Report to the Chairman, Committee on

Banking, Housing, and Urban Affairs,

U.S. Senate

United States General Accounting Office

GAO

September 2002 PRIVATE PENSIONS

Participants Need

Information on the

Risks of Investing in

Employer Securities

and the Benefits of

Diversification

GAO-02-943
Page i GAO-02-943 Private Pensions

Letter 1

Results in Brief 2

Background 5

More Than Half of the Fortune 1,000 Companies Hold Employer

Securities in Their Defined Contribution and Defined Benefit

Plans 8

Investing in Employer Securities Can Present Significant Risks for

Employees’ Retirement Savings 14

Current Laws Provide for Disclosures To Plan Participants, but

Information About Investment Diversification and Risk Is Not

Required 19

Conclusion 28

Matter for Consideration 29

Agency Comments 29

Appendix I Scope and Methodology 31

Review of Form 5500 Data 31

Implications of Investing in Employer Securities 33

Regulatory Provisions for Disclosures 33

Appendix II Bankruptcy and Legal Proceedings of Companies

Whose Employees Participated in Employer-Sponsored

Plans 35

Enron 35

Color Tile 36

Southland 36

Lucent 37

Appendix III SEC’s Application of the Securities Laws to

Retirement Plans 38

Registration Requirements Under the Securities Act and the

Exchange Act 39

Registration and Reporting Requirements Under the Securities

Exchange Act 49

Conclusion 51

Appendix IV Comments from the Department of Labor 52

Contents
Page ii GAO-02-943 Private Pensions

Table

Table 1: Pension Plan Assets for Fortune 1,000 Companies by

Industry 10

Figures

Figure 1: Employer Securities Held by Defined Benefit and Defined

Contribution Plans 9

Figure 2: Holdings of Fortune 1,000 Companies’ Pension Plans 13

Abbreviations

DOL Department of Labor

EIN Employer Identification Number

ERISA Employee Retirement Income Security Act

ESOP employee stock ownership plans

IRS Internal Revenue Service

PBGC Pension Benefit Guaranty Corporation

PWBA Pension and Welfare Benefits Administration

SAR summary annual report

SEC Securities and Exchange Commission

SMM summary of material modifications

SPD summary plan description
Page 1 GAO-02-943 Private Pensions

September 6, 2002

The Honorable Paul S. Sarbanes

Chairman

Committee on Banking, Housing, and Urban Affairs

United States Senate

Dear Mr. Chairman:

The financial collapse of the Enron Corporation and other large firms and

the effects on workers and retirees has raised questions about retirement

funds being invested in employer securities and the laws governing such

investments. Pensions are an important source of income for many

retirees, and the federal government has encouraged employers to sponsor

and maintain pension and savings plans for their employees. Over 70

million U.S. workers participate in pension and savings plans, and such

plans in 1998 represented about $4 trillion in retirement savings. The

continued growth in these plans and their vulnerabilities has caused

Congress to focus on issues related to participants investing in employer

securities through employer-sponsored retirement plans.

Enron’s plan participants held a substantial percentage of their retirement

assets in employer securities. Because of the financial losses suffered by

Enron plan participants and the potential for losses to be incurred by

participants in retirement and savings plans that are highly concentrated

in employer securities, you asked us to: (1) determine the number, types,

and dollar amounts of private pension plans that invest in employer

securities; (2) describe why investing in employer securities through

employer-sponsored plans can pose risks to plan participants; and

(3) describe the regulatory provisions for disclosures to participants

owning employer securities through their employer-sponsored plans. You

also asked us to discuss the Securities and Exchange Commission’s (SEC)

administrative determination not to explore the application of the

Securities Act of 1933 and the Securities Exchange Act of 1934 to

retirement plans. This information is presented in appendix III.

To determine the number and types of private pension plans invested in

employer securities, we analyzed plan financial information filed annually

(Form 5500s) with the Department of Labor’s Pension and Welfare

Benefits Administration (PWBA). We analyzed data for the Fortune 1,000

companies for plan year 1998, which was the most recent year for which

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-02-943 Private Pensions

complete plan-specific data were available for our review. To calculate the

percentage of pension plan assets held as employer securities, we first

subtracted certain assets that cannot be specifically identified as employer

securities from total plan assets to arrive at “known assets.” To describe

the risks of investing in employer securities through employer-sponsored

plans, we focused on six companies whose private pension plans

according to industry data were heavily invested in employer securities.

We used these companies as examples to illustrate the risks that

employees face when their employer-sponsored plans have high

concentrations of employer securities or real property. For four of the

companies we used publicly available information. We obtained

information directly from the other two companies, but we agreed not to

disclose their names. In addition, as part of our review of regulatory

provisions, we interviewed officials from the Department of Labor (DOL),

SEC, and industry associations about the laws governing employer

securities purchases by retirement plans and the investment information

that employers provide to plan participants.

We conducted our work between February and August 2002 in accordance

with generally accepted government auditing standards. (See app. I for

more details about our scope and methodology.)

