Employer Stock in Retirement Plans: Investment Risk and Retirement Security

CRS Report for Congress
Employer Stock in Retirement Plans:
Investment Risk and Retirement Security
Updated January 28, 2003
Patrick J. Purcell
Specialist in Social Legislation
Domestic Social Policy Division

Congressional Research Service ˜ The Library of Congress

Company Stock in Retirement Plans:
Investment Risk and Retirement Security
Summary
The financial losses suffered by participants in the Enron Corporation’s 401(k)
retirement plan received wide publicity and prompted questions about the laws and
regulations that govern these plans. In the wake of the Enron bankruptcy, numerous
bills were introduced in the 107th Congress with the intent of protecting workers
from the financial losses that employees risk when they invest a large proportion of
their retirement savings in securities issued by their employers. Enron is not the only
company whose employees and retirees have seen the value of their retirement
accounts reduced by a plunge in the company’s stock price. Employees of Rite Aid,
Lucent Technologies, Nortel Networks, Qwest Communications, the Williams
Companies, Providian Financial Corporation, IKON Office Solutions, Global
Crossing, and WorldCom also have had their retirement accounts substantially
reduced by sharp drops in the price of the companies’ stock.
This CRS Report begins by describing the shift from traditional defined benefit
pensions to defined contribution plans – like the 401(k) – that has occurred over the
last 20 to 25 years. It then summarizes recent research findings on the extent to
which employees’ retirement savings are invested in employer stock. The third
section of the report outlines the provisions of federal law that define an employer’s
duty to manage its retirement plan in the best interest of the plan’s participants. The
report concludes with a summary of pension reform legislation passed by the House
of Representatives in April 2002 and a description of several pension reform bills
that were introduced in the Senate in 2002.
Neither the Employee Retirement Income Security Act (ERISA) nor the Internal
Revenue Code limit the proportion of assets in a defined contribution plan that can
be invested in “qualifying employer securities,” called “employer stock” or “company
stock.” Experts state that individuals who concentrate assets in employer stock
assume unnecessary risk, because for any expected rate of return from employer
stock there is a diversified portfolio that will provide the same rate of return with less
investment risk. Although some employees might realize substantial gains by
investing their retirement accounts in employer securities, all market participants will
in the aggregate earn the market rate of return. There will be winners among workers
who choose to invest heavily in employer stock, but there also will be losers.
A CRS analysis of forms filed with the Securities and Exchange Commission
by 278 firms showed that, on average, company stock comprised 38.0% of the assets
in their defined contribution plans. The median concentration of company stock was
24.7%. Both figures are higher than the 10% to 20% that many investment advisors
recommend as the maximum exposure to a single firm’s securities. A statistical
analysis showed that three variables had positive and statistically significant
relationships to the percentage of plan assets invested in company stock: (1) making
the company matching contribution with company stock, (2) an average annual total
return on company stock that exceeded the return on the S&P 500 over the previous
three years, and (3) the size of the company measured in terms of total assets.

Contents
In troduction ..............................................1
I. Overview of Employer-sponsored Retirement Plans.................1
The two types of retirement plan..............................1
Reasons for the shift to DC plans.............................3
ERISA and the decline of the defined benefit plan................3
The Revenue Act of 1978 and the rise of the “401(k)”.............4
II. The Role of Company Stock in Retirement Plans..................6
Company stock and investment risk...........................6
Company stock and investment choice.........................7
Employee ownership vs. retirement income security...............8
How much company stock is in retirement plans.................8
CRS analysis of the S.E.C. Form 11-K........................10
Multivariate analysis......................................14
III. ERISA and Company Stock in Retirement Plans.................15
Fiduciary duties under ERISA...............................16
Who is a fiduciary under ERISA?............................16
Fiduciary responsibility in an employee-directed plan............18
Employer stock in an ERISA § 404(c) plan.....................19^th
IV. Bills in the 107 Congress..................................22
H.R. 3762...............................................22
Senate bills..............................................23
Appendix A: Regression Results................................28
Form of the model and summary statistics.....................28
References ..................................................33
List of Tables
Table 1. Retirement Plans and Participants, by Type of Plan................2
Table 2. Company Stock in Defined Contribution Plans ..................10
Table 3. Company Stock Concentration by Firm Characteristics............13
Table A-1. Regression Analysis of Company Stock in 2000...............31
Table A-2. Mean and Median Employment, Revenues, and Assets in 2000...32

Company Stock in Retirement Plans:
Investment Risk and Retirement Security
Introduction. The financial losses suffered by participants in the Enron
Corporation’s 401(k) retirement plan received wide publicity and prompted questions
about the laws and regulations that govern these plans. In the wake of the Enron
bankruptcy, numerous bills were introduced in the 107th Congress to protect workers
from the financial losses that employees risk when they invest a large proportion of
their retirement savings in securities issued by their employers. Enron is not the only
company whose employees and retirees have seen the value of their retirement
accounts reduced by a plunge in the company’s stock price. Employees of Rite Aid,
Lucent Technologies, Nortel Networks, Qwest Communications, the Williams
Companies, Providian Financial Corporation, IKON Office Solutions, Global
Crossing, and WorldCom also have had their retirement accounts substantially
reduced by sharp drops in the price of the companies’ stock.
This CRS report begins by describing the shift from traditional defined benefit
pensions to defined contribution plans – like the 401(k) – that has occurred over the
last 20 to 25 years. It then summarizes recent research findings on the extent to
which employees’ retirement savings are invested in employer stock. The third
section of the report outlines the provisions of federal law that define an employer’s
duty to manage its retirement plan in the best interest of the plan’s participants. The
report concludes with a summary of pension reform legislation passed by the House
of Representatives in April 2002 and a description of several pension reform bills
that were introduced in the Senate in 2002.
I. Overview of Employer-sponsored Retirement Plans
The two types of retirement plan.Over the past two decades, the
proportion of American workers who participate in employer-sponsored retirement
plans has remained relatively steady. In 1979, 46% of all workers participated in
employer-sponsored retirement plans, while in 2000, an estimated 47% of all workers
participated in such plans.¹ Although the overall rate of participation in employer-
sponsored retirement plans has changed very little over this time, there has been a
shift in the distribution of plans and participants from defined benefit plans to defined
contribution plans. (See Table 1). In a defined contribution plan, it is usually up to
the employee to decide whether or not to participate, how much to contribute to the
plan, and how to invest these contributions. Consequently, workers today bear more
of the responsibility of providing for their retirement than when defined benefit plans
were the dominant form of plan.

¹ Retirement plan participation rates for the civilian workforce age 16 and older in 1979 and

2000 are based on the April 1979 and March 2001 Current Population Surveys, respectively.

Table 1. Retirement Plans and Participants, by Type of Plan
DefinedDB planDefinedDC plan
Yearbenefitparticipants contributionparticipants
plans (thousands) plans (thousands )
1979 139,489 29,440 331,432 17,489
1980 148,096 30,133 340,805 18,893
1985 170,172 29,024 461,963 33,244
1990 113,062 26,344 599,245 35,488
1995 69,49223,531623,91242,662
1996 63,65723,262632,56644,625
1997 59,49922,745660,54247,979
1998 56,40522,994673,62650,335
^So^urce^{: U.S. Dep}^a^r^t^m^eⁿ^t^o^f^L^a^b^o^r^{, P}^eⁿ^s^ioⁿ^&^W^e^lf^ar^{e B}^eⁿ^e^f^{its A}^d^mⁱⁿⁱ^str^a^tioⁿ^.
Employers sponsor retirement plans voluntarily, but those who choose to do so
must abide by the requirements of the Employee Retirement Income Security Act of

1974 (P.L. 93-406), popularly known as ERISA. In order for a plan to be tax-

qualified – that is for contributions to the plan and investment earnings on those
contributions to be eligible for deferral of federal income taxes – the plan must also
comply with the relevant sections of the Internal Revenue Code of 1986. Employer-
sponsored retirement plans are legally classified as either defined benefit plans or
defined contribution plans. In a defined benefit or “DB” plan, the retirement benefit
is usually paid as a lifelong annuity based on the employee’s length of service and
average salary in the years immediately preceding retirement. DB plans are funded
by employer contributions to a pension trust. The contributions and investment
earnings must be equal to the benefits that workers accrue each year. In a defined
benefit plan, the investment risk is borne by the employer. If the value of the pension
trust is not equal to the present value of the plan’s accrued obligations, the plan’s
sponsor is required to make up this shortfall – called an unfunded liability – through
additional contributions over a period of years. Defined benefit plans are insured up
to certain limits by the Pension Benefit Guaranty Corporation (PBGC). Defined
contribution plans are not insured by the PBGC.
The Internal Revenue Code designates plans that provide individual accounts
for each participant and that pay benefits based solely on the contributions to the
accounts and subsequent investment gains or losses as defined contribution plans.²
The most common defined contribution plan is the 401(k), named for a section of the
Internal Revenue Code that was added by the Revenue Act of 1978 (P.L. 95-600).
Under ERISA and the tax code, a 401(k) plan is both a “defined contribution plan”
and an “individual account plan.” In a 401(k) plan, the employee as well as the
employer can make pre-tax contributions to his or her account. Typically, the
participants can allocate the investment of their account balances among a menu of
investment options selected by the employer and/or a plan administrator appointed
by the employer. Employer stock (also called company stock) is often one of those

² Any plan that does not fit this definition is classified as a defined benefit plan. See 26
U.S.C. § 414(i) and § 414(j).

options. In a defined contribution plan, the participant’s retirement benefit consists
of the balance in the account, which is the sum of all the contributions that have been
made plus interest, dividends, and capital gains (or losses). The participant usually
has the choice of receiving these funds in the form of a life-long annuity, as a series
of fixed payments over a period of years, or as a lump sum.
In recent years, many large employers have converted their traditional DB plans
to hybrid plans that have characteristics of both defined benefit and defined
contribution plans. The most popular of these hybrids has been the cash balance
plan. A cash balance plan looks like a defined contribution plan in that the accrued
benefit is defined in terms of an account balance. The employer (but not the
employee) makes contributions to the plan and pays interest on the accumulated
balance. However, in a cash balance plan, the account balances are merely a record
of the participant’s accrued benefit. They are not individual accounts owned by the
participants. Legally, therefore, a cash balance plan is a defined benefit plan.
Reasons for the shift to DC plans. Some analysts consider the decline in
the number of defined benefit plans to be an unintended consequence of the passage
of ERISA in 1974. Likewise, the growth in the number of defined contribution plans
is sometimes said to be, at least in part, an unexpected result of an amendment to the
Internal Revenue Code that was included in the Revenue Act of 1978.
ERISA and the decline of the defined benefit plan. The Employee
Retirement Income Security Act of 1974 was passed by Congress to protect the
interests of pension participants and beneficiaries in the private sector.³ ERISA was
enacted in response to instances in which pension funds had been mishandled or
plans had become insolvent. It also addressed certain obstacles to receipt of pension
benefits such as onerous age and length-of-service requirements. ERISA established
standards for private pension plans that make it more likely that pension participants
will receive the pension benefits that they have earned. For example, ERISA
requires defined benefit pension plans to be “fully funded.” This means that the
assets held by the pension fund must equal the present value of the benefits owed to
current retirees and to employees who have “vested,” i.e., who have earned the right
to receive benefits when they retire. If the assets in the pension fund lose value or
appreciate more slowly than vested benefits, the employer is responsible for the
shortfall. To maintain its fully-funded status, the plan must grow each year – through
employer contributions and investment earnings – by an amount equal to the increase
in the present value of the benefits accrued by the plan’s participants. The legal
requirement to keep the plan fully funded means that the employer is at risk for the
full value of the benefits that have been earned by the plan participants. Any assets
in excess of the amount needed to pay benefits are the property of the employer,
although these assets are subject to a federal excise tax of up to 50% if they are used
for any other purpose than to provide pensions or retiree health benefits.
In addition to the financial risk assumed by an employer that sponsors a DB
plan, there are ongoing administrative expenses for maintaining the plan’s records,

