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Must we save 401(k) investors from themselves?

By Steven Syre & Charles Stein, 1/6/2002

To regulate 401(k) plans or not to regulate them: That is the question for today.

The calls for regulation have poured in since the demise of Enron. When the Houston energy-trading firm melted down in December, its stock price and the retirement savings of thousands of employees melted down along with it. About 57 percent of all of the money in Enron's 401(k) was invested in the company's own stock.

And when it comes to packing the retirement plan with company stock, Enron was by no means the worst offender. At Procter & Gamble, 95 percent of the 401(k) is invested in P&G stock, according to DC Plan Investing, a newsletter. At Coca-Cola and General Electric, the comparable numbers are 81 percent and 77 percent, respectively. The big numbers are the result of contributions from employees and the companies.

Jon Corzine thinks such heavy concentration of assets is a bad idea, and the former head of Goldman Sachs, now a Democratic senator from New Jersey, wants to do something about it. Corzine and Senator Barbara Boxer, Democrat of California, have introduced a bill that would make it illegal to put more than 20 percent of a retirement plan's money into a single stock. The bill also would change some other rules that govern the way 401(k)s operate.

''This is not what you call heavy-handed regulation,'' Corzine said when he introduced the legislation. ''These are prudent investor rules that will protect people in the long run.''

The case for regulation is straightforward. Many investors are unsophisticated and may not appreciate the kind of risk they are taking when they invest the bulk of their retirement money in their own company's stock.

''When you invest heavily in company stock, you are in double jeopardy because you can lose your job and your retirement at the same time,'' said Louis Berney, editor of DC Plan Investing.

There is an argument in defense of regulating 401(k) s: We already have similar laws in place for traditional defined-benefit pension plans. US companies cannot invest more than 10 percent of the assets of a pension plan in company stock.

The rule, which dates from the 1970s, is based on the notion that diversification is the best way to ensure that pension money will be there when employees retire. In practice, most pension plans limit their investments in any single stock to 5 percent of the plan's assets.

Traditional pensions and 401(k)s are quite different animals. One involves a promise to pay benefits in the future. The other is a contribution today with no guarantees of future performance. But the truth is, at many firms the 401(k) is the only retirement plan available. Given that, why not treat both types of plans the same way? Plenty of reasons, say the opponents of regulation.

''Part of the freedom in a capitalist system is the freedom to go broke,'' said John Spooner, a well-known Boston author and stock broker. If 401(k) money belongs to an employee, says Spooner, then it is up to the employee to decide how it should be invested. Some people may do poorly. Others may do very well.

In fact, by investing heavily in company stock many Americans have become rich. It has happened at General Electric, Coke, Microsoft, and Wal-Mart. Writing about Wal-Mart in his new book, ''Giants of Enterprise,'' Harvard Business School professor Richard Tedlow said: ''People from humble backgrounds who never dreamed they would be able to accumulate capital found themselves with holdings worth hundreds of thousands of dollars.''

On a smaller scale, the same thing happened at The Boston Globe. A dollar invested in Globe stock when the company went public in 1973 was worth $120 by the time the business was purchased by The New York Times Co. in 1993. Spooner had many Globe employees as clients and he regularly exhorted them to buy more stock. ''I told them, `You don't own enough of this company.''' In this case, he turned out to be right.

Critics of regulation also point out that setting a limit on investments in company stock won't protect 401(k) participants from losing their money. Consider the fate of a popular growth mutual fund like Putnam Investments' Vista fund, which is regularly sold to 401(k) plans. Between March 2000 and the end of 2001 the fund lost 52 percent of its value. That may not be a meltdown on the scale of an Enron or a Lucent Technologies (down 90 percent in two years), but it is still a pretty heavy loss to absorb.

Where do we come down on this issue?

As free-market types we generally lean toward letting investors make their own choices, good or bad. In a market system, if you limit the risk, you also limit the reward. ''You don't get rich through diversification,'' said Paul Strella, a retirement specialist at William M. Mercer, a benefits consulting firm.

On the other hand, it's hard not to be disturbed by stories of employees losing their life savings. Do they need to be protected from themselves, especially if they are not terribly sophisticated investors?

Would more investor education solve the problem? Should employees have to sign a disclaimer, spelling out the risks they are taking whenever they choose to invest more than a certain percentage of their retirement assets in company stock?

We don't have all the answers. But we would be curious to hear what you think. Send us an e-mail, letting us know where you stand.

Steven Syre (617-929-2918) and Charles Stein (617-929-2922) can be reached by e-mail at boscap@globe.com.

This story ran on page F1 of the Boston Globe on 1/6/2002. © Copyright 2002 Globe Newspaper Company.

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