Our analysis of the 1998 plan data for the Fortune 1,000 firms showed that

about 550 of those companies held employer securities in their defined

benefit plans or defined contribution plans, covering about 13 million

participants.1

 Our review is not representative of the entire employersponsored plan universe, but Fortune 1,000 plans covered about

40 percent of the total participants in company plans in 1998. Employer

securities held by these plans totaled $213 billion, or 21 percent of total

known assets. However, when all assets are included, including those that

cannot be specifically identified as employer securities, employer

securities represented 12 percent of total plan assets. DOL’s analysis

showed that for defined contribution plans in 1998, employer securities

represented about 16 percent of total plan assets and less than 1 percent

for defined benefit plans.2

 Manufacturers held 45 percent of the employer

 1

Defined benefit plans promise to provide generally a level of monthly retirement income

that is based on salary, years of service, and age at retirement. The benefits from defined

contribution plans are based on the contributions to and investment returns on individual

accounts.

2

DOL’s analysis included all plans with 100 or more participants.

Results in Brief
Page 3 GAO-02-943 Private Pensions

stock holdings of the Fortune 1,000 firms. However, such holdings only

represented about 10 percent of the total plan assets held by that sector.

For plans that reported holding employer securities, employee stock

ownership plans (ESOPs), including ESOPs combined with other defined

contribution plans, held the highest concentrations of employer

securities,3

 with these securities making up 58 percent of the total plan

assets of ESOPs. 401(k) type plans held 26 percent of their total assets in

employer securities.4

 Defined benefit plans had less than 5 percent of their

plan assets in employer securities. The highest dollar value of employer

stock holdings were held in companies whose plans combined

components of 401(k) type plans with ESOPs. The amount of employer

securities in private pension plans is likely higher than we reported. Some

companies did not report holding employer securities directly in their

plans, but reported holding plan assets in separate accounts, such as

master trust agreements, that may include employer securities.5

Investment in employer securities through employer-sponsored retirement

plans can present significant risks for employees. If the employees’

retirement savings is largely in employer securities in these plans,

employees risk losing not only their jobs should the company go out of

business, but also a significant portion of their savings. Employees at such

companies as Enron and Southland experienced such consequences as

both companies declared bankruptcy. Even if employers do not declare

bankruptcy, employees are still subject to the dual risk of loss of job and

loss of retirement savings because corporate losses and stock price

declines can result in companies significantly reducing their operations,

such as in the case of Lucent. However, despite the risks, not every

company whose retirement plans have high concentrations of employer

securities results in employees incurring significant losses. Much depends

on the corporate decisions made by the company’s leadership, which will

determine whether or not the company stays in business. Two companies

whose plans we reviewed had high concentrations of employer securities

 3

ESOPs are defined contribution plans that require plan sponsors to invest plan assets

principally in shares of the sponsor’s stock.

4

These are limited to defined contribution plans with a 401(k) type feature that are

combined with profit-sharing/thrift savings plans.

5

An employer-sponsored plan that pools its assets in a master trust with those of other

plans for investment purposes reports only one asset amount on the Form 5500. This

amount represents the plan’s interest in the master trust but provides no information about

the master trust’s investments, such as employer stock.
Page 4 GAO-02-943 Private Pensions

holdings, and, other than the volatility of the companies’ stock price, the

employees have not suffered substantial losses due to company failure or

downsizing. Finally, some companies help employees mitigate their losses

by balancing plans where risks of loss are borne by employees with plans

where the employer bears such risks. Other plans limit restrictions they

place on diversification of employer contributions. For example,

employees at one company held employer securities through the

companies’ profit-sharing plan that was combined with the company’s

401(k) plan, and the company placed few restrictions on the ability of

employees to diversify employer contributions.

Under the Employee Retirement Income Security Act (ERISA) and the

Securities Acts, DOL and SEC are responsible for ensuring that certain

disclosures are made to plan participants regarding their investments.6

Although employees in plans where they control their investments

(participant-directed accounts) receive disclosures under ERISA regarding

their investments, such regulations do not require companies to disclose

the importance of diversification or warn employees about the potential

risks of owning employer securities. SEC requires companies with defined

contribution plans that offer employees an opportunity to invest in

employer stock to register and disclose to SEC specific information about

those plans. In addition, in most cases the underlying securities of those

plans must be registered with SEC. However, SEC does not routinely

review these company plan filings because pension plans generally fall

under other federal regulation. (See app. III for SEC’s determination of

how securities law applies to pension plans.) Industry representatives that

we spoke with said that some companies provide plan participants with

investment education, including information about the risks involved in

owning employer stock. However, the investment information the

companies provide is done on a voluntarily basis and varies by company.

These industry officials also said that employers are concerned about the

potential liability associated with making individualized investment advice

available to plan participants. DOL recently issued guidance about

investment advice to make it easier for plans to use independent

investment advisors to provide advice to participants in retirement plans.

