock than cash.
But the relationship between workers and their bosses as pension plan administrators differs from that between brokers and shareholders who purchase securities in the market. While “buyer beware” serves as the rule for open market purchases, executives in charge of internal company stock plans become fiduciaries, placing them on the law’s highest level of trust.
To be sure, company stock in recent years has declined as a percentage of total pension plan assets, from a peak of 35 percent in 1999 to 20 percent in 2005, according to a survey conducted by Hewitt Associates, a suburban Chicago human resources firm. But when Hewitt surveyed workers in 2004, company stock was the average plan participant’s single largest holding, accounting for 26.5 percent of total balances. The figure climbed to 40.8 percent when Hewitt eliminated from the survey sample workers whose plans didn’t offer company stock.
Limited Employer Disclosure
While ERISA requires management to make extensive disclosures to participants in company stock plans, significantly it does not require employers to advise of the in vestment risks and the benefits of diversification. So Enron stock probably was a cinch for the company’s officers and directors to peddle to employees.
The stock had been performing unremarkably during the 1990s, posting no significant gains. But in 1997, Enron decided to diversify beyond its core business of natural gas production and distribution. As company officials promoted Enron’s new ventures, the public and the stock markets reacted favorably, sending Enron’s price per share from about $40 in mid 1999 to a high of $90 in August 2000. By April 2001, Enron ranked as the nation’s seventh largest company on the Fortune 500 list.
Besides outside investors, Enron employees gobbled up shares. By early 2001, some 20,000 Enron workers held more than $1.3 billion in company stock in their 401(k) accounts. It’s well known what happened next.
Enron is in the process of settling its workers’ claims; Sarko figures that employees will average about 27 cents on the dollar when it’s all over. Settlements are also in the works in other visible symbols of corporate scandal, such as WorldCom Inc. and Global Crossing Ltd. Lawyers on both sides see the real tests coming in cases where corporate wrongdoing is less clear cut.
“To date, it has been an easier lawsuit to plead because there has been a uniform failure by companies to fulfill their fiduciary duties,” says Sarko, lead plaintiffs counsel in ERISA cases against Enron, WorldCom, Global Crossing and more. “So far, it’s been easy pickings.”
But Milofsky and Schering Plough may suggest a less positive trend than plaintiffs lawyers would have hoped for. Both cases reached the appellate level as the result of rare successful motions to dismiss. Defense lawyer Shapiro figures 85 percent of motions to dismiss fail in ERISA cases because trial judges are reluctant to grant them without seeing at least some factual development of the allegations.
“The motions to dismiss are not going very well,” Shapiro acknowledges. “But the summary judgments are going very well for the defendants.”
Though company stock is an important component of employee portfolios, mutual funds remain the overwhelming favorite in 401(k) plans. But when a particular stock in a mutual fund fails to perform as expected, fund managers replace it and the participants are none the wiser.
Company stock, however, remains especially susceptible to ERISA claims. It typically sits in its own fund, which enables shareholders—and trolling plaintiffs lawyers—to see for themselves its ups and downs in the market. Shapiro worries that some investors may panic and run to court with allegations of fiduciary breaches in instances that actually turn out to be normal market fluctuations.
“You don’t day trade on your retirement investment,” he says.
What’s more, Shapiro says, ERISA suits involving company stock can go much deeper and do more damage than the fiduciary violations they attempt to rectify.
“When the plaintiffs are saying that this stock is so imprudent it shouldn’t be in your plan, they’re not just attacking the plan,” he says. “They’re attacking the company’s business model itself.”
Philadelphia plaintiffs lawyer Peter H. LeVan Jr., who argued Schering Plough, has some simple advice for companies that want to avoid being called imprudent in ERISA litigation.
“One way for a company to insulate itself from these kinds of suits is to turn [its stock plan] over to an independent fiduciary,” he says. “But they don’t want to do that because they lose control.”
