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A Perspective on the Apparent Rush to Indict and Limit Employee Ownership Through 401(k) Plans and ESOPs

David Johanson

January 2002

Many of us have read with interest the following headlines in the first few weeks of 2002 (what was to be the year of balance):

BUSH SEEKS REVIEW OF 401(K) LAW

COMPANIES, LAWMAKERS CONSIDER 401(K) SAFEGUARDS

WHITE HOUSE ANNOUNCES INTENT TO CHANGE ERISA LAWS TO PREVENT FUTURE ENRONS

CHANGES WOULD ADDRESS USE OF COMPANY STOCK IN ERISA PLANS; DETAILS NOT RELEASED, KSOPS AND ESOPS COULD BE IMPACTED

J. Michael Keeling of The ESOP Association characterized these headlines as follows in a recent announcement to The ESOP Association's members: "In an ominous development, the White House has added its voice in support of Congressional and media voices calling for changes in the laws permitting company stock as an asset of a defined contribution plan. The White House said it intended to develop proposals to prevent situations such as Enron, where employees lost (substantial) savings due to the collapse of the value of company stock in savings plans, from occurring in the future."

Efforts are well underway at The ESOP Association, the Profit Sharing/401(k) Council of America and other major employee benefit groups to fight any unnecessary or unreasonable restrictions on the use of company stock as a benefit under a 401(k) plan, an ESOP and/or other employee benefit plans. I respect, appreciate and applaud these efforts and look forward to continued direction from the administrative leaders of these organizations to provide a focus on the key issues that will support the continued development of well run broad-based employee owned companies that maintain effective ownership cultures and provide a basic respect and dignity for employees as part of the employer-employee work environment.

Nevertheless, having (1) read the headlines and the articles that follow, (2) been bombarded with a torrent of information (as reported on CNN and elsewhere) about the need for protections to prevent the substantial loss of retirement savings as in the Enron bankruptcy and (3) thoughtfully considered the subject of protective restraints on employee ownership, my preliminary thoughts are that the primary cause of the substantial loss in retirement plan savings in the Enron bankruptcy case was not employee ownership or the manner in which employees were allowed to invest in the company (although the trading restriction apparently due to a change in third-party recordkeepers near Enron's last moments as a viable company did contribute to the losses). The primary culprits in the Enron case appear to have been (in no certain order): (1) substantial financial accounting irregularities that masked Enron's overstatement of earnings by more than $580 million from 1997 until 2001; (2) deficiencies in securities law disclosure documentation and regulation of such disclosures that prevented the public from accurately understanding the risks of an investment in Enron; and (3) insider trading violations which allowed Enron's executives to liquidate more than $1 billion in Enron company stock while it was trading near its peak ($83 per share in January of 2001).

Of course, the sudden concern by the media, the Bush Administration and Congress with employee ownership in 401(k) plans, ESOPs and other types of employee benefit plans goes beyond the Enron bankruptcy case - the Enron case simply focuses our nation's attention once again on the "issue of the day." President Bush used a number of statements in making his announcement on January 10, 2002 (that he is asking for recommendations to change what he refers to as the "pension" laws due to "the recent wave of bankruptcies" resulting in employees losing their pension savings) that should concern employee ownership advocates. President Bush has asked the U.S. Treasury and Commerce Departments to study "pension laws" in an effort "to make sure that people are not exposed to losing their life savings as a result of a bankruptcy." Furthermore, as Michael Keeling of The ESOP Association has consistently reminded me throughout my career as an employee ownership attorney, the U.S. Treasury Department and its counterparts at the White House know about, and the key staff people in Congress who have repeatedly asked for restrictions on the use of company stock in employee benefit plans are aware of, other higher profile employee owned companies that have experienced severe financial difficulties that have resulted in substantial losses of retirement plan savings for the employee owners of such companies. There is a credible risk that President Bush, Congress, the U.S. Treasury Department and the U.S. Department of Labor will attempt to change our current laws for investing in company stock in a manner that many of us do not find acceptable.

