New best practices are emerging for company stock in DC plans

A new Russell Investments research paper revisits the role of company stock in a defined contribution (DC) plan. It’s a role that is changing.


Is the company stock option just a legacy feature of DC 1.0?

As DC plans have shifted from being primarily supplemental savings plans to becoming the primary retirement savings vehicle for a huge number of Americans, their design has evolved. Many aspects of that evolution are clear: the importance of choice architecture and the role of default options; increased focus on lifetime retirement income; and so on. But one question that is not fully resolved as this new design takes shape is the question of what role the company stock option should play.

The reason it can be a problem is that company stock is volatile, much more so than a diversified portfolio. Nobody complains when that means an increase in value, but if the company stock falls sharply in value, fiduciaries can find themselves on the back foot.

A spotlight has been thrown on this question by a number of stock drop lawsuits, in which fiduciaries have been accused of failing in their duty to put plan participants’ interests first. Of particular importance is Fifth Third Bancorp v. Dudenhoeffer, in which the U.S. Supreme Court essentially re-wrote the script for how these lawsuits were to be framed. So the lawyers will stay busy.  But it’s given fiduciaries cause to re-think their strategy.

Some are deciding that the company stock option is not worth the trouble. According to a survey by the Plan Sponsor Council of America, among plans with more than 5,000 participants, 48.5% included a company stock option in 2013 (the percentage is much lower for smaller plans), slightly down from previous years. But the same survey found, remarkably, that among those who do offer the option, company stock represents roughly 20% of plan assets. That’s a big number, and it means that a large number of plan participants have a concentrated exposure to a single stock in their retirement plan: a single stock which, as it happens, is the same company that pays their wages each week or month. So this remains a significant component of many DC plans.

The new best practices that are emerging

For plan fiduciaries who do continue to offer a company stock option, Mark Teborek’s recent paper identifies a number of actions that are being taken in order to ensure that plan participants are protected and, by extension, that the likelihood of a lawsuit is minimized. These include plan design features to guard against over-allocation, and ensuring that descriptions of the option—in plan documents and employee communications—are unambiguous and accurate. The process for evaluating the appropriateness of the option is another area of attention, possibly including an independent fiduciary as part of that process. And there may be a formal definition of what would determine a “special circumstance” in which the market price may not be relied upon as a reasonable measure of stock value.

There’s a new world of DC plans, in which the auto-features and choice architecture are the order of the day. In this new world, it’s reasonable to expect that the company stock option will play a diminished role. But not every DC plan is the same, and we do not expect this option to disappear completely.  For those who do continue to offer it, new best practices are emerging to make sure that the company stock option is not out of place in the changed world of DC 2.0.

 


USI-23330-12-18
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