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A supervisor has legitimate worries about the value of the company stock in the 401(k) plan, but would doing something about it constitute illegal trading on inside information?
This article is the third of an occasional series on ethical issues faced by human resource professionals. For guidance in ethical dilemmas faced by HR, the Society for Human Resource Management recently developed a new “Code of Ethical and Professional Standards in Human Resource Management.”
When the computer’s distinctive “beep” snapped Sarah Jones from her concentration on the latest financial statements, she glanced at her watch and realized it was already time for her appointment with Bob Smith, a production supervisor at Apex Corp., a medium-sized, publicly traded pharmaceutical-products manufacturer.
Sarah, vice president for HR at Apex, liked to know beforehand what people wanted to talk about, but Bob refused to tell her in advance and seemed anxious to meet as soon as possible. As she pondered the possibilities, Bob entered her office and closed the door. He was clearly worried.
“I don’t know how much you know about this,” Bob began, “but Apex is likely to be hit soon with a costly penalty by a federal regulatory agency.” For several months, Bob explained, the production department has been unable to resolve the agency’s complaints of deficient manufacturing practices. If the agency isn’t satisfied with Apex’s remedial efforts within a month, it will halt production of the company’s top moneymaking product for as long as it takes to satisfy the agency’s demands for changes in equipment and processes. Halting production for those types of changes would last about 12 weeks—maybe more.
Sarah had heard discussions of the agency’s inspections and subsequent negotiations in meetings of the executive committee, but the situation had never seemed as dire as Bob painted it. A lengthy shutdown, of course, not only would cut deeply into revenues for more than a quarter but also would seriously weaken investor confidence in the company and depress its stock value.
She began to wonder if Bob was overstating the problem, even as she continued to wonder why, exactly, he had come to tell her this now.
“You know, the CEO and my superiors are probably the only people at the company who know the details of this,” Bob said. They are aware, he said, that the company’s responses to the agency have been “too little, too late.” When production is halted, he added, “a lot of people are going to get hurt” because the stock price will drop sharply. Many employees have invested substantial amounts of their own 401(k) deferrals in Apex stock, and the company’s contributions are made with company stock.
Bob wants Sarah to persuade the CEO that the company should start making 401(k) matches with cash instead of company stock. “And I think you should warn employees that they may want to move their company stock in the 401(k) into one of the other fund selections.”
“Why didn’t you take this to your boss?” Sarah asks him.
“Because he wouldn’t do anything,” Bob says, “and nothing would happen. I figured you’d see the problem and do something about it. Besides, you have access to the CEO; I don’t.”
As if that were not enough to lay on Sarah, Bob said he was planning on moving his own company stock to other funds—and asked her if he can tell his friends they should do the same.
Sarah is a member of the company’s executive committee but is not a member of the committee that oversees the 401(k) plan. Administration of the plan is outsourced to a large firm with a solid track record in the industry. The company provides general financial education for all employees on saving for retirement in the 401(k) plan but offers no third-party advice service on how funds should be invested.
“I’m not sure what I should do—or even what I can or can’t do—with what you’ve just told me,” she tells Bob. “You’ve given me a couple problems. First, would it be right for you to get rid of your company stock—and tell others to do the same—now that you know some negative information that very few other people know? I think I know the answer, but I have to make sure.
“And, second, what can or should I do about recommending that the company suspend use of its stock for 401(k) matches? Should I take it to the CEO? Or to the 401(k) committee? Or both?
“I need some time to think about all this. And right now I don’t know who to ask for help.”
By Steve LeBlanc
Sarah is right to wonder if Bob is overstating the situation. A calm, rational approach will serve Sarah, her co-workers and Apex best. Keep in mind that nothing has happened yet. Apex is still in discussions with the federal agency, and various outcomes are possible. It’s too soon to slam on the brakes.
But Sarah needs a plan. If the worst does happen, her co-workers’ retirement funds (and perhaps, for some, the ability to retire at all) will rest on decisions that she and the other senior Apex executives are about to make.
First, Sarah must buy some time until she can determine the seriousness of the situation. She has to tell Bob about how insider trading regulations govern his use of the information and about his responsibility as a supervisor to prevent rumor-based panic among employees. In other words, she should tell him to “zip it.” If Bob thinks things are bad now, he needs to understand he could find himself in trouble if he acts irresponsibly.
Sarah should assure Bob that she takes his comments very seriously and will begin immediately to gather additional information so she can make the best recommendations regarding the situation. Bob should also be encouraged to continue to go to Sarah as the situation unfolds. Although it’s unlikely that at his level Bob would know the whole story, he could provide Sarah with valuable information as the problem develops.