³ Legally, both defined benefit plans and defined contribution plans are pension plans.
ERISA applies to both kinds of plan, although it prescribes separate rules for each type.

processing changes in information for plan participants, assuring that the plan
remains in compliance with relevant regulations, and paying insurance premiums to
the Pension Benefit Guaranty Corporation (PBGC). Estimating the present value of
the benefits that have been earned under the plan requires an actuary to forecast the
ages, lengths of service, and salaries of the plan sponsor’s employees many years in
the future. If at any point the plan becomes “under-funded,” the firm must restore it
to fully-funded status over a period of years or risk losing its tax-qualified status, a
consequence that can result in substantial taxes and penalties. Furthermore, if a
pension plan develops an unfunded liability, this liability must be displayed in the
firm’s financial statements.⁴ The standards established under ERISA have made
workers’ pensions more secure; however, many employers – especially small
employers – have said that the cost of complying with ERISA has made DB plans
prohibitively expensive to administer.
The Revenue Act of 1978 and the rise of the “401(k)”. The decline in
the number of DB plans began at nearly the same time that the number of defined
contribution plans – particularly “401(k)” plans – began to rise rapidly. Section
401(k) was added to the Internal Revenue Code by the Revenue Act of 1978, but it
was not until 1981 – after regulations had been published by the IRS – that the first
401(k) plan was established. Defined contribution plans existed before the Revenue
Act of 1978, but it was only after the advent of the 401(k) that DC plans overtook
traditional defined benefit pensions in number of plans, participants, and total assets.
Earlier defined contribution plans had been funded exclusively by employer
contributions. In a 401(k) plan, however, the employee as well as the employer can⁵
make contributions with pre-tax income. The ability of both the employer and the
employee to contribute on a pre-tax basis and the voluntary nature of employee⁶
participation are defining characteristics of the 401(k) plan. These characteristics
place much responsibility on the participant, who must decide whether or not to
participate in the plan, how much to contribute, and how to invest the contributions.
Defined contribution plans are relatively less burdensome to administer than
defined benefit plans because they do not require actuarial forecasts of future
employment, salaries, and benefit obligations. Nor is the cost of funding a DC plan
as variable and unpredictable as the cost of funding a DB plan. Because the benefit
provided by the plan is equal to the account balance, a DC plan is by definition fully
funded at all times. In a DC plan, the employer makes no promise about the amount
of benefits to be paid during retirement. The firm merely commits itself to making
contributions of a certain amount or a certain percentage of pay during the
employee’s tenure with the employer. These contributions are sometimes
conditioned on the employee also making contributions. Defined contribution plans
are not insured by the PBGC, and so the firm pays no PBGC insurance premiums.

⁴ The reverse is also true. Should the plan become over-funded, the excess assets can be
entered on the firm’s balance sheet. Financial reporting of pension fund liabilities is
governed by the Financial Accounting Standards Board’s statement 87 and statement 132.
⁵ The option to defer current cash income and to deposit that amount into an individual
account is the reason that the 401(k) is sometimes called a cash or deferred arrangement.
⁶ A growing number of firms are enrolling all eligible employees in their 401(k) plans, so
that the default condition is for the employee to be enrolled with the option to quit the plan.

In a DC plan it is the employee who bears the risk that the contributions to the
plan and subsequent investment earnings will be sufficient to provide an adequate
income during retirement. If the contributions made to the account by the employer
and the employee are too small, or if the securities in which the account is invested
lose value or increase in value too slowly, the employee risks having an income in
retirement that cannot sustain his or her desired standard of living. If this situation
occurs, the worker might choose to delay retirement. The principal kinds of defined
contribution plan are listed in Exhibit 1.
Exhibit 1. Principal Types of Defined Contribution Plans
A. Qualified plans under Internal Revenue Code § 401(a)
1. Money purchase pension plans
a. Traditional money purchase plans
b. Target benefit plans
c. Thrift plans (other than profit sharing plans)
2. Profit sharing plans
a. Traditional profit sharing plans
b. Thrift plans
c. Cash or deferred arrangements (I.R.C. § 401(k))
3. Stock bonus plans
a. Traditional stock bonus plans
b. Employee stock ownership plans (ESOPs)
4. Voluntary employee contributions under qualified plans
B. Tax-deferred annuities under I.R.C. § 403(b)
C. Deferred compensation plans for state and local governments and
tax-exempt organizations under I.R.C. § 457
D. Individual retirement accounts (IRAs and SIMPLE plans) under I.R.C. § 408
E. Non-qualified plans (Plans that do not qualify under the Internal Revenue Code)
^Source:^{McGill A}ⁿ^d^Gr^u^b^b^s^,^Fundam^ent^a^l^s^of^Prⁱ^v^at^{e Pens}ⁱ^ons^{, 6}^th^ed^itioⁿ^.
II. The Role of Company Stock in Retirement Plans
Company stock and investment risk. As noted earlier, a fundamental
characteristic of defined contribution retirement plans is that the employee bears the
investment risk, which is defined as the risk of loss inherent in the purchase of
stocks, bonds, and other financial assets. An investor who understands the risk and
return characteristics of stocks and bonds, and who has a well-defined set of
preferences for one set of risk-and-return characteristics versus another, will be able
to allocate his investments in a way that balances his tolerance for risk with the
expected rate of return from each kind of investment. For example, an informed
investor understands that the risk of loss associated with holding a single stock is
always greater than the risk of loss associated with holding a well-diversified stock
portfolio of the same value. Recent research seems to indicate, however, that many

401(k) plan participants have a poor understanding of investment risk. As a result,

they may make choices about the allocation of their investments that are not well-⁷
informed decisions.

⁷ Benartzi & Thaler, “How Much Is Investor Autonomy Worth?” Journal of Finance, 2002.

When an individual chooses to allocate a large proportion of his or her total
assets to a single security – such as employer stock – instead diversifying among a
range of stock and bond mutual funds, that person is assuming more risk than is
necessary to achieve a particular expected rate of return. Some workers who invest
in employer stock may do so out of loyalty or because they enjoy the feeling of being
an owner-employee. Others may believe that their employers’ stock will outperform
the overall market over some particular time horizon. Nevertheless, for any given
expected rate of return, there exists a diversified portfolio of assets that will provide
the same expected rate of return with less risk to the investor than a portfolio
concentrated in company stock. Economists have estimated that a portfolio invested
in the stock of a single firm listed on the New York Stock Exchange is, on average,
twice as risky in terms of price volatility as a well-diversified portfolio of stocks.⁸
A portfolio invested in a single firm listed on the NASDAQ – with its more volatile
stock prices – was three-and-a-half times as risky as a well-diversified portfolio.
There is no governmental insurance plan for defined contribution plans as there
is for defined benefit plans.⁹ There is, however, a financial mechanism through
which investors can purchase a form of insurance against the possibility that a
particular security will drop in value. By purchasing an option known as a “put,” an
investor can insure against the possibility of a security declining in value within a
period of time that is specified in the option contract. If the stock falls below the
value defined in the contract, the seller of the option must pay the investor the
amount guaranteed by the contract. The price of the put option, therefore, is much
like an insurance premium. If the stock price does not fall by the specified amount,
the investor loses the amount that he or she paid to purchase the option contract;
however, if the price of the stock collapses and has not recovered by the date
specified in the option contract, the investor is assured of getting back the amount
guaranteed in the option contract. An option could be designed to guarantee the
purchaser the better of the actual rate of return on a company’s stock or the rate of
return of a stock market index. Such options, however, would likely be priced
beyond the reach of all but the most affluent investors.¹⁰ Moreover, not all company
stocks have underlying options that trade on an exchange.
Company stock and investment choice. Many public policy analysts
have studied the extent to which defined contribution plans are invested in employer

⁸ Lisa Meulbroek, “Company Stock in Pension Plans: How Costly Is It?” Harvard Business
School Working Paper 02-058, March 2002. Meulbroek emphasizes that “the cost of
holding company stock . . . is a function not of the level risk of holding a single-stock
portfolio, but the lack of compensation received for bearing that risk.”
⁹ Defined benefit pension plans are insured up to certain limits by the Pension Benefit
Guaranty Corporation (PBGC), a publicly chartered corporation that was established by the
Employee Retirement Income Security Act of 1974 (P.L. 93-406). For more information, see
CRS Report 95-118, “The Pension Benefit Guaranty Corporation: A Fact Sheet.”
¹⁰ Krishna Ramswamy, “Company Stock and DC Plan Diversification,” prepared for the
Pension Research Council Conference at the University of Pennsylvania, April 2002. He
estimates that the premium for an option contract guaranteeing the better of the rate of return
on the stock or the rate of return of a well-diversified portfolio would be about $178 per year
for each $1,000 of stock held, a cost that “will appear prohibitive to most investors.”

stock and have attempted to identify the reasons that employers and employees take
on this risk. One hypothesis is that many participants in 401(k) plans divide their
contributions proportionally among all the investment options offered by the plan.¹¹
In a plan with six investment options, for example, many participants will direct one-
sixth of their contributions to each fund. The investment choices of workers who
follow this “1/n” investment strategy do not appear to be strongly sensitive to the
kind of investment options offered (whether equity funds or bond funds) and,
consequently, “the array of funds offered to plan participants can have a surprisingly
strong influence on the assets they end up owning.”¹² Research has found that when
company stock is offered as an investment option, it comprises a substantial
proportion of plan assets. For example, in a sample of 170 large plans, plan assets
were split almost evenly between equities (stocks) and fixed-income investments
(bonds) in the 103 plans that did not offer company stock as an investment choice.
In the 67 plans that allowed employees to invest in company stock, however, 42% of
the plan assets were invested in company stock, 29% in other equities and 29% in
fixed-income investments.¹³
Another recent study found that employees’ tendency to purchase company
stock is strongly influenced by the stock’s past performance.¹⁴ Employees may tend
to “excessively extrapolate” past gains into the future, leading them to invest
relatively more heavily in employer stock than employees of firms whose stock has
experienced average or below-average performance. Workers whose employers make
matching contributions in the form of company stock also appear to be more likely
to purchase company stock than workers who are able to direct the company’s
matching contribution to investments of their own choice. Economists have
suggested that employees see the company’s choice to make its matching
contribution with company stock as a form of “implicit investment advice.” Workers
may interpret it as an endorsement of the company’s stock as an appropriate
investment for their retirement account. Although the past performance of company
stock appears to have a substantial effect on workers’ investment choices, economists
generally agree that past gains are a poor predictor of a stock’s future performance,
and that “chasing past returns is not an optimal strategy” for investors to follow.¹⁵

¹¹ Shlomo Benartzi and Richard Thaler, “Naive Diversification Strategies in Defined
Contribution Savings Plans,” American Economic Review (91, 1), March 2001, pp. 79-98.
¹² Benartzi and Thaler, 2001, page 81.
¹³ Benartzi and Thaler, 2001, page 95. This finding is supported by the Employee Benefit
Research Institute (EBRI) and Investment Company Institute (ICI) data base representing
more than 35,000 plans. These data show that in 2000, 70.4% of assets in plans that did not
offer employer stock as an investment option were invested in equity funds. In plans that
offered company stock as an option, 44.6% of plan assets were invested in equity funds and

31.8% in company stock. See EBRI Issue Brief 239, November 2001, Table 5, page 10.

