Pensioners save little by little most of their working life, sharing the spirit of Leonard Cohen’s soulful lyrics about hoped-for independence: ‘Like a bird on a wire, I have tried in my way to be free.’ Unfortunately, many at Enron, Tyco and WorldCom have ended up as birds on a wire with little freedom and few retirement benefits.
Cohen himself had his investment fund recently pillaged and wiped out by his own fund managers. Forensic accountants discovered that $8.4 mn had evaporated in questionable transactions. He went to court to get it back and succeeded, only to have lawyers’ fees take what was left. Cohen, 70 years old and broke, now has to go back to work to feed himself, a fate he has accepted with his legendary resignation and fatalism. But unlike this famous poet and singer, most of those bilked out of pension benefits do not have an artist’s license to print money.
They do, however, have an increasingly powerful case against those who mismanage pension funds. This is of importance to corporate officers who manage financial reporting because the cases brought by aggrieved pensioners are based for the most part on the fact that somehow, in some way, pensioners were not properly informed about their company’s stock in their 401K plan.
When Lynn Lincoln Sarko, managing partner at Keller Rohrback and co-lead counsel representing Enron pension plan participants, was asked if the current deluge of ‘stock drop’ cases by pensioners was ushering in a higher standard of corporate disclosure, he replied: ‘In a word, yes!’ A class of suit almost unheard of until the Enron fiasco and Sarko’s litigation, there have now been over 130 stock drop cases before the courts. Why is this important? Because the Employee Retirement Income Security Act (Erisa) is enforced under trust law and according to judgments under the law, the fiduciary duty of plan sponsors is ‘the highest known to the law.’We are looking at a much higher bar on corporate reporting.
Rocky ground for employee stock pensions
The employee stock ownership plan (Esop) and 401K investor who owns stock through a pension plan has been welcomed and then largely taken for granted by management. A recent Fortune survey shows that 86 percent of all Fortune 100 company 401K plans hold company stock. Figures are difficult to verify, but estimates indicate that at least 2,000 companies feature their own stock in their plans. Hewitt Associates’ 2005 survey noted that where the employer stock choice was available, only 25 percent of employees opted for it in 2005, down from 41 percent in 1991. Enron did not close the book on pension fraud and employee investor reporting requirements, it opened it.
Ken Lay’s famous words, ‘I love employee ownership. It is important to the company. But in the future we will be doing it differently,’ still attract attention. ‘His words remain sizzling in my mind,’ recollects fellow Texan Michael Keeling, president of the Esop Association, with both anger and irony in his voice. In any case, Lay was at least right on this one. The birds are now getting revenge, big time.
On the legislative side, the big bird of prey chasing irresponsible management is the Pension Protection Act of 2006 (PPA), sometimes referred to as the Enron Act. The PPA puts more fiduciary and reporting requirements on management’s shoulders, including an annual report to plan participants, and sets stringent requirements on various liquidation and diversification issues.
Christopher Rillo, a partner at Groom Law Group, cites the Guidant case to illustrate the ambiguities of this litigation. Guidant’s stock price dropped due to a product recall, only to soar when a takeover bid materialized, and the case went before the courts. Another case Rillo mentions is that of WR Grace, where pension fiduciaries were sued because they held onto the stock for too long while the price plummeted, and in another class action because they sold the stock prematurely at too low a price. In two cases decided in 2006, those of State Street Bank/United Airlines and US Airways, the judiciary decided that maintaining company stock in a plan was not necessarily imprudent.
Doing more harm than good
One of the most patient perspectives comes from Janis Gregory, senior VP of the Erisa Industry Committee, who reflects: ‘I hope that in the long term we don’t look back and realize we did more damage than good.’ There is some statistical evidence indicating that both employers and employees are pulling away from 401K plans. Gregory comments that philosophical reasons for shared ownership rather than financial gain are, in her view, the inspiration for most Esops.
Yet stock drop cases have been divisive, expensive and time consuming. Beyond litigation and settlement costs, fiduciary insurance costs have risen and policies have become more restrictive. Some cases are based on regulations governing plan management and fiduciary duties, but almost all feature the point that corporate insiders did not act to fulfill their fiduciary responsibilities in terms of financial reporting.
Rillo emphasizes the importance of a well-thought-out defense strategy involving pension portfolio reassessments, consistency of reporting, procedural prudence, plan and fiduciary restructuring, and a host of other factors, but one of his main points of emphasis is on the need to rethink communications and reporting. Stock drop litigation is of concern to IROs and others providing corporate financial information because participant communications are one of the most frequent and controversial elements of litigation. The divide between what a fiduciary overseeing a pension plan must report to a plan participant and act upon, and what a company director is obligated to report to other investors, is an issue that is being defined in the courts.
