More Education, Not More Regulation, Is Needed to Help Workers

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More Education, Not More Regulation, Is Needed to Help Workers

February 28, 2002 10 min read
David John
Former Senior Research Fellow in Retirement Security and Financial Institutions
David is a former Senior Research Fellow in Retirement Security and Financial Institutions.

The reaction to Enron's failure ironically could end up threatening the retirement assets of the almost 40 million American workers who now participate in 401(k) plans. To be sure, the Enron collapse has revealed a serious weakness with the way some workers invest their savings; but some of the potential cures could be far worse than the problem. Investing any retirement savings in only one asset, whether company stock or any other single stock or corporate bond, is extremely risky, and this type of investing should be discouraged. However, the best approach would be educating worker-investors, not congressional micromanagement of their plans.

In encouraging workers to save for their retirement, 401(k) plans have been very successful. The more than 320,000 plans contain almost $2.0 trillion worth of assets. All 401(k) plans are voluntary; employers are not required to offer them, and when they do, workers are not required to participate. If they do offer a 401(k) plan, employers are not required to provide any match for an employee's savings. There is room to improve 401(k) plans, but any change that discourages workers or employers from participating is likely to do more harm than good.

Rather than increasing federal regulation on these company-sponsored retirement plans, a far more effective policy would be to require employers to provide more information about the potential risks workers face if they invest a large proportion of their plan contributions in company stock. Moreover, workers who receive such stock as a match for their contributions should be able to sell it within a reasonable period. Finally, companies should provide workers with adequate notice when the plan administrator changes. Such steps would ensure that American workers become better investors.

Concerns about 401(k) Accounts

Questions about 401(k) plans took center stage following the Enron collapse, but other issues raised by the Enron debacle have nothing to do with retirement investing. Issues such as Enron's failure to offer a true picture of its financial condition, whether accounting firms should also offer consulting services, questionable and perhaps illegal behavior by Enron executives, and campaign finance reform are all important and should be given appropriate attention. But none of these issues affects the structure of 401(k) plans, and none of them should be a part of this debate.

The three major concerns about the current structure of 401 (k) plans are:

  • The potential losses that workers who put a large proportion of their retirement plan assets in an employer's stock could suffer if that stock goes down in value;
  • Assets that are locked in investments that are losing value because an employer changes plan administrators; and
  • The low level of financial literacy among many workers and the inability or unwillingness of employers to assist in educating their employees.

The huge losses suffered by Enron employees who were heavily invested in that company's stock demonstrate the seriousness of these concerns. An additional factor was that Enron workers who had received company stock as a match for their personal contributions were prohibited from selling the stock until they reached the age of 55. Essentially, they were locked into what proved to be a disastrous asset.

Even in the wake of this unfortunate scenario, a review of history will show that Congress should not rush to adopt policies that would harm the basic nature of 401(k) plans.

The Wrong Solution: A statutory cap on employer stock

Some legislators reacted predictably to the collapse of Enron employees' retirement assets by attempting to ban the behaviors that caused it. They sought to prohibit employees from holding more than a set percentage of their 401(k) assets in company stock. Another equally mistaken approach would be to prohibit the plan from offering the worker both company stock as a match for his or her investments and the opportunity to invest in that stock; plans would be allowed to offer only one or the other.

There are two problems with these proposals:

  1. Administering a statutory cap on how much of a worker's 401(k) assets could be invested in company stock would be difficult. For instance, it is not clear when the cap would be enforced. Pension experts have noted that a statutory cap would be exceeded mainly when employer stock is going up in value. Would pension managers be forced to sell the company stock on the day that it exceeded the cap? If so, employees would be punished if, after a short-term rise in the company stock price, it then goes back to its historical level.

    An alternative would be to enforce such a cap at a set interval, such as monthly or quarterly. Unless legislation precisely spells out how the enforcement of this cap should take place, plan administrators could be liable for choosing the wrong time period. If a statutory cap is exceeded and employer stock must be sold as a result, would plan administrators be required to purchase more stock for the employee if stock prices later fell? That type of buying and selling could raise administrative costs without any appreciable benefit to the employee.

  2. Statutory caps are likely to discourage employers from matching employee contributions, and could discourage employees from 401(k) participation. Both employee participation in a 401(k) plan and any employer matches of those contributions are voluntary. While there is a tax benefit to both if they do so, both employer and employee are using their own money. If the proposed cap raises the employer's cost of providing a match to the employee's savings, some companies may choose to drop the matches altogether. Statutory caps also are likely to raise the administrative costs that employees must pay. In addition, some employees will strongly believe that their best retirement investment is the employer's stock. The combination could cause some workers to shift their investments out of their 401(k)s and into plans that offer them greater flexibility at a lower cost.

There is a precedent for sharply reducing any company-imposed restrictions on the sale of stock given to employees as a match for their contributions. At one time, it was allowable for employers to reclaim any matching contributions if the employee ever left the company. This practice, however, was prohibited a number of years ago. Instead, workers have been allowed to keep all company contributions once they have been employed for five years. This system is known as "vesting."

Similarly, workers should be allowed to sell the company stock given to them as a match for their 401(k) contributions after a set time has elapsed. Once they are vested, workers should be allowed to manage employer matches in the same way that they can invest the rest of their portfolio.