¹⁴ Shlomo Benartzi, “Excessive Extrapolation and the Allocation of 401(k) Accounts to
Company Stock,” Journal of Finance (56, 5), October 2001.
¹⁵ Paul Sengmuller, “Performance Predicts Asset Allocation: Company Stock in 401(k)
Plans,” Columbia University, Department of Economics, April 2002, page 31.

Employee ownership vs. retirement income security. Olivia Mitchell
of the University of Pennsylvania and Steven Utkus of The Vanguard Group have
estimated that 23 million people have access to company stock through defined
contribution retirement plans. Of this number, they estimate that 11 million hold
concentrated stock positions exceeding 20 percent of account balances. Of these, 5
million hold positions exceeding 60 percent of account balances.¹⁶ Mitchell and
Utkus suggest that because holding a high concentration of company stock increases
portfolio risk, such concentrations “will produce greater extremes in realized
retirement wealth as well as lower median wealth, than would a system of more
diversified investments.”¹⁷ Moreover, they find that the growth of defined
contribution plans that include large concentrations of company stock has “gradually
blurred the distinction between plans designed to enhance employee ownership and¹⁸
plans designed to maximize retirement security.” While some employees might
realize substantial gains by investing their retirement accounts in employer securities,
the authors observe that “investing in a single stock must be a zero-sum game across
investors, with all participants in the aggregate earning the market return.”¹⁹ In short,
while there will certainly be winners among workers who choose to invest their
retirement accounts in employer stock, there will just as certainly be losers, too.
How much company stock is in retirement plans. The most
comprehensive source of data on ownership of employer securities in defined
contribution plans is the Form 5500, which tax-qualified plans with 100 or more
participants must file each year with the Internal Revenue Service. In 1998, 52,278
defined contribution plans of all types with 100 or more participants filed the Form

5500. Among these plans, 16.6% of total assets consisted of employer securities.²⁰

Among 401(k) plans with 100 or more participants, employer securities comprised
15.3% of total plan assets in 1998.²¹ More recently, the Employee Benefit Research
Institute (EBRI) and the Investment Company Institute (ICI) reported on company
stock held by the 35,367 plans represented in the EBRI/ICI data base. They reported
that in 2000, company stock comprised 18.6% of the total assets held in 401(k) plans.
Among plans that held any company stock, it accounted for 31.8% of plan assets.²²

¹⁶ Olivia S. Mitchell and Steven P. Utkus, “Company Stock and Retirement Plan
Diversification,” Pension Research Council Working Paper 2002-4, April 2002, page 2.
¹⁷ Mitchell and Utkus, (2002), page 2.
¹⁸ Mitchell and Utkus, (2002), page 9.
¹⁹ Mitchell and Utkus, (2002), page 29.
²⁰ In 1998, there were 52,278 defined contribution plans with 100 or more participants. The
plans had 47.9 million total participants and 40.7 million active participants. Assets totaled
$1.645 trillion, of which $273.2 billion were employer securities. (U.S. Dept. of Labor,

2002, page 26 for assets; page 66 for number of plans, and pages 71 and 74 for participants.)

²¹ Assets of 401(k)-type plans with 100 or more participants totaled $1.353 trillion, of which
$207.6 billion were employer securities. (U.S. Department of Labor, 2002, page 54)
²² Sarah Holden and Jack VanDerhei, “401(k) Plan Asset Allocation, Account Balances and
Loan Activity in 2000,” EBRI Issue Brief Number 239, November 2001, page 10.

Both the IRS Form 5500 and the EBRI/ICI data base represent plans of all sizes;
however, company stock is not uniformly distributed among small and large plans.
The EBRI/ICI data show that among plans with 5,000 or more participants, company
stock comprised 25.6% of total plan assets. Among plans with 5,000 or more
participants that held any company stock, it comprised 33.6% of plan assets.
Likewise, the Profit Sharing/401(k) Council of America (PSCA) reports that in 2000,
company stock accounted for 39.2% of assets in the defined contribution plans of the
909 firms that responded to the PSCA’s annual survey.²³ Thirty-one percent of the
plans in the PSCA survey had 1,000 or more participants and 58% had 200 or more
participants. A survey conducted by the Institute of Management and
Administration (IOMA) in 2001 found that among a sample of 220 – mainly large –
firms, company stock made up 36.1% percent of DC plan assets.
To further study how firm size, plan design, and the concentration of company
stock in the firm’s retirement plan are related, CRS analyzed company filings of the
S.E.C. Form 11-K. CRS examined data for all of the defined contribution plans
sponsored by 278, predominantly large, firms This analysis confirms that the
concentration of company stock in defined contribution plans is substantial among
large, publicly traded corporations.²⁴ On average, company stock comprised 38.0%
of the assets in these firms’ defined contribution plans. (See Table 2.)
Table 2. Company Stock in Defined Contribution Plans
SourceYearSample SizeCompany stock as apercentage of assets
I.R.S. Form 5500199852,278 plans16.6%
EBRI/ICI Data Base200035,367 plans^a18.6%
Profit Sharing/401(k) Council2000 909 firms^b39.2%
CRS analysis of S.E.C. Form 11-K2000 278 firms^b38.0%
IOMA/DC Plan Investing2001 220 firms^b36.1%
^a^In^plan^s^th^{at h}^e^{ld com}^p^an^y^s^t^ock^,^{it accou}ⁿ^t^{ed f}^o^{r an}^av^erag^{e of}^{31.8% of}^plan^as^s^e^ts^.
^b^Man^y^larg^{e f}ⁱ^rm^s^s^pon^s^o^{r m}^o^{re th}^an^on^{e def}ⁱⁿ^e^{d con}^t^ribu^tion^retirem^en^{t plan}^.
CRS analysis of the S.E.C. Form 11-K. We studied the defined
contribution plans of 261 firms that were included in either the Fortune 500 or the
Standard & Poor’s 500 and that filed a Form 11-K electronically with the S.E.C. in

2001. We also included the plans of 16 firms that were not in either of these indices²⁵

that we selected randomly from the S.E.C.’s EDGAR database. Many firms filed
more than one Form 11-K because they sponsored more than one defined
contribution plan. In those cases, we summed plan assets over all plans. For plan-
specific characteristics, we used those of the plan with the greatest total assets.

²³ 44^th Annual Survey of Profit Sharing and 401(k) Plans, Profit Sharing 401(k) Council of
America, Chicago, October 2001.
²⁴ The Form 11-K must be filed annually with the S.E.C. by firms that allow employees
voluntarily to purchase company stock through an employer-sponsored savings plan.
²⁵ EDGAR (Electronic Data Gathering Analysis and Retrieval) can be accessed at
[ h t t p : / / www.s e c . go v/ e d ga r / s e a r c h e d ga r / we bus e r s .ht m] .

Characteristics of the firm, such as employment, revenues, and total corporate assets
were taken from the S.E.C. Form 10-K that the firm filed in 2001.²⁶ We excluded
plans that covered primarily employees outside the United States and plans that were
pure Employee Stock Ownership Plans (ESOPs) or Employee Stock Purchase Plans.
We included ESOPs that had a 401(k) salary deferral feature. (These plans are
popularly known as “KSOPs”). In 2000, the firms in our sample employed 12.9
million workers, or an average of 46,340 employees per firm. They had average
revenues of $13.438 billion and average corporate assets of $22.327 billion in 2000.
(Medians are reported in the Appendix). The sample firms’ defined contribution
plans had $423.6 billion in total assets as of the end of fiscal year 2000.
Company stock accounted for 38.0% of the assets held by the defined
contribution plans of the firms in our sample. The average (or mean), however, is
skewed by high concentrations of stock in a relatively small number of firms. The
median concentration of company stock was 24.7%. (In half of all firms in the
sample, company stock comprised more than 24.7% of plan assets, and in the other
half, company stock was less than 24.7% of plan assets). Still, even this figure is
considerably higher than the 10% to 20% that many investment advisors recommend
as the maximum exposure to a single firm’s securities in a well-diversified
investment portfolio. Some workers own stock outside their 401(k) retirement plan
– which could reduce the percentage of their total financial assets invested in
company stock – but many do not. Moreover, the data in Table 3 reflect only the
company stock owned through 401(k) plans and so-called “KSOPs” (ESOPs with a
401(k) feature.) They do not take account of company stock owned through
traditional ESOPs, Employee Stock Purchase Plans, or acquired through company
stock options.
In an analysis of 11-K forms filed in 1993, Benartzi (2001) found higher
concentrations of company stock among firms that made their matching contributions
with company stock and also among firms whose stock had outperformed a major
stock market index over a long period. The CRS analysis of 11-k forms filed in 2001
found similar results in both cases. Among the 146 firms in the sample that required
all or part of the firm’s matching contribution to the DC plan to be made with
company stock, company stock made up 45.4% of plan assets, compared with 27.2%²⁷
in firms that allowed the employee to direct the investment of the company match.
The median concentrations of company stock were 35.7% and 12.1%, respectively,
in these firms.
We measured each company’s stock performance as the ratio of its average
annual total return over a three-year period (1997 through 1999) to the average
annual total return of the S&P 500 over the same three years. Of the 66 firms in the
sample that “beat the market” over the three-year period, company stock comprised

49.7% of average plan assets in 2000, compared with 31.1% among the 212 firms

²⁶ The Form 10-K is a detailed financial report that must be filed annually with the S.E.C.
by all firms whose stock is offered for sale to the public.
²⁷ This group includes a small number of firms that made no matching contribution in 2000.

whose three-year average annual total return was less than the S&P 500.²⁸ The
median concentrations of company stock were 40.1% and 21.0%, respectively,
among these firms.
Mitchell and Utkus (2002) suggest that an employer who also offers a defined
benefit plan might be more willing to tolerate high concentrations of company stock
in the company’s DC plan because the DB plan offers employees a measure of
security in the event that the company’s stock were to collapse. Likewise, “long-term
employees with a valuable DB benefit providing a guaranteed income stream . . .
might reasonably seek greater single-stock risk in the DC plan with company
stock.”²⁹ The data from the 11-K forms studied by CRS do not reveal a direct
correlation between company stock in a firm’s DC plans and its sponsorship of a DB
plan. Of the 278 firms in the sample, 205 sponsored a DB plan.³⁰ The mean
concentration of company stock was actually lower among these firms (36.3%) than
among the firms that did not sponsor a DB plan (51.6%). The median concentration
of company stock, however, differed very little between the two groups of firms:
24.8% among those that also sponsored a defined benefit plan and 23.7% among
those that had only a DC plan. These median concentrations differed only slightly
from the median concentration among the full sample of 278 firms, which was 24.7%
Table 3 also shows the concentration of company stock in relation to company
size, measured in terms of employees, total company assets, and total company³¹
revenues. Evidence is mixed on the relationship between the number of employees
in the firm and the concentration of company stock in the firm’s defined contribution
plans. The mean concentration of company stock was higher in firms with more
employees than the sample median (39.0% vs. 32.6%), but the median concentration
was higher among firms with fewer than the median number of employees (27.9%
vs. 22.3%). The relationship between company size and the concentration of
company stock was strongest when company size was measured in terms of total
assets.³² Among the firms for which company assets exceeded the sample median,
the mean concentration of company stock in the firms’ defined contribution plans
was 39.8%, compared to 26.8% among firms with company assets less than the
sample median. The median concentration of company stock among firms in the
upper half of the asset distribution (33.0%) was nearly twice that of firms in the
lower half of the distribution (17.3%).