 6

ERISA is a federal law that sets minimum standards for pension plans sponsored by

private employers.
Page 5 GAO-02-943 Private Pensions

This report includes a Matter for Congressional Consideration to require

employers to provide an investment education notice containing basic

information on risk management and the importance of diversification.7

We provided a draft of this report to the Department of Labor, the

Department of Treasury, and the Securities and Exchange Commission.

All three agencies provided us with technical comments and we

incorporated each agency’s comments as appropriate. DOL also provided

written comments that are reprinted in appendix IV. DOL agreed with our

conclusion that additional investment education is necessary, but stated

that the Secretary of Labor does not currently have the legal authority

under ERISA to require DOL to issue an investment education notice.

Consequently, we changed our recommendation to a Matter for

Congressional Consideration to amend ERISA so that it requires plan

sponsors to provide an education notice.

The U.S. private pension system is voluntary; employers decide whether to

establish a retirement plan and determine the design, terms, and features

of the plan or plans they choose to sponsor. The federal government

encourages employers to sponsor and maintain private pension plans for

their employees and provides tax incentives offered under the Internal

Revenue Code to those who do. Although there is a wide range of specific

plan designs that are permissible under current law, private sector pension

plans are classified either as defined benefit or defined contribution plans.

Defined benefit plans promise to provide, generally, a level of monthly

retirement income that is based on salary, years of service, and age at

retirement. The benefits from defined contribution plans are based on the

contributions to and investment returns on individual accounts. Most

private sector pension plans are defined contribution plans and this has

been true for a number of years. Since the late 1980s, the number of

defined benefit plans has decreased, and most new pension plans have

been defined contribution plans. Many employers, particularly those with

more than 1,000 employees, sponsor both defined benefit and defined

contribution plans. More workers are covered by defined contribution

plans than defined benefit plans, and the assets held by defined

contribution plans now exceeds those held by defined benefit plans.

 7

For information on other issues we raised with Congress, see U.S. General Accounting

Office, Private Pensions: Key Issues to Consider Following the Enron Collapse,

GAO-02-480T (Washington, D.C.: Feb. 27, 2002).

Background
Page 6 GAO-02-943 Private Pensions

According to DOL, employers sponsored over 673,000 defined contribution

plans as of 1998 compared with about 56,400 defined benefit plans.

Defined contribution plans had about 58 million participants while defined

benefit plans had about 42 million participants.

Defined contribution plans are central to the debate about employee stock

ownership through employer-sponsored plans. Defined contribution plans

include thrift savings plans, profit-sharing plans, and ESOPs. The most

dominant and fastest growing defined contribution plans are 401(k) type

plans, which are plans that allow employees to choose to contribute a

portion of their pre-tax compensation to the plan under section 401(k) of

the Internal Revenue Code. Most 401(k) plans are participant-directed,

meaning that participants make investment decisions about their own

retirement plan contributions within a set of investment choices selected

by the plan sponsor. Employees are usually able to choose from a menu of

diversified fund options when investing their own contributions. Over the

last 20 years, employers have gradually expanded the investment choices

of participants such that most plans are offering over 10 investment

choices for participants, including investing in employer stock. Employees

generally have less flexibility over the investments of the employer

contributions to these plans, which frequently take the form of company

stock.

Many employers combine defined contribution plans with a 401(k) feature

and ESOPs or profit-sharing/thrift savings plans with a 401(k) feature. 8

High concentrations of employer securities are likely to be found when

ESOPs and 401(k) type plans are linked or when 401(k) plans and profitsharing plans are linked. This is especially true when plans are combined

with ESOPs, which by definition seek to provide for employee ownership.

Moreover, under current law, ESOPs may require participants not to divest

their employer stock holdings until they reach the age of 55 or 10 years of

service, essentially restricting participant’s rights to diversify employer

stock holdings.

ERISA has a rule that places a 10 percent limitation on acquiring and

holding employer securities and employer real property for defined benefit

 8

A profit-sharing plan is a type of defined contribution plan that provides for contributions

to employees based on employer profits. Profit-sharing plans provide for employer

contributions to participants based on a definite formula that is generally based on

employee compensation. A thrift savings plan is a defined contribution plan to which

employees make contributions, usually as a percentage of salary.
Page 7 GAO-02-943 Private Pensions

plans. The 10 percent limitation states that a plan may not acquire any

qualified employer securities or real property if immediately after the

acquisition the aggregate fair market value of such assets exceeds

10 percent of the fair market value of the plan’s total assets. Employer

securities and real property that appreciate in value after acquisition to

10 percent or more of total plan assets do not have to be sold. Defined

contribution plans other than 401(k) type plans that are not ESOPs are

generally exempt from the 10 percent limitation.

Under ERISA, the Internal Revenue Service (IRS) and DOL’s PWBA are

primarily responsible for enforcing laws related to private pension plans.

PWBA enforces ERISA’s reporting and disclosure provisions and fiduciary

standards, which concern how plans should operate in the best interest of

participants. The IRS enforces requirements concerning how employees

become eligible to participate in benefit plans and earn rights to benefits.