The Real Solution: Improving Financial Literacy

One way to deal with employees who have their 401(k) assets concentrated in company stock or any other asset would be to make sure they understand the risk involved. Massive financial illiteracy was, in fact, the real cause of the Enron employee losses. One worker quoted in The Washington Post stated that the reason he left all of his 401(k) money in Enron stock, despite the urging of his wife and financial advisor who wanted him to diversify his investments, was his "conservative" approach to investments.1 A more knowledgeable investor would have recognized that this lack of diversification was anything but conservative.

This problem is not unique to Enron. Workers at a number of other companies have most of their 401(k) assets invested in corporate stock. Nor is the problem limited to risky strategies that could result in severe losses. A significant number of workers have gone to the other extreme and invest their 401(k) funds in low-risk assets that make it very difficult for their 401(k) plans to grow large enough to meet their retirement needs. Both investing errors are likely to hurt plan owners.

Workers need more information in order to make informed choices, not more congressional micromanagement. For example, employers should:

  • Provide statements of risk to each employee based on his or her 401(k) portfolio. Employers must provide workers with a statement of their 401(k) accounts at least annually; many plans provide these statements more frequently. It would be far more effective for employers to place a warning prominently on the account statement regarding the risk each employee personally faces. As a further guidance, the Securities and Exchange Commission (SEC) could provide a model portfolio, appropriate for the worker's age, which the plan manager could include in the statement without liability.

    Such notice would make it clear to the worker that he or she could face massive losses if the company stock goes down. The worker could either change the investment portfolio or let it stand and accept the current risk. This approach would prove far more effective than having Congress attempt to impose its wisdom upon the worker.

  • Provide adequate notice when changing plan administrators. Companies that sponsor 401(k) plans change plan administrators fairly regularly, usually because the new one offers lower costs or better investment choices. During such a change, accounts are routinely frozen for a time while any pending transactions are completed and the complete record is sent to the new administrator. This process is similar when an individual changes banks for a checking account; one routinely waits for all outstanding checks to clear before closing the old account.

    Until Enron's collapse, this process was not controversial. However, many Enron employees claimed that during the "blackout" period when their accounts were frozen, they were prevented from selling their Enron stock to preserve some part of their investment. They also claimed to have been caught unaware and not to have known that the change in plan administrators was coming. The blackout period lasted about 11 days, during which Enron's stock price dropped almost 50 percent, from about $13 a share to about $7. However, the stock price had already been dropping for quite some time and had traded close to $85 a share at the beginning of 2001. While employees with 401(k) plans including Enron stock could only watch their retirement savings decline, Enron executives who owned company stock not in the 401(k) plan were able to sell their shares.

    The solution to this problem is simple--greater and uniform disclosure requirements. All affected employees should be notified in writing at least three weeks before a planned change of administrators and clearly informed about exactly how long their accounts will be unavailable. It is true that employee investments could lose (or gain) value during the change, but at least they would know in advance that their accounts were unavailable and why.

    The Bush Administration has proposed to ban corporate executives from trading any company stock that they own outside of 401(k) plans during the blackout period. That would put them on an equal footing with employees. Of course, executives who own corporate stock in their 401(k) accounts already would be on an equal footing with employees, and there would be no similar ban on non-executives selling such stock. This sales restriction appears to be more a gesture for public relations than a solution to a real problem, and it probably would be more trouble to enforce than it is worth.

To a large extent, American workers are simply unprepared to invest. Most school systems have no formal financial education program. If such education is included at all, it is often left to ad hoc programs sponsored by financial or nonprofit groups. As a result, when an employee is faced with investment decisions that may make the difference between a comfortable retirement and poverty, he or she is often completely unprepared. One solution might be for that information to be offered to new 401(k) participants at the workplace.

Unfortunately, current law discourages companies from offering investment advice to their workers by placing the liability for poor advice on the company rather than on the entity giving the advice. As a result, most companies do nothing at all to educate their employees on how best to invest their 401(k) plans.

Last November, the House passed the Retirement Security Advice Act (H.R. 2269), sponsored by Representative John Boehner (R-OH), which would shift most of the potential liability from the employer to the entity that actually provides the investment advice. The employer would retain the responsibility to choose a reputable investment advisor. The strong bipartisan support for this bill in the House would seem to indicate that it is an appropriate response to the Enron problems; as yet, however, the Senate has refused to consider it.


An increasing proportion of workers will depend on 401(k) plans, or similar retirement investment accounts, for a major portion of their income in retirement. The losses suffered by Enron employees illustrate a problem that needs addressing, but the wrong policy approach could make the problem even worse. Any legislative solutions should be considered very carefully.

Employers are not required to offer 401(k) accounts to their employees, and employees are not required to participate in them. Congress should react to the Enron case by promoting more education for Americans about retirement investing instead of trying to micromanage their accounts.

David C. John is a Research Fellow at The Heritage Foundation.

1. Anne Hull, "For Enron Families, Dreams and Faith Lost," The Washington Post, January 20, 2002, p. A1.


David John

Former Senior Research Fellow in Retirement Security and Financial Institutions