²⁸ A stock’s total rate of return accounts for price changes, stock splits, and dividends.
From 1997 through 1999, the average annual total rate of return on the S&P 500 Index was

25.6%.

²⁹ Mitchell and Utkus (2002), page 27.
³⁰ We classified a firm as offering a DB plan if the 10-K form it filed in 2001 indicated that
it sponsored a defined benefit plan covering “most” or “substantially all” of its employees.
³¹ In most cases, firms reported the total number of employees as of the end of the firm’s
fiscal year. A relatively few firms reported the number of full-time equivalent employees.
Most firms do not report the number of plan participants on the Form 11-K.
³² For the full sample, the correlation coefficient between revenues and assets was 0.626.

The bottom panel of Table 3 shows the concentration of company stock relative
to the location of the firm, defined as the region of the United States in which its
principal offices are located. The mean concentration of company stock is somewhat
lower in companies with headquarters in the Midwest and South than among firms
with headquarters in the East or West. The median concentration is lowest among
firms in the Midwest. However, in a regression analysis (discussed in the next
section), the firm’s location was not a statistically significant variable in relation to
company stock concentration when other characteristics of the firm and of the firm’s
defined contribution plans were taken into account.
Table 3. Company Stock Concentration by Firm Characteristics
Company stock as a
Company characteristic:Number of companies:percentage of total DC
plan assets:
MeanMedian
All companies in sample27838.0%24.7%
Company matching contribution:
Match given as company stock14645.4%35.7%
All other companies13227.2%12.1%
Company stock performance:
Three-year average total return exceeded
S&P 5006649.7%40.1%
Three-year average total return lagged the
S&P 50021231.1%21.0%
Type of retirement plan sponsored:
Company had only a DC plan7351.6%23.7%
Company also had a DB plan20536.3%24.8%
Number of employees in 2000:
Company had fewer workers than the ¹
sample median13932.6%27.9%
Company had more workers than the¹
sample median13939.0%22.3%
Total company revenues in 2000:
Company’s revenues were less²
than the sample median13934.1%22.8%
Company’s revenues were more than the²
sample median13938.6%29.0%
Total company assets in 2000:
Company assets were less than the³
sample median13926.8%17.3%
Company assets were more than the²
sample median13939.8%33.0%
Location of firm’s principal offices:
Northeast 71 43.0% 28.3%
Midwest 78 36.0% 17.2%
South 82 35.7% 28.4%
West 47 40.3% 32.0%

^Source:^C^o^m^p^an^y^fⁱ^lⁱⁿ^g^s^of^F^o^rm^s^10-^k^an^{d 11-}^K^wⁱ^t^h^t^h^{e S}^.^E.C^.ⁱⁿ^2001.
^No^tes:
^{1. S}^a^m^p^l^e^m^e^di^an^w^a^s^{18,750 em}^pl^oy^ees^.
^{2. Sam}^p^{le m}^e^dian^w^a^s^{$5.341 billion}ⁱⁿ^{total rev}^eⁿ^u^e^.
^{3. Sam}^p^{le m}^e^dian^w^a^s^{$7.316 billion}ⁱⁿ^{total as}^s^e^ts^.
Multivariate analysis. The data displayed in Table 3 indicate that the
concentration of company stock is higher in firms that (1) make their matching
contributions with company stock, (2) have experienced better-than-average stock
performance, and (3) are relatively large in terms of total assets. In other words, all
three of these variables are positively correlated with the proportion of the
company’s DC plan that is invested in company stock. However, statistics that show
the relationship between only two variables at a time can sometimes be misleading
because many variables might simultaneously influence a firm’s decision to
contribute stock to a retirement plan or a worker’s decision to purchase company
stock. Some of these variables may have strong interaction effects on each other.
We can control for the interaction effects among variables by employing multi-
variate regression analysis. This procedure measures the extent to which changes
in one or more independent variables are associated with changes in a dependent
variable (also called the response variable). Regression analysis shows how a
specific change in each independent variable is associated with a change in the
dependent variable when all of the other independent variables remain fixed at their
mean values. A properly specified model will show whether the dependent variable
and a particular independent variable increase or decrease together or whether they
move in opposite directions, and whether the change in the dependent variable is
large or small. One must be careful, however, not to infer that a change in the value
of an independent variable causes a change in the dependent variable. The dependent
variable might be affected by some other factor or factors that are not included in the
regression model, but that change simultaneously with one or more of the
independent variables included in the model. The possibility of having omitted a
potentially important variable is especially acute in the social sciences where
controlled experiments are not often possible.
Summary of the regression results. In this model, the dependent
variable is the percentage of a firm’s total defined contribution plan assets invested
in company stock at the end of fiscal year 2000, as reported on the Form 11-K that
the firm filed with the S.E.C. in 2001.³³ We included six independent variables that
economic theory or previous empirical research suggested might be related to the
concentration of company stock. (Complete results of the regression analysis are
shown in the Appendix). In this case, the results of the multi-variate analysis
confirmed what the simple descriptive statistics shown in Table 3 had revealed.
Three variables were shown to have a positive and statistically significant
relationship to the percentage of a company’s DC plan assets invested in company
stock. They were: (1) making the company matching contribution with company
stock, (2) an average annual total return on company stock that exceeded the return

³³ For most firms, the 11-K filed in 2001 reported the status of the DC plan for the fiscal
year that ended in 2000. For some firms, 2001 filings cover fiscal years that ended in 2001.

on the S&P 500 over the previous three years, and (3) the size of the company
measured in terms of total assets.
More than half of the firms in the sample (146 out of 278) made all or part of
their matching contributions with company stock in 2000. The regression results
indicate that, with all other variables held at their mean values, the concentration of
company stock would be 17.7 percentage points higher at a firm that made its
matching contribution with company stock than at a firm that did not. The
performance of the company stock – expressed as the ratio of the average annual rate
of total return on company stock from 1997 through 1999 to the average annual rate
of total return of the S&P 500 index over the same three-year period – also had a
positive and statistically significant relationship to the concentration of company
stock in the sample firms’ defined contribution plans. The results suggests that, other
things being equal, the concentration of company stock would be 5.3 percentage
points higher at a firm where the 3-year rate average of return on company stock was
twice the rate of return of the S&P 500 when compared with a firm where the 3-year
rate average of return on company stock was the same as the return on the S&P 500.³⁴
Finally, the regression results indicate that even among the relatively large firms in
our sample, the concentration of company stock increases with company size. The
effect is not especially dramatic, however. Among the 278 firms in this sample, a
10% increase in total company assets is associated with an increase in the
concentration of company stock of only 0.4 percentage points.
III. ERISA and Company Stock in Retirement Plans
The widely publicized financial losses suffered by participants in the Enron
Corporation’s 401(k) plan prompted many Members of Congress to question whether
the laws and regulations that govern these plans need to be re-examined.³⁵ To ensure
that the assets of pension trust funds are diversified beyond the assets of the company
itself, Congress limited the amount of employer stock that can be held in a defined
benefit plan to 10% of plan assets when it passed ERISA in 1974.³⁶ This reduces the
risk that a pension fund would become insolvent as a result of the company that
sponsors the plan going bankrupt. Congress has generally exempted defined
contribution plans from limits on investing in employer stock ³⁷ except for certain
plans that require salary deferrals equal to more than 1% of employee pay to be used

³⁴ Because we are looking at the concentration of company stock at a point in time, we
cannot say how much of this 5.3 percentage point excess of company stock is attributable
to additional employee purchases and how much is due to the fact that, absent periodic re-
balancing of portfolios, a higher rate of return on any security will lead to that security
comprising a larger proportion of an investor’s portfolio.
³⁵ See The Enron Bankruptcy and Employer Stock in Retirement Plans, CRS Report
RS21115, by Patrick J. Purcell.
³⁶ See 29 U.S.C. §1107(a).
³⁷ See 29 U.S.C. § 1104(a)(2) and § 1107(b). ERISA § 404(a)(2) states that “in the case
of an eligible individual account plan . . . the diversification requirement of paragraph
(1)(C) and the prudence requirement (only to the extent that it requires diversification) of
paragraph (1)(B) is not violated by acquisition or holding of qualifying employer real
property or qualifying employer securities.” [Emphasis added].

for purchasing employer stock.³⁸ Some participants in Enron’s 401(k) plan – in
which 62% of the assets consisted of Enron stock at the end of 2000 – have charged
that the plan’s administrators violated their duty as fiduciaries by allowing
participants to continue investing in Enron stock and continuing to make the
company’s matching contributions with Enron stock even after they knew – or should
have known – that the company was in serious financial trouble.³⁹ Several plan
participants have filed suit against Enron in federal district court seeking restitution
for the losses they sustained to their retirement account balances.⁴⁰
Fiduciary duties under ERISA. Section 404(a)(1) of ERISA (29 U.S.C. §
1104(a)(1)) requires a plan fiduciary to act “solely in the interest of the participants
and beneficiaries” of the plan “for the exclusive purpose of providing benefits to
participants and their beneficiaries and defraying reasonable expenses of
administering the plan.” The fiduciary must carry out his or her responsibilities
“with the care, skill, prudence, and diligence under the circumstances then prevailing
that a prudent man acting in a like capacity and familiar with such matters would use
in the conduct of an enterprise of a like character and with like aims.”
Although ERISA generally does not limit the amount of company stock that can
be held in a DC plan, the plan sponsor still has a fiduciary duty to manage the plan
in the best interest of the participants – including the obligation to select investment
options that are appropriate for a retirement plan – and to monitor these investment
options to assure that they remain suitable investments for plan participants. If a plan
offers company stock as an investment option or makes matching contributions with
company stock, the employer must make a disinterested assessment as to whether the
stock is an appropriate investment for the plan’s participants. This can sometimes
put company officers who are plan fiduciaries in a difficult situation. Mitchell and
Utkus (2002) state that, “the employer as fiduciary stands in a somewhat tenuous if
not contradictory position in the oversight of company stock” because if the firm
encounters difficulties, its executives “could be in the incongruous position of
removing company stock from the retirement plan, while simultaneously seeking to
inspire confidence in the company” among outside investors.⁴¹
Who is a fiduciary under ERISA? Section 3(21)(A) of ERISA (29 U.S.C.
§ 1002(21)(A)) defines as a fiduciary any person who:
(1) exercises any discretionary authority or discretionary control respecting the
management of the plan or exercises any authority or control respecting the
management or disposition of its assets, or
(2) renders investment advice to plan participants or administrators for a fee or
other compensation, or has the authority or responsibility to do so, or

³⁸ See 29 U.S.C. § 1107(b)(2).
³⁹ A fiduciary is an individual, company, or association responsible for managing another’s
assets. The responsibilities of an ERISA fiduciary are defined at 29 U.S.C. §§ 1101-1114.
⁴⁰ Tittle v. Enron Corp., S.D. Texas, No. H-01-3913; Rinard v. Enron Corp.; and Kemper
v. Enron Corp. These three suits have since been consolidated under Tittle v. Enron.
⁴¹ Mitchell and Utkus (2002), page 22.

