MONEY 401(k)s

The Supreme Court Just Helped Save Investors From Themselves

Many companies and their workers still ignore the risks of holding employer stock in 401(k)s. That's about to change.

Savvy investors already know it’s not smart to hold your employer’s stock in your 401(k) retirement plan. Wednesday’s unanimous ruling by the Supreme Court should make it harder for employers to encourage it. That’s probably a good thing.

The case, which involved Cincinnati-based bank Fifth Third FIFTH THIRD BANCORP FITB 0.7376% , revolves around whether workers can hold top brass responsible for big losses on employer stock in their retirement plans. Fifth Third, once seen as a sleepy mid-western bank, saw its stock plunge more than 70% during the financial crisis, stinging investors. The Supreme Court didn’t resolve whether or not Fifth Third—which maintains it treated 401(k) savers and its other investors appropriately—really shirked its responsibilities. Ultimately the case was sent back to a lower court, which will decide whether it can proceed.

Even so, the Supreme Court made an important tweak to the rules that companies need to follow when setting up their 401(k) plans, benefits lawyers say. Up till now companies used to get something of a legal free pass when they added employer stock to 401(k)s. That’s not necessarily so anymore.

Here’s how that’s changed: Employers are required to make sure plans include only “prudent” investment options like diversified stock and bond funds. Because giving employees stock is seen as a motivational tool and a way to help workers share the wealth, however, company stock was a special exception. Not any more. Now employers will potentially have to justify that their stock is prudent, perhaps by pointing to a bond rating or a healthy price-to-earnings ratio, according to Bruce Ashton, a Los Angeles-based benefits lawyer. “They’ll have to show more diligence,” he says.

The upshot, according Marcia Wagner, another prominent benefits lawyer, is that fewer employers will offer stock in their 401(k)s. “It’s risky for them now,” she says. That’s “a tectonic shift.”

Ultimately it’s good news for investors. The popularity of company stock in retirement plans has been waning for years, at least since the implosion of Enron in 2001, when the spectacle of employees losing their jobs and their savings at once became national news.

While nearly 20% of 401(k) dollars were in employer stock in 1999, according to benefits researcher EBRI, by 2012, the latest date for which data is available, that total had fallen to 7%.

Still not everyone seems to have gotten the memo. About 6% of employees have more than 90% of their 401(k)s invested in company stock EBRI reports. Meanwhile about one in10 employers still require 401(k) matching contributions be in stock, according to Aon Hewitt, a benefits consulting company.

Maybe not for much longer.

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