Next, Sarah must meet with her CEO to learn more about this situation. While conflicts like this happen every day, a production stoppage remains an option of last resort. Generally, all sides prefer a more constructive outcome.
If a production halt is ordered, however, the executive committee and subsequently the 401(k) committee should quickly call emergency meetings, with Sarah and the CEO present at both. To maintain calm within the company, the CEO would have to issue a statement immediately to all employees, detailing the situation, assessing the potential impact on the company’s stock price and explaining Apex’s efforts to address the problems on all fronts. Employee meetings with financial advisers from the plan’s investment agent (at company expense, if necessary) would have to be scheduled to help employees evaluate their options and make informed decisions regarding their holdings—decisions based not on fear but on logical, clear thinking and an understanding of the situation.
Sarah, the CEO and other senior executives need to show strong leadership now. This is not a time for the faint of heart. The survival of the company may be at stake. Apex should resist the urge to go into a defensive mode regarding the stock match. The company will need its cash to get through this, and stopping the match altogether will send employees into a panic. The match should continue. Employees will respond with confidence in their company’s ability to emerge from this situation. When the company does recover, it will have even stronger employee commitment than before.
Regardless of the outcome, Apex should review its current stock policy as soon as possible and take steps to reduce employees’ exposure, perhaps putting a cap on the percentage of their portfolios that can be in the form of Apex stock. Company stock still has a place in employees’ retirement portfolios. The keys are communication and moderation.
Steve LeBlanc, SPHR, is human resource manager at ECM Plastics Inc., in Worcester, Mass. For 13 years he was senior vice president for human resources at BSCC, a division of Connectivity Technologies Inc., a nationwide manufacturer and distributor of wire, cable and networking products. He also was in charge of the administration of the parent company’s employee stock option plan and was a trustee for the company’s 401(k) plan.
By Mary E. Bruno and Brian H. Blaney
It’s clear that both Sarah and Bob need to carefully consider any actions regarding Apex stock.
First, Bob’s plan to move his own company stock to other funds would be a great idea if he also plans to move into a new office—one with bars on the door!
Bob’s plan appears to be a classic case of insider trading, that is, trading in a company’s stock while in possession of material nonpublic information. The likelihood that the federal agency will order Apex to shut down a production line for some time is both material (in that production would likely be halted for a full quarter of the year) and nonpublic (even within the company, only a few people know about it). The fact that Bob would sell stock based on bad news rather than buy it based on good news makes no difference in a charge of insider trading. He could be liable for damages equal to three times the loss he would avoid by selling the stock. And he could be sentenced to prison. It makes no difference that he appears to hold the stock within a 401(k) plan.
Next, Bob has suggested that he tell his friends to sell their Apex stock. With friends like Bob, these folks really don’t need enemies. If they trade on Bob’s inside information, they, too, can be prosecuted for insider trading. And Bob can be liable for insider trading (even if he doesn’t sell the stock himself) for “tipping” his friends [the term for giving insider information to others].
It is Sarah who faces the tougher question: What, if anything, should she do about the 401(k) plan?
First, Apex has little to worry about with regard to the non-matching portion of employees’ 401(k) accounts—the portion that employees control. As a conscientious employer, Apex should ensure that the plan administrator educates employees about the benefits of a diversified portfolio. It is up to each employee—not Apex—to make investment decisions. Therefore, Apex should not be liable for any problems with that portion of the accounts.
The matching portion of the 401(k) plan is a different matter. As at many companies that make matching contributions in the form of company stock, Apex’s 401(k) plan participants probably are not free to sell that stock for some time.
Critics of such practices call them irresponsible because they force employees to rely on their employers for both current income and retirement savings. If something happens to both an employer and its stock, the results can be catastrophic for employees. Employers make a counterargument that such practices serve the legitimate purpose of further aligning the interests of employees with those of the company.
Sarah should recommend that Apex let each employee decide whether to receive the matching contributions in stock or in cash. However, that decision will ultimately be made by the 401(k) committee. The trickier question is whether the 401(k) committee could change the policy now that it knows (or could base its decision on Sarah’s recommendation, which is based at least in part on her knowledge) of the potential shutdown by the federal agency. The safest course of action is to wait and change to an elective contribution only when the 401(k) committee (and, ideally, Apex as a whole) does not possess material nonpublic information.
It is unclear how responsibilities are divided between the CEO and the 401(k) committee. The safest course would be to bring the issue to both the CEO and the committee and to have them collectively reach agreement to proceed as Sarah recommends.
As the vice president of HR, Sarah should be familiar with the corporation’s insider trading policy. If Apex does not have one, it needs to develop, implement and distribute one to employees. Employees must be trained on these issues. Such policies are critical to address the kinds of questions that arise in publicly traded companies. In the absence of such a policy, Apex can be held liable for a violation of securities laws.