The IRS also enforces funding requirements designed to ensure that plans

subject to such requirements have sufficient assets to pay promised

benefits.

In addition to the types of plans employers provide, some employersponsored plans have complex designs, such as floor-offset arrangements.

Such arrangements consist of separate, but associated defined benefit and

defined contribution plans. The benefits accrued under one plan offset the

benefit payable from the other. In 1987, Congress limited the use of such

plans significantly invested in employer securities. However, plans in

existence when the provision was enacted were grandfathered.

Because plan participants are investing in employer securities, securities

law investor protection and disclosure requirements are also important.

Congress enacted the Securities Act of 1933 and the Securities Exchange

Act of 1934 in response to fraud in the securities markets and because of a

perceived lack of public information in the stock markets. The 1940

Investment Company Act, combined with the 1933 act, is the basis for SEC

regulation of investment companies. Companies meeting this description

must register under the Investment Company Act of 1940 and offer their

shares under the Securities Act of 1933. These laws seek to ensure

vigorous market competition by mandating full and fair disclosure and

prohibiting fraud. Under these acts, a primary mission of the SEC is to

protect investors and maintain the integrity of the securities market

through extensive disclosure, enforcement, and education, but the

securities laws also presume individual responsibility for investment

decisions.
Page 8 GAO-02-943 Private Pensions

About 550 of the Fortune 1,000 firms in 1998 held employer securities in

their defined contribution or defined benefit plans. Such holdings totaled

over $213 billion and represented 21 percent of the known assets.

However, when all assets are included, including those that cannot be

specifically identified as employer securities, employer securities

represented 12 percent of total assets. DOL’s analysis showed that for

defined contribution plans in 1998, employer securities represented about

16 percent of total plan assets and less than 1 percent for defined benefit

plans. Our analysis found that the employer securities holdings were

concentrated in different industries, with the bulk of the holdings held by

manufacturers, which included technology and computer companies. For

plans that reported holding employer securities, most of the employer

securities were concentrated in ESOPs, including ESOPs combined with

other defined contribution plans. A significant portion of employer

securities were also held in the companies’ 401(k) type plans. The largest

dollar amounts of employer securities holdings were in companies whose

retirement plans combined their 401(k) type plan with ESOPs. Because

some companies reported holding their plan assets in master trust

agreements, the amount of employer securities holdings in these firms’

employer plans are likely to be higher than we can determine based on

1998 Form 5500 data.

About $213 billion in plan assets held in the employer-sponsored plans of

the Fortune 1,000 were held in employer securities. Almost all of the

$213 billion of assets in employer securities were held in the Fortune

1,000’s defined contribution plans. As shown in figure 1, less than

1 percent of defined benefit plan holdings were in employer securities and

24 percent of defined contribution holdings were in employer securities. 9

 9

The Fortune 1,000 defined contribution plans had about $848 billion in plan holdings and

defined benefit plans had about $981 billion in holdings.

More Than Half of the

Fortune 1,000

Companies Hold

Employer Securities

in Their Defined

Contribution and

Defined Benefit Plans

Fortune 1,000 Employer

Plans Report Over $213

Billion of Their Assets in

Employer Securities
Page 9 GAO-02-943 Private Pensions

Figure 1: Employer Securities Held by Defined Benefit and Defined Contribution Plans (billions)

Source: GAO analysis of 1998 Form 5500 data.

The Fortune 1,000 sponsored roughly 3,500 defined contribution or

defined benefit plans. Fifty-six percent, or about 2,000 of those plans, were

defined contribution plans and 44 percent, or more than 1,500 plans, were

defined benefit plans. More than 37 million employees were covered by

these plans, which was nearly 40 percent of the total participants in all

company plans in 1998.10 Twenty million employees participated in one or

more defined contribution plans sponsored by the Fortune 1,000, and over

17 million employees were covered by defined benefit plans.

 10Total participant numbers include double counting.

• Other defined contribution holdings $640.8

•

• Employer securities $212.6

Other defined benefit holdings $975.9

Employer securities $207.2 or 24 percent

of total defined contribution holdings

Employer securities $5.4 or 1 percent

of total defined benefit holdings

•
Page 10 GAO-02-943 Private Pensions

Manufacturers had the highest amount of plan assets in employer

securities of the Fortune 1,000.11 These companies included computer chip

companies and technology firms, as well as traditional manufacturing

companies, such as tool production and hardware firms. The sector held

about $976 billion plan assets in 1998. As shown in table 1, manufacturing

companies held about 45 percent of the employer securities holdings of

the Fortune 1,000 and covered about 41 percent of plan participants of the

Fortune 1,000.