(3) has any discretionary authority or discretionary responsibility in the
administration of such plan.
Thus, a fiduciary under ERISA is defined in terms of managing and
administering the plan, rather than by job title. A person is a fiduciary of the plan
only to the extent that he or she has the authority and responsibility to perform the
functions of plan management and administration that ERISA defines as those of a
fiduciary. Thus, the officers and directors of a company may or may not be
fiduciaries of the plan, depending on their authority and responsibility to manage and
administer the plan. Moreover, a company officer or director who does not act as
a fiduciary in the normal course of business might be considered a fiduciary with
respect to a particular action that carries with it the duties and responsibilities of a
plan fiduciary. With respect to that action, the company officer or director is a
fiduciary under ERISA. This functional definition of a fiduciary – that a fiduciary
is as a fiduciary does – was affirmed by the Supreme Court in Varity Corporation v.
Howe in 1996, wherein the Court ruled that:
In relevant part, the statute says that a “person is a fiduciary with respect to a
plan,” and therefore subject to ERISA fiduciary duties, “to the extent” that he or
she “exercises any discretionary authority or discretionary control respecting
management” of the plan, or “has any discretionary authority or discretionary⁴²
responsibility in the administration” of the plan. ERISA § 3(21)(A) [Emphasis
added.]
Company officer or plan fiduciary: which comes first? A plan
fiduciary under ERISA must act “solely in the interest of the participants and
beneficiaries.” If actions taken in the best interest of plan participants also were
always in the best interest of the firm’s management, then no conflicts would arise
between the roles of plan fiduciary and company officer. However, such conflicts of
interest do sometimes arise. An attorney who specializes in ERISA has noted that
“ironically, even if you are acting in the good faith of the company, you may not be
acting in the best interests of the plan participants. There is often an inherent tension.
You must manage a pension plan for the benefit of participants and not for the⁴³
company. These are mutually exclusive.”
An example of the conflict that can occur between the interests of a firm’s
management and the interests of the participants in its retirement plan is provided by⁴⁴
a recently settled lawsuit between a bank and its employees. In two class action
lawsuits, current and former employees of the bank alleged that the company used
the proprietary funds in its 401(k) plan to increase the bank’s profits at the expense
of plan participants. The plan participants charged that the firm sponsoring the plan
engaged in self-dealing when it used its 401(k) plan to boost its profits by forcing

⁴² The Court also recognized that to decide whether an action falls within the definition of
a “fiduciary” act, a judge must “interpret the statutory terms which limit the scope of
fiduciary activity to discretionary acts of plan ‘management’ and ‘administration’” because
“these words are not self defining . . . .” Varity v. Howe, (94-1471), 516 U.S. 480 (1996)
⁴³ Ann Longmore of Willis Global Financial and Executive Risks, as quoted by Russ
Banham in. “Defending Your 401(k),” CFO Magazine, April 1, 2000.
⁴⁴ Franklin v. First Union Corporation (U.S. District Court, Eastern District of Virginia).

them to invest exclusively in funds managed by the bank and by charging improper
fees for plan participation. In March 2001, a judge granted preliminary approval to
a settlement in which the bank agreed to pay $26 million to the plaintiffs and to make
structural changes in its 401(k) plan.⁴⁵
Fiduciary responsibility in an employee-directed plan. Section 404(c)
of ERISA (29 U.S.C. 1104(c)) provides that if a plan permits a participant or
beneficiary “to exercise control over the assets in his account,” the participant will
be responsible for any investment losses that may result form his investment choices.
The plan’s fiduciaries will be relieved of responsibility for investment losses that
result from the participants’ investment decisions. The federal regulations that
interpret ERISA § 404(c) specify that a plan qualifies for relief from responsibility
for investment losses only if it provides the participant (1) the opportunity to exercise
control over the assets in his or her account, and (2) the opportunity to choose from⁴⁶
a broad range of investment alternatives. A participant or beneficiary is deemed to
have access to a broad range of investment alternatives if he has a reasonable
opportunity to:
(A)materially affect the potential return on the portion of the individual
account with respect to which he is permitted to exercise control and the
degree of risk to which such amounts are subject;
(B)choose from at least three investment alternatives
(1)each of which is diversified;
(2)each of which has materially different risk and return characteristics;
(3)which in the aggregate enable the participant . . . to achieve a
portfolio with aggregate risk and return characteristics at any point
within the range normally appropriate for the participant or
beneficiary; and
(4)each of which when combined with investments in the other
alternatives tends to minimize through diversification the overall risk
of a participant’s or beneficiary’s portfolio; and
(C)diversify the investment of that portion of his individual account with
respect to which he is permitted to exercise control so as to minimize the
risk of large losses, taking into account the nature of the plan and the size⁴⁷
of participants’ or beneficiaries’ accounts.
Exercising control over investments. The relief from liability for
investment losses available to a fiduciary under ERISA § 404(c) applies “only with
respect to a transaction where a participant or beneficiary has exercised independent

⁴⁵ “Court Approves First Union Settlement,” Employee Benefit Plan Review, Vol. 55, No.

12, June 2001, page 42.

⁴⁶ 29 C.F.R. § 2550.404c-1(b)(1). Significantly, the regulation allows for the possibility of
investing the entire value of an individual account in a single security, as shown in an
example published with the regulation: “A participant, P, independently exercises control
over assets in his individual account plan by directing a plan fiduciary, F, to invest 100%
of his account balance in a single stock. P is not a fiduciary with respect to the plan by
reason of his exercise of control and F will not be liable for any losses that necessarily
result form P’s investment instruction.” (See 29 C.F.R. § 2550.404c-1(f)(5)).
⁴⁷ 29 C.F.R. § 2550.404c-1(b)(3).

control in fact with respect to the investment of assets in his individual account.”⁴⁸
A participant’s or beneficiary’s exercise of control is not independent in fact if “a
plan fiduciary has concealed material non-public facts regarding the investment from
the participant or beneficiary, unless the disclosure of such information by the plan
fiduciary to the participant or beneficiary would violate any provision of federal law
or any provision of state law which is not preempted” by ERISA.⁴⁹ Thus, the
regulation relieves the fiduciary from the obligation to disclose to plan participants
and beneficiaries important financial information about the company only if that
disclosure would violate another federal law, such as the Securities Act of 1933.
The section 404(c) regulations further state that relief from fiduciary liability is
contingent upon the participant having the opportunity to obtain “sufficient
information to make informed decisions with regard to investment alternatives
available under the plan.”⁵⁰ Thus, an employer that allows plan participants to invest
in a particular mutual fund, for example, would have to provide participants with the
same information generally available to the public, such as the fund’s most recent
prospectus. However, while the regulation requires plan fiduciaries to provide
information that is necessary for participants to make informed investment decisions,
a “fiduciary has no obligation . . . to provide investment advice to a participant or
beneficiary under an ERISA section 404(c) plan.”⁵¹ [Emphasis added.]
An important caveat. Relief from responsibility for investment losses
through ERISA § 404(c) is available to a plan’s fiduciaries only after they have met
their obligation to select appropriate investment alternatives from which plan
participants may choose. The Department of Labor’s regulation for ERISA § 404(c)
emphasizes . . . that the act of designating investment alternatives . . . in an
ERISA Section 404(c) plan is a fiduciary function to which the limitation on
liability provided by Section 404(c) is not applicable. All of the fiduciary
provisions of ERISA remain applicable to both the initial designation of
investment alternatives and investment managers and the ongoing determination
that such alternatives and managers remain suitable and prudent investment
alternatives for the plan. Therefore, the particular plan fiduciaries responsible for⁵²
performing these functions must do so in accordance with ERISA.
Employer stock in an ERISA § 404(c) plan. Because employer stock is
not a diversified investment, it cannot be one of the three “core” investment options
required by ERISA § 404(c). A plan that offers qualifying employer securities as an
investment option must offer at least three other diversified investment options in
order to qualify under section 404(c). Nevertheless, while ERISA § 404(c) requires
a plan to offer participants the opportunity to diversify their investments, it does not

⁴⁸ 29 C.F.R. § 2550.404c-1(c)(1)
⁴⁹ 29 C.F.R. § 2550.404c-1(c)(2)
⁵⁰ 29 C.F.R. § 2550.404c-1(b)(2).
⁵¹ 29 C.F.R. § 2550.404c-1(c)(4)
⁵² “Final Regulation Regarding Participant Directed Individual Account Plans (ERISA
Section 404(c) Plans),” Federal Register, vol. 57, no. 198, October 13, 1992, page 46922.

require participants actually to do so. In fact, the Labor Department’s regulations
state that in a defined contribution plan, “ERISA’s ‘diversification’ requirement, and
ERISA’s ‘prudence’ requirement as it applies to diversification, are not violated by
the acquisition of up to 100% of qualifying employer securities, if the plan so
provides.”⁵³ However, this exemption from ERISA’s prudence requirement applies
to defined contribution plans only as it relates to diversification. In all other aspects
of plan management and administration – including the selection of investment
options – the plan fiduciaries are bound by ERISA to act with “care, skill, prudence,
and ... diligence.”
Although ERISA does not limit the proportion of assets in a defined
contribution plan that can be invested in employer stock, “the fiduciaries of a plan
must act prudently if they decide to permit employer stock as an investment
alternative available to participants under the plan.”⁵⁴ Furthermore, if employer stock
is offered as an investment alternative, the plan fiduciaries must ensure that
“information provided to shareholders of such securities is provided to participants
and beneficiaries with accounts holding such securities.”⁵⁵ The fiduciaries also must
continue to evaluate the suitability of company stock as an investment option because
“neither the statute nor the regulation eliminates the fiduciary’s underlying
responsibility with regard to the selection and monitoring of the plan’s investment
options.”⁵⁶ In the event that the employer stock fund in a participant-directed plan
does not meet all of the requirements under ERISA § 404(c), only the employer stock
portion of the plan will fail to qualify under section 404(c). The other investment
funds of the plan will qualify for liability protection under section 404(c) to the
extent that they satisfy the section 404(c) requirements.⁵⁷
Fiduciary duty and employer stock. Enron is not the only company to
have been sued in recent years by participants in an employer-sponsored retirement
plan in which participants had invested in company stock. Rite Aid, Lucent
Technologies, Nortel Networks, Qwest Communications, Williams Companies,
Providian Financial Corporation, IKON Office Solutions, WorldCom, and Xerox all

