Wednesday, November 27, 2013

Company Stock as a 401(K) Option

Company Stock as a 401(K) Option

The Solicitor General of the United States has petitioned the Supreme Court to hear a case involving the ability of employees to bring a class action suit against their employer’s inclusion of the company stock in a 401(K) plan.  This type of litigation is known as stock-drop class action and seems to be initiated whenever a company’s equity plunges in value.  Many courts have been reluctant to allow these types of suits to proceed when the situation involves a 401(K) with an option to purchase company stock.  The courts have ruled that there’s a presumption that the decision to create such an option is reasonable given Congress’s intention to encourage employee ownership.   The suits have been dismissed at a preliminary stage..

The Sixth Circuit Court of Ap   The bank maintained a stock option in its 401(K) despite its ongoing mortgage problems.  The bank’s stock plummeted, the value of 401(K) balances fell, and a class action lawsuit ensued.  The Sixth Circuit ruled that the presumption of reasonableness did not apply at the preliminary stage of the case and allowed the plaintiffs to at least initiate their case.   The Supreme Court is being asked to determine if the Sixth Circuit or other circuit courts have the correct interpretation of the law.
Fund of Funds (2003)
peals broke away from the rulings of other circuits and allowed a class action to proceed against Fifth Third Bancorp.

Aside from the legal debate, corporations argue that if the Supreme Court sides with the Sixth Circuit, it will bring on a flood of stock-drop lawsuits by the class action bar.  The US Department of Labor counters the standard of winning one of these cases would remain high given the that a stock ownership option in a 401(K) plan is presumed to be reasonable.


I’m not in any position to handicap the outcome of this case.  However, I strongly believe that including a company’s stock in a 401(K) plan is a very bad idea.  By working at the company, employees are already taking on a great deal of risk.  Their salaries and career are tied to the wellbeing of the company.  When employees also buy the company’s stock in their 401(K)s, they are also betting their retirement on company’s future.  In addition, they may also be participating in a stock option or stock purchase plans using after-tax dollars.  In short, employees are taking an enormous amount of company-specific risk and shouldn’t risk their retirement as well.  While Congress has blessed the inclusion of company stock in a 401(K) plan, it completely violates the notion of prudent and diversified investing.

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