Table 1: Pension Plan Assets for Fortune 1,000 Companies by Industry

(Dollars in billions)

Industry

Employer

securities owned

Percent of all

employer

securities

Total

assets

Concentration of

employer

securities

(percent)

Plan

participants

Percent of all

plan

participants

Manufacturing $94.7 44.54 $975.9 9.7 15,117,571 40.84

Finance, insurance

and real estate 28.9 13.61 152.8

18.9

3,270,537 8.84

Communication and

information 21.0 9.91 202.9

10.4

2,785,218 7.52

Retail trade 19.9 9.36 61.5 32.3 4,508,681 12.18

Utilities 14.2 6.69 115.2 12.3 1,239,577 3.35

Services 13.7 6.45 106.0 12.9 4,362,308 11.79

Industry not

reported 9.0 4.25 102.5

8.8

2,668,234 7.21

Transportation 6.5 3.08 75.4 8.7 2,018,620 5.45

Wholesale trade 2.3 1.08 14.3 16.1 547,821 1.48

Mining 1.4 0.69 15.7 9.4 254,506 0.69

Construction 0.706 0.33 5.4 13.1 159,462 0.43

Agriculture 0.27 0.01 1.4 1.9 81,322 0.22

Total $212.6 100.00 $1,829.3 11.6 37,013,857 100.00

Source: GAO’s analysis of 1998 Form 5500 data. Numbers may not add to total due to rounding.

Although manufacturers held the highest amount of employer securities of

the 12 sectors, such holdings represented less than 10 percent of the

sector’s total assets. More than 90 percent of the manufacturing sector’s

assets were held in assets other than employer securities, which provided

for some diversification for the industry. The retail sector, which includes

car, food, and clothing sales companies, had the highest concentration of

industry assets in employer securities, with about 32 percent of the

 11We based our industry classifications on those used by DOL in the Private Pension

Bulletin: Abstract of 1998 Form 5500 Annual Reports, Number 11, Winter 2001-02.

Manufacturers Held the

Highest Amounts of Plan

Assets in Employer

Securities, but Such

Holdings Were Less Than

10 Percent of the

Industry’s Assets
Page 11 GAO-02-943 Private Pensions

industries’ plans assets in employer securities. Companies in the industries

of mining, construction, and agriculture had the lowest amounts of

employer securities and also covered the fewest number of plan

participants.

Not surprisingly, ESOPs had the highest percentages of plan assets in

employer securities of plans that reported holding such assets. ESOPs,

including ESOPs combined with other defined contribution plans, held

over three-fifths of their known assets in employer securities, while 401(k)

type plans held a little over a quarter of their known assets in employer

securities. Given the requirements that plans must meet to be designated

as an ESOP, it is not surprising that ESOPs and ESOPs with other plan

features hold the highest percentages of employer securities holdings. For

example, ESOPs must be primarily invested in qualifying employer

securities in order for the plan to receive the legal designation of an ESOP.

In addition, in order to ensure that a company’s employees continue to

hold that minimum threshold of company stock, many ESOPs restrict

employees’ ability to sell their company stock.

About 220 firms in the Fortune 1,000 sponsored plans that were ESOPs or

ESOPs combined with other defined contribution plans. Those plans held

a total of $143 billion in employer securities. Fifty-eight percent of ESOP

total plan assets were in employer securities. However, certain types of

ESOPs reported higher concentrations than others. For example, standalone ESOPs—ESOPs that are not combined with other defined

contribution plans—had over 98 percent of plan assets in employer

securities. Eighty-four companies sponsored such ESOPs, covering a little

over 1 million participants.

About 475 companies had defined contribution plans with a 401(k) type

feature and such plans had the highest total dollar amount of employer

securities totaling $172 billion in employer securities. Given that twice as

many companies sponsored a 401(k) type plan as those offering an ESOP,

the high dollar amounts in the 401(k) plans are not unusual. 401(k) type

plans also held significant percentages of plan assets in employer

securities, although not as high as ESOPs. For example, about 324

companies reported sponsoring 401(k) plans that were combined with

profit-sharing/thrift savings plans, which was by far the most prevalent

type of 401(k) plan offered by the Fortune 1,000 and covered more than

half of the participants participating in 401(k) plans.Twenty-six percent of

those plans’ assets were held in employer securities, totaling about

$44 billion.

ESOPs Held the Highest

Percentages of Plan Assets

in Employer Securities

Although 401(k) Type

Plans Had Higher Dollar

Amounts, and Plans That

Combined Features Held

the Most Employer

Securities
Page 12 GAO-02-943 Private Pensions

The type of defined contribution plan that had the greatest amount of

employer securities were plans that combined a 401(k) type plan with an

ESOP. About 96 companies sponsored such plans, covering about

2.5 million employees. These plans held about $93 billion of employer

securities and about 44 percent of all employer securities, which was the

highest amount of employer securities holdings in any of the plan types

sponsored by the Fortune 1,000.

Recent industry data suggest that companies are increasingly sponsoring

plans that combine features of defined contribution plans. For example,

plans that combine ESOPs with a 401(k) type plan are becoming more

prevalent among large, publicly traded companies. Because these plans

hold the most employer securities, many more workers are likely to have a

significant amount of their retirement savings invested in the securities of

their employers. Retirement savings, therefore, may increasingly become

more dependent on employer stock ownership.