⁵³ G. M. Morrison and A. L. Scialabba, “Using Employer Stock in a 401(k) Retirement
Plan,” Journal of Pension Planning and Compliance, vol. 25, no. 3; Fall 1999, page 56.
⁵⁴ Morrison and Scialabba (1999), page 54.
⁵⁵ 29 C.F.R. § 2550.404(c)-1(d)(2).
⁵⁶ Thomas S. Gigot, “401(k) Plan Litigation under ERISA,” Journal of Pension Planning
and Compliance,” vol. 27, no. 3 (Fall 2001), page 65.
⁵⁷ “A plan which otherwise qualifies as an ERISA section 404(c) plan would not cease to be
an ERISA section 404(c) plan merely because a particular non-core investment alternative
offered under the plan (e.g., an employer security investment alternative) fails to meet the
requirements for section 404(c) relief. Accordingly, to the extent that an employer security
investment alternative fails to comply with the requirements of paragraph (d)(2)(ii)(E)(4),
the fiduciaries of a plan which otherwise meets the requirements of section 404(c) would
lose section 404(c) protection and would be responsible as fiduciaries only with respect to
transactions involving the employer security investment alternative.” “Final Regulation
Regarding Participant Directed Individual Account Plans (ERISA Section 404(c) Plans),”
Federal Register, vol. 57, no. 198, October 13, 1992, page 46928.

have been involved in lawsuits in which plan participants alleged that plan fiduciaries
breached their duties with respect to investment in employer stock.⁵⁸ As these cases
indicate, when the employer’s stock suffers a precipitous decline in value the “loss
of retirement savings can . . . trigger claims that the plan’s fiduciaries breached their
duties of care and loyalty by allowing the plan to continue buying company stock, or
by failing to sell company stock, as the company’s financial condition deteriorated.”⁵⁹
If an employer both allows participants to purchase employer stock voluntarily and
makes its matching contributions with employer stock, the participants could assert
that (1) the company breached its fiduciary duty by continuing to make its stock
available as an investment option after the plan administrators knew (or should have
known) that it was likely to decline in value substantially, and/or (2) that any terms
of the plan that prevented participants from diversifying out of company stock
represented a breach of fiduciary duty.
Reflecting on the recent lawsuits that have alleged breaches of fiduciary duty
with respect to employer securities in defined contribution retirement plans, two
attorneys who specialize in ERISA recently observed that:
ERISA requires that plan fiduciaries prudently monitor the investments in 401(k)
plans, including employer stock. Although the standard for that review may not
be clear, at the least the fiduciaries must periodically review the investment for
its suitability for participant direction and cannot ignore evidence indicating that
the employer stock is no longer appropriate for the plan. More likely, the
fiduciaries have an affirmative duty to investigate the quality of the stock as an
ongoing investment, to hire independent experts when needed, and to act on the⁶⁰
results of those activities.
Recent employer actions. Some firms that require employees to hold
employer securities until a certain age (typically 50 or 55) or until they leave the
company recently have announced plans to reduce or remove those restrictions. A
survey by Hewitt Associates of 280 companies with an average of 22,000 employees
found that 38% invest the employer’s matching contributions all or partly in company
stock. Of that number, 86% place some type of restriction on diversification of the
matching account in company stock. However, 62% indicated in the survey that they

⁵⁸ Rite Aid and IKON Offices Solutions announced in May 2002 that they had reached
settlement agreements in Kolar v. Rite Aid Corp. et al., E.D. Pa.., 01-cv-1229, and
Whetman, et al. v. IKON Office Solutions, Inc., E.D. Pa, Docket No. 00-87. Of the other
cases referred to, three involve Global Crossing: McAllister v. Winnick, Ramkissoon v.
Winnick, and Johnson v. Winnick. The others are Van Nes v. Williams Companies, Inc.;
Brooks v. Qwest Communications International, Inc.; Kauffmann v. Nortel Networks Corp.;
Reinhart v. Lucent Technologies; Spindler v. Providian Financial Corp.; Rambo v.
WorldCom and Patti v. Xerox.
⁵⁹ Gigot (2001), page 68.
⁶⁰ F. Reish and J. Faucher, “The Enron and Lucent Cases: Responsibilities for Employer
Stock,” Journal of Pension Benefits, vol. 9, no. 3 (Spring 2002), pages 59-60.

have, or are likely to, ease existing restrictions on diversification of company
matching contributions out of the company stock fund in 2002.⁶¹
IV. Bills in the 107^th Congress
H.R. 3762. The collapse of Enron Corporation’s stock in 2001 left thousands
of the firm’s employees with significantly reduced retirement account balances. The
plight of those whose retirement savings were virtually wiped out received
substantial coverage by the news media. In the first few months of 2002, numerous
bills were introduced in Congress that would reform the oversight and regulation of
employer-sponsored retirement plans, all with the intention of preventing “another⁶²
Enron.” On April 11, 2002 the House of Representatives passed H.R. 3762, the
“Pension Security Act of 2002,” by a vote of 255 - 163.
The main provisions of the bill would:
^!require plans to provide participants with periodic benefit
statements,
^!provide protection to participants from suspensions, limitations, or
restrictions on their ability to diversify their investments in the plan,
^!direct the Secretary of Labor to develop a program to educate and
inform plan fiduciaries of their duties and obligations,
^!provide plan participants with the right to sell employer stock no
more than three years after they receive it,
^!allow employers voluntarily to offer investment advice through the
retirement plan’s service provider, and
^!prohibit company owners, officers or directors from trading any
employer securities or derivatives during a period when retirement
plan participants are restricted in their ability to direct investments
under the plan.
Periodic benefit statements. Defined benefit plans would be required to
provide active plan participants with a statement, at least once every three years, that
informs them of their total accrued benefits, their total vested (nonforfeitable)
benefits, and the date on which benefits will become vested. Defined contribution
plans (except for ESOPs that do not include either employee contributions or
employer matching contributions) would be required to provide participants with
quarterly statements of their total accrued benefits, their total vested (nonforfeitable)
benefits, and the date on which benefits will become vested. The statement must
include the value of investments allocated to employer securities and an explanation
of any limitations or restrictions on the participants’ ability to direct investments in
the account. It must also inform the participant of the importance of maintaining a
well-diversified investment portfolio, including a discussion of the risk of holding
more than 25% of one’s assets in single security, such as the employer’s stock.

⁶¹ Press release,
[http://www.hewitt.com/ hewitt/resource/ news room/pressrel/2002/04-22-02.htm] .
⁶² For more information, see CRS Report RL31319, “Employer Stock in Retirement Plans:
Bills in the 107^th Congress,” by Patrick J. Purcell.

Protection during “blackout” or “lockdown” periods. Companies
sometimes suspend transactions in their 401(k) accounts, most commonly when they
are changing plan administrators, installing new software, or performing other
routine administrative tasks that require a temporary suspension of account activity.
H.R. 3762 would require defined contribution plans to provide written notice to
participants at least 30 days before any action that would suspend, limit, or restrict
their ability to direct their investments under the plan for at least 3 consecutive
business days. The notice must state the reason for the restriction of account activity
and its expected length, identify the affected investments, and advise the participants
to evaluate their investment decisions accordingly. The Secretary of Labor would
be required to issue model notices and would be authorized to issue regulations
identifying exceptions to the notice requirement. The bill specifies that relief from
fiduciary liability ERISA § 404(c) would not apply during a lockdown that is
unreasonable in length or is not preceded by required notice to plan participants.⁶³
Diversification out of company stock. Defined contribution plans of
publicly traded companies (other than ESOPs that hold neither employee
contributions nor employer matching contributions) would be required to provide
participants with the right to sell company stock held in their accounts no later than
3 years after the end of the plan year during which the stock is allocated to their
accounts. Stock allocated to employee accounts prior to enactment could be sold in

20% annual increments, reaching 100% in 2007. Upon enactment of the bill,

participants would have the right to sell immediately all employer stock purchased
with their own contributions. Plans would be required to offer at least three
investment options in addition to employer stock and to allow participants the
opportunity to trade shares no less frequently than quarterly.
Senate bills. In the Senate, jurisdiction over employer-sponsored retirement
plans is shared by the Committee on Health, Education, Labor, and Pensions (which
had jurisdiction over ERISA) and the Finance Committee (which has jurisdiction
over the Internal Revenue Code). On March 21, 2002 the Senate Committee on
Health, Education, Labor, and Pensions ordered reported S. 1992, the “Protecting
America’s Pensions Act of 2002.” On April 17, 2002 Finance Committee members
John Kerry and Olympia Snowe introduced S. 2190, the “Worker Investment and
Retirement Education Act of 2002.” On July 11, 2002 the Finance Committee
ordered reported S. 1971, the “National Employee Savings and Trust Equity^th
Guarantee Act.” None of these bills reached the Senate floor in the 107 Congress.
Periodic benefit statements. S. 1992 would require administrators of
participant-directed individual account plans to provide quarterly statements to
participants. It would require administrators of defined benefit plans to provide
statements to participants at least once every three years. Statements for all plans
must include total accrued benefits and total vested benefits (or the earliest date at
which vesting will occur). Statements for individual account plans must include the

⁶³ ERISA § 404(c) states generally that a plan fiduciary will not be held liable for
investment losses that result from an individual participant’s investment losses, provided
that individual plan participants are able to exercise control over the investment of their
accounts.

