When shares of Enron plunged from $84 earlier this year to practically zero, thousands of the company’s employees lost not just their jobs but also most of the value of their 401(k) retirement accounts. For the average employee, Enron stock represented three-fifths of 401(k) assets, and the energy company’s meltdown — after revelations of misleading, probably fraudulent, accounting practices — was a personal calamity.
Now politicians, including Democratic Sens. Barbara Boxer of California and Jon Corzine of New Jersey, are rushing in to protect other Americans from similar disasters. And President Bush has ordered “a policy review to protect people’s pensions.” But government intervention would only introduce a dangerous idea: that investors shouldn’t bear the burden of their own decisions.
Enormous Responsibility
Let’s be clear: Enron executives and outside auditors who lied to investors — including their own 21,000 employees — bear an enormous responsibility, moral and legal. But the employees also bear some responsibility. Most of them had far too large a proportion of their retirement assets tied up in their own company. They took a risk.
Enron offered a typical 401(k): Employees could invest up to 6% of their base pay in a wide range of options, including stock mutual funds like Fidelity Magellan, bonds, money-market funds and a self-directed Schwab account that could buy practically anything. They could also choose Enron stock, purchased at the regular market price. Whatever employees contributed with their own money, the company matched, up to 50% (that is, 3% of base pay), with Enron stock.
In other words, free Enron stock — $1,800 worth a year for an employee making $60,000 in base pay — was part of the compensation package. Workers knew it, and they presumably liked it. Workers also knew that their 401(k) had a rule, also common to such plans, that they had to keep the company stock given to them by Enron until they were at least 50 years old. Any Enron stock they bought themselves, of course, they could transfer at will.
Enron stock soared in value — but turned out to be a blessing and a curse. Imagine the case of an employee who joined the company in 1997, when the stock was worth (after adjusting for splits) about $20 a share. If the employee bought other assets which grew at 10% a year, by the end of 2000 those assets had grown by about one-third while the Enron stock had more than quadrupled. His 401(k) account became lopsided, with far more Enron stock than anything else.
That was a predicament common to many Enron employees when their company stock crashed. The wise move, as Enron climbed, would have been to buy other assets for a separate, taxable plan to balance the company stock. How many employees did that? Probably not many — presumably for some because they didn’t have the money. If Social Security had been reformed, they could have directed part of their payroll taxes into broad indexes of stocks and bonds, offsetting their Enron holdings. But that’s a subject for another day.
Warren Buffett, the best investor of the last century, is fond of quoting Mae West as saying, “Too much of a good thing can be wonderful.” But for most investors, picking the good thing isn’t easy. The most important rule, by far, for successful investors is, “Diversify, diversify, diversify.”
As late as October, even the independent Value Line Investment Survey was giving Enron an “A” rating for financial strength and saying the stock had “above-average appreciation potential.” If Enron had represented 5% of your portfolio — the maximum for any stock, as far as I’m concerned — then its bankruptcy would have put only a small dent in your retirement account. Instead, a study released in November by the Employee Benefit Research Institute and the Investment Company Institute found that company stock represents nearly one-third of the total assets in the 401(k) plans of employees of firms that offer their own stock as an investment option.
That’s far, far too much. Right this second, the 37 million Americans with 401(k) plans should be reviewing them to be sure they’re diversified.
Instead, they’re being told by politicians, don’t worry, the government will fix everything so you can play the stock market with no downside risk. Ms. Boxer and Mr. Corzine want a law that would prohibit any one stock from representing more than 20% of a 401(k) plan’s assets. But all this does is reduce investor choice and responsibility while stepping ever closer toward some kind of federally mandated retirement system.
The big problem is that too few Americans understand what prudent portfolios are. Current laws don’t help. Under the Employee Retirement Income Security Act of 1974, the guiding federal pension statute, overseen by the Labor Department, companies are held liable for investment advice offered to their employees, even if it is given by independent professionals they hire. So most 401(k) participants get no advice at all. They’re forced to choose among assets they don’t understand. A recent study by John Hancock Financial Services, for example, found that many investors believe that a diversified stock fund is more risky than their company’s stock, and that a bond fund is risk-free.
Last month, the Labor Department issued an opinion at the request of SunAmerica that lightened some of the legal burden and let the investment advisor help employees allocate their assets. More important is the Retirement Security Advice Act, introduced by Rep. John Boehner (R., Ohio), which removes unreasonable employer liability. It’s backed by the administration and has passed the House. A similar bill is sponsored in the Senate by Jeff Bingaman (D., N.M.).
That pension rules are complicated is no excuse for the inaccuracies of the reporting on Enron’s retirement plan — especially the claim that rich managers could sell their stock while lowly workers were “locked in.” All plan members, including top executives, were prevented from moving any of their 401(k) assets between Oct. 29 and Nov. 13 — a temporary shutdown, announced on Oct. 4, supposedly to allow for a transition to a new outside plan administrator. By then Enron’s stock had already fallen to $13.81 (it declined another $3.83 during the 10 trading days of the freeze).
Timing
The timing of the changeover does sound a little fishy, and investigators should examine it carefully. But such shutdowns are common, and there’s no need to ban them. One small change in the law that might be worthwhile is for companies to be prevented from issuing restricted stock to plan members. Other investors aren’t barred from selling stock before they’re 50; employees shouldn’t be either.
But let’s not lose sight of the main lesson of the Enron disaster: Bad things happen to good investors, and diversification is the best protection. Companies should design plans that make diversification easier, but, ultimately, the responsibility for wise investing must lie with the investor. Politicians who say it doesn’t are only encouraging risky behavior.
— Made available through http://www.techcentralstation.com. This article first appeared in The Wall Street Journal.