Defined benefit plans have smaller percentages of employer securities

than ESOPs or 401(k) type plans. Seventy-five companies of the Fortune

1,000 sponsored defined benefit plans holding employer securities. Such

plans covered 2.3 million participants and held about $120 billion of plan

assets. Employer securities accounted for about 5 percent, or over

$5 billion, of the known assets of these defined benefit plans.

Finally, little information is reported on complex plan designs such as

floor-offset arrangements. The 1998 Form 5500 did not require employers

to identify plans with floor-offset arrangements. Furthermore, agency and

industry officials said there is little information on the number of

employer-sponsored plans that have such features.

Because we cannot isolate employer securities held in “master trust

agreements,” our figures on employer securities holdings are likely to be

understated. A master trust agreement is a trust in which assets of more

than one plan sponsored by a single employer or by a group of employers

are held under common control. As shown in figure 2, master trust assets

held the highest percentage of pension plan assets.

Amount of Employer

Securities Could Likely Be

Higher
Page 13 GAO-02-943 Private Pensions

Figure 2: Holdings of Fortune 1,000 Companies’ Pension Plans

Note: Total Plan Assets: $1.8 trillion.

Source: GAO’s analysis of 1998 Form 5500 data.

The amount of employer securities plans held within master trust

agreements cannot be determined from the 1998 Form 5500. For reporting

purposes, assets of a master trust are considered to be held in one or more

investment accounts that may consist of a pool of assets or a single asset.

In addition, only the account total of the master trust account is required

to be reported on the Form 5500. For example, 29 percent of the ESOPs

sponsored by the Fortune 1,000 reported not holding employer securities.

However, because ESOPs are required by law to hold employer securities,

if such holdings are not reported under the ESOP account they are likely

to be in the master trust agreement accounts. Consequently, our reported

dollar amounts of employer securities are likely to understate the amount

of plan assets held in employer securities. However, DOL officials said

that few Fortune 1,000 companies are likely to hold a significant

percentage of employer securities in master trust agreements.

Recognizing the difficulty of identifying plan assets held in master trusts,

DOL revised the Form 5500 for the 1999 plan filing year. Beginning with

the 1999 filing year, master trusts will file a form 5500 report along with

schedules itemizing the types of assets they hold. According to DOL

officials, this will help ensure adequate reporting on the plan assets held in

master trust investment accounts.

12% • Employer securities

43% • Other assets

• 45%

Master trust accounts
Page 14 GAO-02-943 Private Pensions

In addition to employer securities holdings in master trust agreements, we

also found basic filing errors in the data. While examples we found may

understate or overstate our concentrations, we were not able to determine

the extent to which such filings errors occurred. For example, we found

filing errors such as the misreporting of employer securities as corporate

debt instruments or stock (other than employer’s own common stock). In

one case, we identified an ESOP that was reported to hold no securities. A

DOL official reviewed this plan and, by examining an accountant’s report

that accompanied the Form 5500, discovered that the plan actually held

employer securities and had made a mistake in filling out the Form 5500—

a mistake that, according to DOL officials, occurs frequently. Furthermore,

data reported on the Form 5500 combines all employer securities into a

single line item. Employer securities held by pension plans may include

employer stock, a marketable obligation such as a bond or note, or an

interest in a publicly traded partnership. Thus, the line item for employer

securities does not accurately reflect the amount of pension plan assets

solely in employer stock.

Investment in employer securities through employer-sponsored retirement

plans can present significant risks for employees. If the employees’

retirement savings is largely in employer securities or other employer

assets, employees risk losing not only their jobs should the company go

out of business, but also a significant portion of their savings. However,

despite the risks, not every company whose employer plan has high

concentrations of employer stock will result in employees incurring

significant losses. Much depends on the decisions made by the company’s

leadership and other factors such as market forces, which determine

whether the company stays in business. Some companies help employees

mitigate their risks by balancing plans where risks of loss are borne by

employees with plans where employers bear such risk. In addition, some

companies help employees limit their exposure to the risk of loss by

allowing employees, if they so choose, to diversify their holdings.

Concentrating their retirement savings in employer securities means that

employees are not only concentrating their assets in a single security, but

are investing in a security that is highly correlated to their work effort and

earnings. Unlike investors, who have ownership in a company but do not

work for the company, employees with high concentrations of holdings of

employer securities in their retirement plans are subjecting two sources of

income, their retirement income and their employment income, to similar

risks. Such holdings directly expose the employee to the losses of the

Investing in Employer

Securities Can

Present Significant

Risks for Employees’

Retirement Savings

High Concentrations of

Employer Stock Holdings

Can Expose Employees to

the Risk of Losing Their

Jobs and Their Retirement

Savings
Page 15 GAO-02-943 Private Pensions

company they work for much more so than if they worked in another

company. In addition, holding significant proportions of employer

securities is directly at odds with modern financial theory, which says that

diversifying a portfolio offers the benefits of reducing risks at very limited

cost.