value of employer securities, an explanation of any restrictions the participant’s right
to diversify out of employer securities, a statement of the importance of diversifying
assets, and notification of the risk inherent in concentrating investment in a single
security. They must include a special notice directed at participants with more than
20% of plan assets invested in employer securities. The Secretary of Labor would
be directed to develop a model statement. In the case of a defined benefit plan, the
administrator would be required to notify participants who are eligible to receive a
distribution from the plan of their right to receive information describing the manner
in which the amount of the distribution was calculated. Plans with more than 100
participants that offer lump-sum distributions or other optional forms of benefit
would be required to provide, prior to any such distribution, a statement describing
the relative values of the alternative forms of distribution, including the interest rate
and mortality assumptions used to derive the estimates, as well as any other
information prescribed by the Secretary of Labor.
Under S. 2190, defined contribution plans that allow participants to exercise
control over their investments would be required to provide participants with a form
outlining basic investment principles, including the benefits of diversification,
information on the relative risk of investing in stocks, bonds, stock mutual funds and
money market mutual funds, resources where they can get more information on
investing, and a worksheet for calculating future retirement benefits. Plans with 100
or more participants would be required to provide participants with benefit
statements that would include total accrued benefits, total vested benefits (or the
earliest date at which vesting will occur), total account balances, and the percentage
of the participant’s assets in each investment option provided under the plan.
S. 1971 would require plan administrators to provide quarterly statements to
participants and annual statements to beneficiaries, including the total benefit accrued
under the plan, the total benefit in which the participant is fully vested (or the earliest
date on which vesting will occur), the value of any employer securities held in the
plan, an explanation of any restrictions on the participant’s right to diversify out of
employer securities, a statement on the importance of diversifying assets, and
notification of the risk inherent in concentrating investment in a single security. The
requirement would apply to all participant-directed plans that are tax-qualified plans
under I.R.C. § 401(a), annuity plans under I.R.C. § 403, and individual retirement
accounts under I.R.C. § 408. The bill would impose an excise tax of $100 per
participant per day on any employer that fails to comply with these requirements.
Divestiture of employer securities. S. 1992 would require
participant-directed individual account plans that hold employer securities that are
readily tradable on an established market to offer at least three other investment
options in addition to employer securities. The bill provides that participants may
diversify all elective deferrals out of employer stock immediately, and that
participants may diversify all employer contributions of employer stock after 3 years
of service. It would require plans to grant voting rights on employer stock to plan
participants. The diversification requirements would not apply to ESOPs that hold
neither employee elective deferrals made under I.R.C. § 401(k) nor employer
matching contributions made under I.R.C. § 401(m). It would require plan
administrators to notify participants of their diversification rights and inform them
of the importance of diversifying assets. The Secretary of Labor would issue model

notices. The Labor Department would be required to study options for applying the
diversification requirements to employer stock that is not publicly traded.
S. 2190 would prohibit defined contribution plans other than ESOPs from
requiring plan participants to invest any of their elective salary deferrals in employer
securities such as company stock. Participants in plans of publicly-held corporations
would have the right to sell immediately employer stock purchased with their own
contributions. With respect to employer contributions – other than matching
contributions – made with company stock, participants would be permitted to sell
these shares after completing five years of service. However, the employee could not
divest more than 50% of employer stock before completing seven years of service.
With respect to employer matching contributions made with company stock,
participants would be permitted to sell these shares after completing three years of
service. However, the employee could not divest more than 50% of employer stock
before completing five years of service. At age 55, employees of publicly traded
companies could sell all employer securities.
Effective on January 1, 2003, S. 1971 would allow participants to diversify
immediately out of employer securities purchased through employee elective
deferrals, and it would allow participants with three or more years of service to
diversify out of all other employer securities. Diversification out of employer
securities held prior to the date of enactment – and not acquired through employee
elective deferrals – would be permitted over a 3-year period. The bill would prohibit
any plan from imposing restrictions and conditions (such as holding periods) on
investments in employer securities that it does not impose on other investment
options in the plan. It would require plans to offer at least three investment options
in addition to employer securities. The diversification requirements of the bill would
apply to all defined contribution plans that hold employer securities that are readily
tradable on an established market except for ESOPs that hold no employer securities
that were either purchased as employee elective deferrals or contributed as matching
contributions for employee elective deferrals. Plans would have to meet the
divestiture requirements in order to qualify under I.R.C. § 401(a).
Suspensions of account activity (“lockdowns” or “blackout”
periods). S. 1992 would require plan administrators to give participants written
notice 30 days before the start of any period during which the participants’ ability to
direct the investment of assets under the plan would be suspended, restricted, or
otherwise limited. It would prohibit such periods from continuing for an
“unreasonable” length of time, as determined by regulations to be issued by the
Secretary of Labor. It would amend ERISA section 404(c)(1) to suspend fiduciaries’
relief from fiduciary liability during a transaction suspension period. The Secretary
of Labor would issue guidance on how plan sponsors could preserve relief from
fiduciary liability during transaction suspension periods.
S. 2190 would require plans to provide participants with written notice 30 days
prior to any suspension of account activity expected to last three or more business
days. Company owners, officers, and directors would be prohibited from buying or
selling employer securities during any period when the participants of the plan are
unable to buy or sell such securities.

S. 1971 would require plans to give participants 30-day advance written notice
of a transaction suspension period lasting for two or more consecutive business days
during which participants’ ability to direct the investment of assets held in the plan
is substantially reduced. Certain exceptions would be specified in regulations issued
by the Secretary of the Treasury. The notice requirement would apply to all
participant-directed plans that are tax-qualified plans under I.R.C. § 401(a), annuity
plans under I.R.C. § 403, and individual retirement accounts under I.R.C. § 408. The
bill would impose an excise tax on employers of $100 per participant per day for
failure to comply. It would amend ERISA section 404(c)(1) to suspend fiduciaries’
relief from fiduciary liability during a transaction suspension period. The Secretary
of the Treasury would issue guidance on how plan sponsors could preserve relief
from fiduciary liability during transaction suspension periods. The bill would impose
an excise tax of 20% on any gain realized by company officers or other insiders on
transactions involving employer securities that occur when the company’s retirement
plan is in a transaction suspension period.
Limits on employer securities or real property. ERISA limits the
amount of employer stock that can be held in a defined benefit plan to 10% of plan
assets.⁶⁴ Defined contribution plans are generally exempted from limits on investing
in employer stock,⁶⁵ except for certain plans that require elective deferrals equal to
more than 1% of employee salary to be used for purchasing employer stock.⁶⁶
Under S. 1992, a participant-directed individual account plan that holds
employer securities that are readily tradable on an established market could either (1)
permit employees’ elective deferrals to be invested in employer securities or (2) make
matching or other employer contributions in the form of employer securities, but not
both. The restriction would include (but would not be limited to) plans that allow for
employee investment in employer securities via a brokerage window. These
restrictions would apply to all defined contribution plans except: (1) Employee Stock
Ownerships Plans (ESOPs) that hold neither employee elective deferrals or employer
matching contributions and (2) defined contribution plans of an employer that also
sponsors a defined benefit plan covering at least 90% of the DC plan participants and
providing for a benefit that is at least the actuarial equivalent of the benefit that
would result from an accrual rate of 1.5% of final average pay times years of service.
This accrual rate need not apply beyond 20 years of service.
Investment advice and retirement planning. S. 1992, S. 1971, and S.
2190 each incorporate S. 1677, the “Independent Investment Advice Act,” which
would grant employers a safe harbor for liability if they arrange for a qualified,
independent investment advisor to provide investment advice to plan participants.
The bills would grant an exemption from the “prohibited transaction” provisions of
ERISA for plan sponsors that provide investment advice to plan participants.

⁶⁴ ERISA § 407(a), (29 U.S.C. §1107(a)).
⁶⁵ ERISA § 404(a)(2) and § 407(b), ((29 U.S.C. § 1104(a)(2) and § 1107(b)).
⁶⁶ ERISA § 407(b)(2), (29 U.S.C. § 1107(b)(2)).

Other provisions. S. 1992 would require the plan sponsor to provide plan
participants with the same investment information it would be required to disclose
to investors under applicable securities laws. S. 1992 also would mandate, in the
case of any company that sponsors an individual account plan and allows employee
elective deferrals to be used to purchase employer securities, that any disclosure
required by the S.E.C. regarding insider trades must be provided by the company to
its employees in written or electronic form within two days of disclosure to the
S.E.C. S. 1992 would require assets of DC plans with 100 or more participants to be
held in a joint trust with equal representation of the interests of plan sponsors and
participants. It would amend ERISA to require persons who breach their fiduciary
duty to participants of a 401(k) plan to make good the losses suffered by plan
participants and beneficiaries resulting from their breach of duty. Participants and
beneficiaries would have the right to sue fiduciaries for losses resulting from breach
of duty. Any insider who participates in a breach of fiduciary duty or who
knowingly conceals such a breach would be held personally liable for any resulting
losses. The bill provides that ERISA § 404(c) is not a valid defense for such breach.
S. 1992 would provide that a person’s right to civil action under ERISA may not be
waived, deferred, or lost pursuant to any agreement between the participant or
beneficiary and the plan sponsor. The bill would amend ERISA § 502 to extend to
persons who do not participate in the plan the opportunity to bring a civil action
seeking equitable or remedial relief in the event of that employer or other person
violates the individual’s rights under ERISA § 510. It would establish an Office of
Pension Participant Advocacy within the Department of Labor. Finally, S. 1992
would direct the Pension Benefit Guaranty Corporation to study the feasibility of a
system of insurance for defined contribution retirement plans.

Appendix A: Regression Results
Form of the model and summary statistics. This analysis makes use of
a standard statistical methodology termed “ordinary least squares” (OLS). The
dependent variable (the matter to be explained) is the percentage of a firm’s total
defined contribution plan assets invested in company stock at the end of fiscal year
2000, as reported by firms on the Form 11-K filed with the S.E.C. in 2001.⁶⁷ We
included six independent variables that economic theory or previous empirical
research suggested might be related to the concentration of company stock in defined
contribution plans. The intercept of 9.8% is statistically significant at the .01 level.
The adjusted R², or “coefficient of determination” is .334. This suggests that the
independent variables explain about one-third of the company-to-company variation
in the concentration of employer stock in defined contribution plans. (Complete
results of the regression analysis are shown in Table A-1).
Mandatory holding period for company stock. Some employers require
company stock that is given by the company as a matching contribution or other
contribution to be held by the worker until he or she reaches a certain age (typically
50 or 55) or until the worker leaves the firm.⁶⁸ Sixty-six firms in our sample reported
on their 11-K forms that they had such a required holding period. We would expect
that, other things being equal, the concentration of company stock in a firms’ DC
plan would be higher if it had a mandatory holding period for company stock than if
employees were free to sell shares at any time. The sign for this variable was
positive, as expected, but the coefficient was not statistically significant.
Matching contribution made in company stock. More than half of the
firms in the sample (146 out of 278) made their matching contributions with
company stock. This variable proved to have a positive and statistically significant
relationship to the concentration of company stock in the firms’ defined contribution
plans. The coefficient of 17.7 indicates that, other things being equal, the
concentration of company stock will be 17.7 percentage points higher at a firm that
makes its matching contribution with company stock than at a firm that does not.
This was the largest coefficient of any independent variable in the regression
equation.
Does the company offer a defined benefit plan? As noted earlier in the
discussion of Table 3, there is reason to believe that the concentration of company
stock might be higher at firms that offer a defined benefit plan as well as a defined
contribution plan. Most of the firms in our sample (205 of 278) offered a DB plan
to a majority of their U.S. employees. We included a variable in the regression with
a value of 1 for firms that sponsored a DB plan and 0 for those that did not. Contrary
to our expectation, the sign of this variable was negative (indicating that the company
stock concentration was lower at firms that also sponsored a DB plan); however, the
coefficient was not statistically significant.

⁶⁷ For most firms, the 11-K filed in 2001 reported the status of the DC plan for the fiscal
year that ended in 2000. For some firms, 2001 filings cover a fiscal year that ended in 2001.
⁶⁸ In some cases – usually KSOPs – the employee also may be required to hold company
stock that they purchase voluntarily for a specified period of time before they can sell it.

