Posted on 12/27/2001 7:47:56 AM PST by tank_sherman
Enron’s retirement meltdown is tragic. We don’t yet know if it’s criminal.
By Michael W. Lynch
"The human impact is staggering," writes CNN’s Bill Press of the Enron collapse. Press details the losses to investors and loss of jobs before landing on the 401(k) wipeout. "Those 11,000 employees whose 401(k) funds were invested exclusively in Enron -- and who were forbidden by Enron’s own rules from diversifying -- today have no retirement plan at all."
The misinformation is staggering as well. Nothing that Press, a Democratic hack who earns his living turning every world event to partisan advantage, says about the 401(k) plan is true. Eleven thousand employees participated in Enron’s plan, which offered a range of investment options. These employees were not invested exclusively in Enron stock, and they were not forbidden from diversifying. It is illegal for a company to force any employee to use more than 1 percent of salary to purchase stock, and as a practical matter, none do.
Press’s claims are extreme, but not wildly unrepresentative of others made about Enron’s 401(k) disaster. And people are demanding action. New York Times columnist Paul Krugman has used Enron to call into question the whole idea of defined-contribution pensions. "It’s easy to make the theoretical case for defined-contribution plans," writes Krugman. But he later adds that "the sad fate of Enron’s employees highlights the difference between theory and practice."
He’s not alone. "One issue raised by the whole Enron debacle is how realistic is the concept of do-it-yourself investing," Karen Ferguson, director of the Pension Rights Center, told The New York Times. And members of Congress have rushed to legislate our way to financial safety. In the Senate, Jon Corzine (D-N.J.) and Barbara Boxer (D-Calif.) want to limit the amount of employer stock that can be held in 401(k) plans to 20 percent of the total investment. In the House, Peter Deutsch (D-Fla.) and Gene Green (D-Texas) want to set the cap at 10 percent.
Here are some facts. Enron maintained a rather typical 401(k) plan for a company of its size. It offered a selection of 20 investment options, Enron stock being one among them. It matched 50 percent of employee contributions up to 6 percent of salary with Enron stock. (And remember, the employee’s own contribution didn’t have to be invested in Enron stock.) Employees couldn’t sell stock that Enron gave them until they turned 50. They were not prohibited from selling Enron stock that they purchased with their own money. At the end of 2000, 62 percent of the value of employee 401(k) plans were held in Enron stock. (This is risky, but not unique. Procter & Gamble’s fund is 95 percent company stock, according to a recent survey by DC Plan Investing. General Electric’s is 77 percent.)
In early 2001, Enron decided to contract out its 401(k) administration to an outside company. The transfer required a freezing of accounts, which took place over a period in October and November. The time frame is under dispute, and is the subject of many lawsuits. The company claims the period was 12 trading days, from October 26 through November 12. One employee has testified that accounts were frozen as early as September 26. One lawsuit claims that different accounts were frozen for different time periods. Another claims the lockdown started on October 17.
This general period was horrible for Enron. Some of the highlights: On October 16, it announced that it had to take a $1.1 billion charge for bad investments. On October 22, the Securities and Exchange Commission (SEC) announced a probe of Enron. On October 29, Moody’s downgraded Enron’s credit ratings. On October 31, the SEC upped its probe to a full-fledged investigation. On November 8, Enron reduced its claim for net income since 1997 by 20 percent.
On October 26, the day Enron claims it froze its 401(k) accounts, its stock was at $13.81. By the time 401(k) investors could sell again, the stock was at $9.98.
This lockdown is troubling, but the facts are murky. Enron claims it was routine and previously scheduled. But considering events, one would think that prudence should dictate that Enron postpone the transfer until less tumultuous times. One retiree claims Enron pushed its stock aggressively. But another retiree who left his entire account in company stock says he was advised to diversify. Did executives push stock on employees while selling from their portfolios? We’ll know more someday, as the Federal Trade Commission, the Department of Labor, and a gazillion attorneys are all investigating the issue.
As crushing as these losses are, they don’t impugn defined-contribution investing, which offers Americans much freedom in practice, not just in theory. And calls for more regulation will only increase administrative costs and reduce choice. What Enron’s employees needed most was sound financial advice not to put all their money on one horse. This is especially true for the retirees, who, it must be noted, were free to sell their Enron stock at any point other than the lockdown period.
Anyone with half a brain knows that it is insane to invest in such a concentration - diversify, diversify, diversify. Buy the S & P Index, buy several indexes but for your own sake (and that of your loved ones), do not invest in just one equity - ever. It is all the more foolish to do it in your employer since, as happened here, when you are out of a job AND a pension fund, you are in a world of hurt. These people have no one to blame except themselves (or their husband/wife/child/parent/financial advisor.)
The Political Whores in Congress will rush to pass some b.s. legislation so they can look sympathetic; they may even try to pass some type of financial bail-out to buy a few more votes with tax-payer dollars; they should be stopped. Let foolish people suffer the consequences of their own actions and it will serve as a bright example of proper conduct for the future. Think of these folks as candidates for the financial equivalent of the The Darwin Awards for 2001.