Employee ownership advocates (including companies, employee owners, consultants and professionals) should mobilize grass roots support, as reasonably necessary, to share positive stories of employee ownership with congressional representatives and senators. Such stories should, however, present broad-based employee ownership in a practical and realistic manner (in other words, employee ownership is not a panacea for all of the world's ills and there are certain pros and cons of implementing employee ownership in certain circumstances - if properly structured and implemented, however, employee ownership is simply a great way to operate a business in a way that may provide substantial financial and intangible benefits to company founders, companies, officers and their employees). We also should attempt to distinguish the Enron facts (and other circumstances in which employee ownership has "failed") from employee ownership as we all have seen it implemented in a positive manner throughout the country. Bad facts such as in the Enron or similar cases can establish case law and result in legislative restrictions that are not necessary with respect to a large percentage of the companies that become employee owned. By sharing with our legislative representatives the circumstances in which employee ownership works well, we will provide distinctions that will help lawmakers to propose properly constructed legislative restrictions on the administration of employee ownership through employee benefit plans that will not adversely impact well run employee owned companies and discourage other companies from heading down that path in the future. We also must continue to be a voice of reason and guard against feeding into the frenzy that will probably develop over this subject during the upcoming months.

I decided to write this editorial to (1) provide a balanced perspective on this subject (we should not be reactive - we should react constructively, efficiently and effectively to any unreasonable and unnecessary restraints on employee ownership) and (2) point out how uninformed it is for anyone to reach conclusions about properly structured broad-based employee owned companies by reviewing the Enron bankruptcy case or any other "failed" employee ownership story and indict the concept of employee ownership as many of us have seen it work throughout the years. Because I do not believe that "employee ownership" through 401(k) plans, ESOPs and other employee benefit plans is "broken," I refuse to join the debate about what we should do to "fix" the problem. I will, however, react swiftly and strongly to any proposals to restrict the amount of company stock that employees may purchase in a properly constructed, administered and regulated 401(k) plan and/or ESOP. I also will strongly support, however, any changes that can be made to address the substantial accounting irregularities and securities law disclosure failures and the limitations on the sale of company stock that employees experienced in the Enron case.

Far too many times we as Americans read about some heinous crimes (either against property or people or of a financial nature) and we quickly jump to conclusions and make generalizations about other human beings or subject matters as a result of our initial reactions. Most recently for example, our nation was faced with a sickening display of cowardice and terror when a group of individuals claiming to be devoted Muslims wrought so much destruction, havoc, despair, injury, emotional and financial distress and death on our country. Many of us have reacted with support and care for those families who have been so adversely affected by this tragedy and have shown restraint and tolerance of those among us of the Muslim religion who live and work in the United States. Others have shown a lack of tolerance and have inappropriately and improperly labeled and profiled all Muslims who live among us as a result of the actions of a few people.

The message is that there is nothing inherently wrong with employee ownership through a well run and properly designed and implemented employee owned company simply because of the circumstances that occurred in the Enron case and in other recent situations. It is imperative that employee ownership advocates convey to their legislative representatives in Congress the importance of employee ownership to employees and attempt to distinguish the headlines of today from the many positive examples of employee ownership that currently exist. As Michael Keeling has indicated, we do not want "Congress (with President Bush's backing) (to) enact laws that repudiate the 27-year positive history of employee ownership through ESOPs." I strongly agree with Michael Keeling that restrictions on the amount of company stock that may be held in an ESOP or other employee benefit plan "will in the short run and the long run hinder the operation and creation of employee ownership through ESOPs (and this is unreasonable and not necessary)." Loosening restrictions on selling company stock, providing employees with adequate financial accounting and securities law disclosure when they decide to invest their elective deferrals in company stock, preventing insider trading that adversely affects employee owners and other investors and properly educating employees regarding the purchase of company stock in a 401(k) plan, however, all are reasonable ideas (some of which are already required by existing legislation and/or regulations).

Note: The opinions expressed by Mr. Johanson, an attorney in private practice, are his own and do not necessarily reflect the views of the NCEO or other organizations.

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