Companies prefer to provide company contributions in employer stock for

a number of reasons. Contributions in employer stock puts more company

shares in the hands of employees who some officials believe are less likely

to sell their shares if the company’s profits are less than expected or in the

event of a threatened takeover. Companies also point out that contributing

employer stock promotes a sense of employee ownership, linking the

interest of employees with the company and other shareholders. In

addition, employer stock contributions provide several tax benefits for

companies.

When employees choose to allocate a large portion of their total assets to

their employer’s securities, they are assuming significant risk in order to

achieve a particular expected rate of return. Studies have shown that

employees feel a great deal of loyalty to their company. Because they work

at the company and interact with the company’s managers, they believe

they know the company and feel more comfortable investing in it. In

addition, some employees enjoy being an owner-employee and some

believe their employer’s stock will outperform the overall market over

some particular time horizon. As a result, some employees consider

investments in employer stock through their employer-sponsored plans a

safe investment. However, employees who have significant portions of

their retirement savings invested in employer stock may be exposing

themselves to greater financial risks than necessary. Generally, financial

theory indicates that, through diversification, an investor can achieve a

similar expected rate of return with less risk than a portfolio concentrated

in employer securities.

The financial collapse of Enron and other companies, such as Color Tile

and Southland, has highlighted how vulnerable participants are when they

tie their retirement savings to their place of employment. For example,

• Enron employees lost their jobs and a significant amount of their

retirement savings as the company became insolvent. The decline in

Enron’s stock price and its subsequent failure substantially reduced the

value of many of its employees’ retirement accounts. Enron’s stock price

went from a high of $80 per share in January 2001, to less than $1 per

share in January 2002. About 62 percent of the assets held in the
Page 16 GAO-02-943 Private Pensions

company’s 401(k) consisted of shares of Enron stock. These

concentrations are the result both of employee investment choice and

employer matching contributions with employer stock. In all, about

20,000 employees lost money because their 401(k) accounts were heavily

invested in Enron stock.

• Color Tile employees lost their jobs and their retirement savings when

Color Tile filed for bankruptcy in January 1996. More than 83 percent of its

$34 million in 401(k) plan assets were invested in Color Tile real property.

During the bankruptcy, participant withdrawals or asset transfers in the

401(k) plan were prohibited until the property was appraised and sold.

• Southland Corporation employees incurred losses in their retirement

savings. Southland’s pension plans included a 401(k) and profit-sharing

plans. Fifty-eight percent of the assets in Southland’s 401(k) plan was used

to buy 1,100 7-Eleven stores which were then leased back to the company.

When Southland filed for Chapter 11 protection in October 1990, the

401(k) plan reduced its holdings in 7-Eleven stores to 46 percent of the

assets in Southland’s 401(k) plan. Unlike Enron and Color Tile, the

Southland Corporation emerged from bankruptcy fairly quickly, with

relatively small job loss to its employees.

See appendix II for additional details on of each company.

Even without bankruptcy, employees are still subject to the dual risk of

loss of job and retirement savings because corporate losses and stock

price declines can result in companies significantly reducing their

operations. For example, between December 31, 1999, and July 2001,

Lucent Technologies’ stock price fell from $82 to $6 per share and

employees’ account balances fell because about 30 percent of the

company’s 401(k) plan assets were in employer securities. For

nonmanagement employees, about one-third of Lucent’s workforce, the

employer 401(k) match was in the form of an ESOP contribution made in

employer stock. Employer contributions to Lucent’s management 401(k)

plan were made in the form of employer stock. In addition, more than

29,000 workers were laid off as a result of the company’s financial

troubles, although the company remains in business.

There are various reasons for companies experiencing financial

difficulties. Although recent company failures have been attributed to

company mismanagement, companies can also experience difficulties

because of such problems as business cycles, market downturns, and

Even if Companies Do Not

Declare Bankruptcy,

Employees Are Still

Subject to Certain Risks
Page 17 GAO-02-943 Private Pensions

declines in a sector of the economy. Depending on the circumstances of

the company, the employer’s stock price can experience a precipitous

drop or it can decline gradually. In either case, substantial holdings of

employer securities in employer-sponsored plans will be affected because

of the company’s financial problems.

Not every company whose employees have high concentrations of

employer securities holdings will experience substantial losses in their

plan assets. Much depends on the corporate decisions made by the

company, which determine whether the company stays in business and the

extent to which the company is forced, if necessary, to reduce operations.

In addition, much depends on the extent that employer’s stock is affected

by general market cycles or market volatility.

Proponents of employer stock investments through employer plans point

to numerous companies that have high concentrations of employer

securities in their employer-sponsored plans and whose participants have

not suffered as a result of such holdings. They state that high

concentrations of employer securities are typically in large companies and

that such companies have demonstrated long-term financial success. They

also state that company performance improves when employees

understand the relationship between their behavior and the accompanying

rewards that accrue to them when they own employer stock.

