Litigation Likely

Experts warn companies that this generational disillusionment is likely to translate into a spike in lawsuits against corporations that don't take to heart Benna's warning about protecting participants' interests. Only a handful of 401(k)-related lawsuits were filed during most of the carefree 1990s. Then suddenly, in 1999, Washington-based law firm Sprenger & Lang went on the warpath with two watershed actions, both against First Union Corp., for liquidating the defined contribution plan of Signet Bank employees after it acquired Signet and for failing to offer First Union employees a choice of non-proprietary investment funds.

First Union agreed to settle the claims against it for $26 million, and only a few months later, SBC Communications Inc. agreed to pay $10 million plus to settle charges it inappropriately liquidated $635 million worth of a competitor's stock held in SBC's sponsored plan. "Five years ago, you could count the number of [401(k)-related] lawsuits on one hand," says attorney Eli Gottesdiener, a former Sprenger & Lang partner now pursuing a class action on behalf of 24,000 current and former Enron Corp. employees whose (k) plans were decimated by the company's bankruptcy. Gottesdiener estimates that companies today are facing "a couple dozen" suits attacking their 401(k) protocol, with damages running into the hundreds of millions for the Enron case alone.

Congress Chimes In

If this were not enough to make employers squirm, Washington has thrust another wild card into the deck as Congress ponders several proposals aimed at protecting (k) plan participants from future scandals. By press time, the only retirement-related issue the federal government had followed through on was a new law that makes executives and directors play by the same "no trading allowed" rule as plan participants during the blackout periods that occur with changes in plan administrators. But by mid-October, President Bush may also sign legislation that could, among other things, require companies to allow workers to sell company stock after three years of receiving it or after three years of service and ensure them 30 days notice before a blackout period begins. The business community is also lobbying furiously against a provision, proposed by U.S. Sen. Ted Kennedy (D-Mass.), that would force companies to choose between using company stock to fund company matches on 401(k)s and offering company stock as an investment option.

So what should a forward-thinking CFO do to protect the company's 401(k) from litigation? Don't wait for lawmakers or plaintiff lawyers to come knocking: Whether you agree or not with the so-called reforms, you should aggressively be analyzing plans for vulnerabilities.

Here is a list of the biggest potential landmines and ways to maneuver safely through them:

Do you offer company stock as an investment option while also using it to fund the company match?

This is a hot issue because so many 401(k)s are in trouble at various struggling companies not because of the drop in equity markets, but because of the heavy concentration of company stock in individual accounts. Sure, you can argue that participants in most cases purposely accumulated the stock. But why have to "argue the case" at all?

First, you should analyze carefully how necessary it is for the company to use stock for both the match and as an investment option. As part of its due diligence, management needs to look at what other companies of similar size and industry are doing. The last step is essential for compliance with Erisa's standard of prudence, says Christine Kellogg, senior retirement consultant at Mercer Human Resource Consulting. "You can't just stick your head in the ground."

Then, you should determine the concentration of company stock holdings among your plan participants. If it seems excessive, you can begin to educate them on the merits of maintaining a balanced portfolio–without making specific recommendations. The company must also allow employees to sell company stock, including stock from the match, without too many additional restrictions.

If you decide to stick with a company stock option in your plan, make sure that an independent consultant is monitoring that decision alongside other investment choices, says Gottesdiener.

Does your provider charge relatively high management fees?

The impact of high fees becomes much more apparent–and painful–in a down market when plan participants aren't happy anyway. If your provider wants to charge anything close to 200 basis points for fund management alone, drop it, says Mercer's Kellogg. Larger plans should get a break on the investment management fee. Depending upon whether management is active or passive, utilizing mutual funds or institutional funds, the price for a $1 billion-plus plan can run anywhere from eight to 120 basis points, says Ward Harris, managing principal with McHenry Consulting Group LLC in Berkeley, Calif. But fees for a company's bundled product are based on the makeup and level of sophistication of a plan population, not necessarily size, with companies paying more for less sophisticated participants, since a financially savvy employee is more likely to have access to computer technology and use it for maintenance of his plan.

How much education does your company provide on the need to invest?

Companies need to look at the long-term picture. If boomers hit old age with insufficient resources, the competitive pressure will mount for companies to provide defined-benefit pensions, as employees begin to seek out employers that provide them. Given that defined contribution plans are significantly cheaper to maintain, it pays to spend time educating employees on the need to save–and save enough.

The Gap Inc., for instance, has watched participation in its $287 million 401(k) climb to 61% from 40% since July 2001, when it initiated automatic enrollment for eligible participants in a balanced fund option at a 2% salary deferral. Employees can, of course, opt out, but before the end of the year, the company plans to write to the new participants reminding them that 2% isn't nearly enough. "We'll tell them that at that rate, you most likely won't have the financial security at retirement that you intend to," says Bernie Knobbe, Gap Inc's senior director of compensation and benefits.. "We will also remind them they have numerous investment fund options in addition to the balanced fund, and we would prefer [them to] eventually make their own investment decisions."

Meanwhile, Philips Electronics North America Corp. is also experimenting to see if employees will agree in advance to devote future pay increases to retirement savings–even if they refuse to sock away more of their regular paychecks. Initial results are encouraging: 16% of the hourly employees in the company's semiconductor division have agreed to deferral hikes of 1% to 3% timed to coincide with regular salary increases, says Lisa Pyne, Philips' benefits director.

Is your company educating workers on safe investing?

Employees can sock away all they want, but if they put 90% in, say, a biotech fund or even your company's stock, then they may have to postpone retirement. Getting an independent voice to talk to them about the need to balance their portfolio could be helpful–particularly if your plan indirectly promotes your company's stock through the match and as an investment option.

Protecting employees from themselves can help you in the end, so don't rush out to offer investment options that could get them–and you–in hot water. At General Motors Corp., the $20 billion defined contribution plans handle the disparity in participants' financial sophistication levels by making sure to offer something for everyone. For instance, those who feel they have "no time at all" to commit to retirement planning are directed to a series of lifestyle funds that are rebalanced regularly by professional money managers.