Enron mgmt will have a lot of explaining to do regarding the company investments and information they put out to the investing public.
On October 26, the day Enron claims it froze its 401(k) accounts, its stock was at $13.81. By the time 401(k) investors could sell again, the stock was at $9.98..... (that's a 30% loss in value)-------------
were free to sell their Enron stock, at any point other than the lockdown period
That was the key period to sell bail out. This is a pathetic apology, with no substance, by Reason Magazine for corruption at the highest level(s) of Enron...
One thing for sure about Enron, the insider sales seemed to indicate what was to come:
The link above for JEFFERY SKILLING was wrong. <--This one should work.
This month the Department of Labor expanded the effect of that private letter ruling by granting a major insurance company a "directive" and releasing it as a guideline for all providers to use, should they choose to offer asset allocation advice to plan particpants. DOL Opinion found here.
The issue of particpant competence to self-direct retirement investments (sec. 404.c) was solved nearly a decade ago; the Department of Labor has already expanded the mandate to all comers; and now Congress will get in on the act and claim credit for fixing the problem.
That's fine...except the government is going to end up supporting all those people who are overconfident about their investing skills. Part of the problem is that the investment industry has done everything possible to keep people from considering safe CDs for investment savings that one 100% needs in the future. See, it's MY money they're playing with if an awful lot of people are paupers in retirement (higher taxes and all that)
It should be noted that these two companies (GE in particular) are involved in so many different sectors that they themselves are well-diversified. In fact, I once heard a comment from a financial planner who said that owning shares of General Electric stock was almost the equivalent of owning shares in an index fund.
His answer:
There are 2 kinds of risk: Systematic and un-systematic. Systematic risk is the risk that the "system" - i.e. the entire market and economy - moves up or down. Un-systematic risk is the risk associated with EACH particular component of that system - i.e. the risk inherent in each company or investment.
You cannot avoid systematic risk over time.
You CAN diversify away 99.9999% of the unsystematic risk.
To achieve returns higher than the market (system) requires accepting more risk and if I remember correctly the studies showed that the increased returns possible were not worth the additional risk. Therefore, over time you are stuck with accepting the market's long term rate of return (about 9% annually, non inflation adjusted) and minimizing the risk associated with that investment.
To achieve alternate returns, look at other investments (real estate, bonds, loan sharking to friends...).
In the '70s and '80s you could achieve adequate diversification if you carefully selected about 10-15 companies. Today, I've read, that number is up to 50. Companies are not as diversified internally today and there appears, to me at least, to be more volatility. So you have two choices:
1. Invest in Vanguard's S&P500 index (mutual) fund which has the lowest annual cost and no management fees. Take a look at Forbes, from about 2-3 weeks ago. They had an excellent article discussing the effect of fees, and which funds were the most cost efficient. 2. Begin building your portfolio in 100-share increments carefully selected. That would cost between $2000 - $5000 each company ==> say $175,000, not an unreasonable amount over 10-20 years. a - There are statistical tools available to select a 50-firm portfolio and you could order your purchases to get the most diversity earliest. b - Or just use judgement as to the sector each company works in, buy over time in all the major sectors selecting in each the 1 or 2 firms which appeal most to you. Key word is "appeal". Dividends, growth history, management, geograpic business area, &etc.
If you wanted to have $175,000 in 15 years, you could start w/ Vanguard for 7 years and invest $6,000/year (and hopefully earn 9%). Then divest from Vanguard and use the funds to buy stocks, but keep investing $6,000/year (about 2 - 100share buys). If you earn 9% overall, you'll have achieved the goal.
NOTE: Consider taxes. There will be capital gains tax in year 7. For each year in the fund, it's likely you will pay tax on dividends and capital gains that the fund earns - these flow through to you. Perhaps reduce your after tax ROR to 6% and recompute ($7,500/year investments). If these investments are in an IRA or 401k plan, then the tax effects may be neglected.
As an example, I have my (3) daughters' funds directly invested, since I got tired of paying the Kiddie Tax when their mutual funds reported gains as the market went down. I bought stocks in March/April and we have about a 4% gain since then. Some went up, some went down. It's a real roller coaster this year. Their portfolio's are worth WAY LESS than the $175k, and consist of about 8-10 stocks currently, but have behaved nicely. I haven't had time to run the statistics, so I used strategy 2b above.
Conclusion: Don't gamble more than you have to. Don't pay more than you have to. Be rational and do your homework (no free lunch). You'll be pleased over time, and not end up like many of those poor folks at Enron.
You caught me in a verbose mood - Merry Christmas.
This is hardly an apology. The article notes that Enron should have postponed the "lockdown." As a result of their actions, they will be required to answer a number of questions and some folks may (and probably should) go to jail. However, to say that Enron management is responsible for the insatiable greed and blind foolishness of their employees prior to and following the "lockdown" is as bad as trying to absolve Enron of any wrongdoing on their part.
There is plenty of blame to go around. As my Daddy used to say, 'A fool and his money were lucky to get together in the first place.'
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