Key components of such policies are definitions of insider trading, including “tipping”; clear statements of prohibitions; penalties for noncompliance; and designation of a person or committee to review proposed stock trades.
The policy at Apex should also address the effects of the ownership of company stock through the 401(k) plan and clearly state that the restrictions on insider trading apply to the stock in the 401(k) plan as well.
Ultimately, Sarah will have to address the issue of Bob’s readiness to act on this information, which should result in discipline, up to and including termination from employment, if he uses or continues to threaten the use of this information. Moreover, now that she knows his intentions, she must act quickly to prevent the use of the information by Bob and his friends.
If she doesn’t take action, she risks placing herself and Apex in a position where there would be additional liability for violation of insider trading laws by her and/or by Apex.
Mary E. Bruno is a shareholder in the labor and employment practice in the Phoenix office of Greenberg Traurig, a law firm with offices in 17 cities. Brian H. Blaney is an associate in the firm’s corporate and securities practice in Phoenix.
By Warren Fusfeld
The people at Apex Corp. have a number of serious problems, and not all involve benefits law. First and foremost, Bob and Sarah have material information concerning Apex that the public generally does not have. Since Apex stock is publicly traded, both must take into account federal and state securities laws. These laws provide for serious consequences for anyone engaged in trading on “inside” information (material, non-public information) or in “tipping” (giving “inside” information to others who can be expected to trade on that information).
If Bob sells his Apex stock, he could incur civil liabilities and/or be convicted of criminal violations of applicable securities laws. Similarly, “tipping” his friends about an expected steep decline in Apex stock value could also result in the same consequences—not only for Bob but also for his friends who act on his tip.
One action that Sarah may appropriately take even prior to public disclosure of Apex’s situation would be to discuss with the CEO stopping additional matching contributions in Apex stock. If such a change in operation of the 401(k) plan is permitted under the plan document, this may avoid adding to the problem. The change is not a decision that, in itself, involves the fiduciary obligations of ERISA—the Employee Retirement Income Security Act. It is, however, critically important that Apex administer the 401(k) plan consistent with the plan document. If stopping contributions in stock requires an amendment to the plan, this would have to be done immediately.
Although Sarah or others at Apex may feel that the committee responsible for the company’s 401(k) plan should have this information since Apex’s problems are likely to impact the participants in the 401(k) plan who have invested in Apex stock, there may not be much reason to share this with them. One or more of the members of the committee may independently already know about Apex’s regulatory problems. Nevertheless, there is virtually nothing the committee can do with that information.
The committee, as a fiduciary of the 401(k) plan, is obligated under ERISA to protect the interests of the participants and beneficiaries of the 401(k) plan. If the committee attempts to protect the participants from the anticipated loss in their Apex stock investments, however, they are violating the same securities laws that should prevent Bob from selling off his own Apex stock.
If the committee could convince Apex to purchase its own stock from the 401(k) plan, which might not be an “insider trading” violation, that could still lead to a suit by Apex’s other shareholders claiming Apex violated its obligations to its shareholders generally under corporate law.
While Bob and Sarah personally are facing an uncomfortable situation and are limited in what they can do with their information, Sarah could suggest that the 401(k) plan committee be more aggressive in regularly monitoring the plan’s investment options. For example, the committee should meet regularly—at least quarterly; establish, and revise when necessary, clear, written objectives for the plan; and consult with competent, outside advisers as to both the overall investment strategies for the committee and the performance of their separate investment options (including the Apex stock investment).
The committee may also want to consider limitations on the extent to which plan participants will be permitted to invest in Apex stock, thereby limiting some of the risks associated with that investment.
Sarah could also bring to the CEO’s attention the possibility that Apex is already obligated to disclose publicly its regulatory problems. Depending on disclosures previously made by Apex (whether through Securities and Exchange Commission filings or otherwise), Apex may be legally required to correct prior statements that were materially inaccurate when made, or it may have to update previously released information that is now misleading to the public.
Once the public knows about Apex’s regulatory problems, Bob, Sarah and the fiduciary committee for the 401(k) plan can take appropriate steps as to their own and the 401(k) plan’s holdings of Apex stock. Of course, the market price of Apex stock will have already dropped. Because Apex’s regulatory problems may be resolved after some period of time, once the market adjustment because of the news occurs, retaining the Apex stock as an investment option of the 401(k) plan may be completely consistent with the committee’s fiduciary obligations to the plan.
Warren Fusfeld chairs the Employee Benefits Practice Group at Wolf, Block, Schorr and Solis-Cohen LLP, a Philadelphia law firm. His practice is primarily in the area of employee benefits and taxation.
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