Company stock performance relative to the S&P 500. Benartzi (2001)
and Sengmuller (2002) both found that employee purchases of company stock
through a retirement savings plan were influenced by the past financial performance
of the stock relative to the market as a whole. To test the relationship of past
company stock performance to the concentration of company stock in the firm’s
401(k) plan, we included a variable that represented the ratio of the average annual
rate of total return realized by the company’s stock from 1997 through 1999 to the
average annual rate of total return of the Standard & Poor’s 500 index over the same
three-year period. This variable had a positive and statistically significant
relationship to the concentration of company stock in the sample firms’ defined
contribution plans. The coefficient of 5.3 indicates that, other things being equal,
the concentration of company stock would be 5.3 percentage points higher at a firm
where the three-year rate average of return on company stock was twice the rate of
return of the S&P 500 when compared with a firm where the three-year rate average
of return on company stock was the same as the return on the S&P 500. Because we
looked at the concentration of company stock at a point in time, we cannot say how
much of this 5.3 percentage point excess of company stock is attributable to
additional employee purchases and how much is due to the fact that, absent periodic
re-balancing of portfolios, a higher rate of return on any security would lead to that
security comprising a larger proportion of an investment portfolio.
Relative variability of company stock. The risk that an investor bears is
the possibility of loss. It is a fundamental tenet of modern portfolio theory that
holding a single stock entails greater risk than holding a well-diversified portfolio of
stocks. This risk is measured as the relative volatility of the expected return on a
given security compared with the expected return for the entire market. This measure⁶⁹
of risk is referred to as a stock’s beta coefficient. Economic theory suggests that for
any given expected rate of return, an investor would prefer to hold a less volatile (i.e.,
less risky) stock. We would therefore expect to find a negative relationship between
a stock’s beta coefficient and its concentration in the company’s retirement plan. To
measure the relationship between the relative volatility of a company’s stock and its
concentration in the company’s defined contribution plan, we calculated the beta
coefficient for each stock for the three-year period from 1997 through 1999. As
expected, the sign associated with a company stock’s beta coefficient was negative;⁷⁰
however, the coefficient was not statistically significant.
Size of the company. Benartzi (2001) found that company size was
positively associated with employee purchases of company stock for their retirement
plans. To test the relationship between company size and the concentration of

⁶⁹ More formally, the beta coefficient is defined as: $ = (Emk - nMK) ÷ (Em² - nM²),
where m = (the market rate of return in period p - the risk-free rate of return in period p),
k = (the rate of return on stock s in period p - the risk-free rate of return in period p),
n = the number of periods, M = the average of m, and K = the average of k.
⁷⁰ Sengmuller (2002) found that neither the market beta nor the standard deviation of
company stock returns was statistically significant in a regression on the allocation of
employee salary deferrals to company stock. Liang and Weisbenner (2002), however, found
that the standard deviation of the return on company stock was negatively and significantly
related to the percentage of employee deferrals allocated to company stock.

company stock in the firm’s retirement plan, we included company assets, expressed
as the natural logarithm of those assets, in the regression model.⁷¹ The results
indicate that, even among a sample of bigger-than-average companies, the
concentration of company stock increases with company size. The effect is not
especially dramatic, however. The regression results indicate that among the firms
in this sample, a 10% increase in total company assets is associated with an increase
in the concentration of company stock in the firm’s DC plans of only 0.4 percentage
points.⁷²
A note on the number of investment options. Benartzi and Thaler
(2001) found evidence that many participants in 401(k) plans follow a “1/n”
diversification strategy. An investor following this strategy would divide his payroll
deferrals proportionally among each of the investment options available in the plan.
Their results suggest that, other things being equal, the proportion of employee
elective deferrals invested in company stock will be lower in a plan with more
investment options than in a plan with fewer options. The percentage of a plan’s
assets invested in company stock at any given time, however, will depend both on the
past performance of company stock relative to the other investment options, and the
extent to which plan participants respond to new investment options by redirecting
some of their deferrals and accumulated assets into the new investments. It is
perhaps not surprising, then, that when we included a variable indicating the number
of investment options available in the plan, the sign was negative but the coefficient
was not statistically significant. We dropped this variable from the final version of
the model.
Table A-1. Regression Analysis of Company Stock in 2000
Dependent variable = Percentage of total DC plan assets invested in company stock
Regression Statistics
Multiple R0.5903
R² 0.3485
Adjusted R²0.3341
Standard Error18.1810
Observations278
Degrees ofF statisticSignificance F
freedom
Regr ession 6 24.1609 0.0000
Residual271
Total277

⁷¹ The logarithm of a variable is sometimes used in econometric analysis when the
relationship between an independent variable and the dependent variable is nonlinear.
⁷² When an independent variable is log transformed and the dependent variable is not, the
expected change in the dependent variable associated with a given percentage change in the
independent variable can be derived as y = log^e([100+x]/100) where x equals the percent
change in the independent variable and y = the change in the dependent variable.

Independent variableCoefficientStandard Errort statisticP-value
Intercept 9.7926 2.7524 3.5578 0.0004
Holding period for co. stock?4.70333.06001.53700.1255
Is match in company stock?17.69242.62336.74440.0000
Does company have a DB plan?-2.38022.7761-0.85740.3920
Company stock vs. S&P 5005.26441.00305.24840.0000
Company stock beta coefficient-0.12250.0871-1.40580.1609
Company assets (log^e of assets) 3.76090.90064.17600.0000
^Source:^C^R^S^an^al^y^sⁱ^s^of^10-^K^an^{d 11-}^K^f^o^rm^s^fⁱ^l^e^{d w}ⁱ^t^h^t^h^{e S}^.^E.C^.ⁱⁿ^2001.
Table A-2. Mean and Median Employment, Revenues, and
Assets in 2000
^Al^l^fⁱ^r^m^sⁱⁿ^s^a^m^p^l^e⁽ⁿ⁼²⁷⁸⁾
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽^b^illio^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^46,340^$13.438^$22.327
^Medi^an^18,750^$5.341^$7.316
^Fi^r^m^s^t^hat^di^r^ect^{ed al}^l^or^par^t^of^m^a^t^c^{h t}^o^com^{pany s}^t^ock⁽^{n =}¹⁴⁶⁾
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^40,998^$14.966^$23.747
^Medi^an^17,050^$5.955^$8.836
^Fi^r^m^s^t^hat^di^{d not}^di^r^ect^m^a^t^c^{h t}^o^com^{pany s}^t^ock⁽^{n =}¹³²⁾
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^52,249^$11.748^$20.756
^Medi^an^19,975^$4.538^$6.420
^Fir^m^s^{that als}^o^{had a de}^{fined benefit plan}⁽ⁿ^{= 205)}
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^41,034^$14.529^$26.853
^Medi^an^18,500^$6.581^$9.127
^Fi^r^m^s^t^hat^{had onl}^{y a def}ⁱⁿ^{ed cont}^rⁱ^butⁱ^{on pl}^an⁽ⁿ⁼⁷³⁾
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^61,241^$10.373^$9,616
^Medi^an^19,220^$3.531^$3,157
^T^h^r^ee-year^{total r}^e^turⁿ^{on company}^s^t^{ock exceeded S&}^{P 500}⁽ⁿ^{=66 )}
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^77,406^18.613^31.607
^Medi^an^23,550^5.181^11.203
^T^h^r^ee-year^t^o^t^a^l^r^e^t^u^rⁿ^{on com}^{pany s}^t^{ock l}^{agged S&}^{P 500}⁽ⁿ⁼²¹²⁾
^E^m^ployees^R^e^ven^u^e^sⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)^A^s^s^e^tsⁱⁿ²⁰⁰⁰⁽ⁱ^{n billio}^ns)
^Mean^36,669^11.827^19.437
^Medi^an^16,050^5.558^6.755
^Source:^C^R^S^an^al^y^sⁱ^s^of^S^.^E.C^.^F^o^rm^10-^k^fⁱ^l^e^{d i}ⁿ^2001.

References
Anonymous. “Court Approves First Union Settlement.” Employee Benefit Plan
Review. Vol. 55, no. 5. June 2001.
Banham, Russ. “Defending Your 401(k).” CFO Magazine, April 1, 2000.
Benartzi, Shlomo. “Excessive Extrapolation and the Allocation of 401(k) Accounts
to Company Stock.” Journal of Finance, Vol. 56, No. 5. October 2001.
Benartzi, Shlomo and Richard H. Thaler. “Naive Diversification Strategies in
Defined Contribution Savings Plans.” American Economic Review, Vol. 91,
No. 1, March 2001.
Benartzi, Shlomo and Richard H. Thaler. “How Much Is Investor Autonomy
Worth?”Journal of Finance, August 2002 (forthcoming).
Gigot, Thomas S. “401(k) Plan Litigation under ERISA,” Journal of Pension
Planningand Compliance,” vol. 27, no. 3, Fall 2001.
Holden, Sarah and Jack VanDerhei, “401(k) Plan Asset Allocation, Account
Balances, and Loan Activity in 2000,” EBRI Issue Brief Number 239, Employee
Benefit Research Institute, Washington DC, November 2001.
Liang, Nellie and Scott Weisbenner. “Investor Behavior and the Purchase of
Company Stock in 401(k) Plans: The Importance of Plan Design.” Working
Paper. Department of Finance, University of Illinois. May 2002.
Meulbroek, Lisa K. “Company Stock in Pension Plans: How Costly Is It?” Harvard
Business School Working Paper 02-058. March 2002.
McGill, Dan M. and Donald S. Grubbs. Fundamentals of Private Pensions. (6^th ed.)
Pension Research Council, Wharton School of Business, University of
Pennsylvania. 1989.
Mitchell, Olivia S. and Stephen P. Utkus. “Company Stock and Retirement Plan
Diversification.” Pension Research Council. University of Pennsylvania.
Working Paper 2002-4, April 2002.
Morrison, George M. and Anthony L. Scialabba, “Using Employer Stock in a

401(k)Retirement Plan, Journal of Pension Planning and Compliance, vol. 25,

No. 3, Fall 1999.
Profit Sharing/401(k) Council of America, 44^th Annual Survey of Profit Sharing and

401(k) Plans, Chicago IL, October 2001.

Purcell, Patrick J. “The Enron Bankruptcy and Employer Stock in Retirement
Plans.” CRS Report RS21115, March 11, 2002.

Ramaswamy, Krishna. “Company Stock and DC Plan Diversification.” Pension
Research Council. University of Pennsylvania. April 2002
Reish, Fred and Joe Faucher, “The Enron and Lucent Cases: Responsibilities for
Employer Stock,” Journal of Pension Benefits, Vol. 9, No. 3, Spring 2002.
Sengmuller, Paul. “Performance Predicts Asset Allocation: Company Stock in

401(k) Plans.” Columbia University, Department of Economics. April 2002.

United States Department of Labor, Pension and Welfare Benefits Administration.
Private Pension Plan Bulletin: Abstract of 1998 Form 5500 Annual Reports.
Number 11, Winter 2001-2002. U.S. Department of Labor, Washington, D.C.