Two companies whose plans we reviewed had high concentrations of

employer stock holdings and their employees had not suffered substantial

losses in their retirement savings because of company failure or

downsizing. Each company offered defined contribution plans in the form

of profit-sharing, ESOPs, and 401(k) plans. The 401(k) plans at both

companies allowed participants to contribute a portion of their salaries on

a pre-tax basis, and the companies offered a variety of investment fund

choices to give plan participants the flexibility and option of investing

their 401(k) accounts. Overall, more than 57 percent of account balances

at one company and up to 92 percent of the employees’ account balances

at the other company are invested in employer stock. At one of the

companies, 83 percent of the employees’ contributions to the 401(k) plan

are invested in employer stock, and roughly 92 percent of the company’s

contribution to employee accounts is invested in employer stock.

Although each company’s stock price has experienced declines in the

recent overall downturn in the stock market, such declines have not

caused their employees to lose significant portions of their retirement

Some Companies Mitigate

Risks of High

Concentrations of

Employer Securities
Page 18 GAO-02-943 Private Pensions

savings. Company officials said that their company would continue to give

their employees every opportunity to invest in employer stock. In addition,

company officials said that despite the recent downturn in the market,

plan participants have not significantly diversified out of the employer

stock.

Some companies help employees mitigate their exposure to risk by

balancing the types plans where risks of loss are borne by employees with

plans where employers bear such risk. When companies provide defined

benefit plans, employees are likely to receive some level of retirement

income even if they have incurred losses in their defined contribution

plans. With a defined benefit plan, the employer, as plan sponsor, is

responsible for funding the promised benefits, investing and managing the

plan assets, and bearing the investment risk. If the defined benefit plans

terminate with insufficient assets to pay promised benefits, the Pension

Benefit Guaranty Corporation (PBGC) provides plan termination

insurance to pay participant’s pension benefits up to a certain limit.12 For

example, according to PBGC, Enron sponsored at least five defined

benefit plans insured by PBGC. The largest of these plans covered about

20,000 participants. If one or more of Enron’s defined benefit plans is

unable to pay promised benefits and is taken over by PBGC, vested

participants and retirees will receive their promised benefits up to the

limit guaranteed under ERISA.13

In addition, some companies help employees mitigate their exposure to

the risk of loss by allowing employees, if they so choose, to diversify their

holdings. Two companies whose plans we reviewed had few restrictions

on their employees’ ability to diversify their holdings of employer

securities. For example, one company allowed vested participants at any

age to diversify out of employer stock in the company-contributed portion

of their account. The other company allowed 100 percent diversification of

employee 401(k) contributions, the company match, and the profit sharing

contributions at all times. Several other companies have publicly

 12PBGC was created to insure the pension benefits of participants—in certain defined

benefit plans—whose plans terminate without sufficient assets to pay all benefits owed. If

a defined benefit plan terminates without sufficient funds to pay all benefits that

participants are entitled to, PBGC takes over the plan and its assets and is responsible for

paying benefits up to limits set by law to participants who are entitled to receive them.

13In accordance with ERISA, PBGC benefit payments are subject to a maximum benefit

guarantee. For plans terminating in 2002, the maximum insured amount payable is

$42,954 per year for a worker who retires at age 65.
Page 19 GAO-02-943 Private Pensions

announced easing restrictions on when employees can diversify employer

contributions in their accounts. For example, one company announced in

February 2002 that 401(k) plan participants could sell any of their

individual account assets, including their employer match in employer

securities, without restriction. Other companies have also lifted their

restriction that required employees to hold their employer securities from

company contributions until age 50.

ERISA and the Securities Act of 1933 require DOL and SEC to ensure that

appropriate disclosures are made to plan participants and investors

regarding their investments. Under ERISA, companies with participantdirected individual account plans are to provide plan participants with

certain information and disclosures beyond the general ERISA reporting

requirements. The Securities Act of 1933 requires companies with defined

contribution plans that offer employer stock to employees to register and

disclose to SEC specific information about those plans. Under the current

disclosure requirements of DOL, there is no requirement that companies

disclose to plan participants the risks involved in investing in employer

stock or the benefits of diversification. Industry representatives we spoke

with said that companies provide employees with investment education

and plan information and in some cases go beyond the minimum

requirements. However, because there is no requirement to educate

employees about the investment risks or the benefits of diversification,

investment education can vary by company. Few employers make more

specific individualized or tailored investment advice available to their plan

participants, in part because of concerns about fiduciary liability.14 DOL

has recently issued guidance about investment advice, which should help

clarify when companies can use independent investment advisors to

provide advice to participants in retirement plans.

ERISA requires DOL to ensure that appropriate disclosures are made to

plan participants regarding their ERISA-covered pension plans. While

companies automatically make certain information available to plan

participants, there is other information that participants must request in

writing. Certain plans, which are designed to meet specific ERISA

provisions, must provide plan participants with disclosures beyond what is

 14Under ERISA, providing investment advice results in fiduciary responsibility for those

providing the advice.

Current Laws Provide

for Disclosures to

Plan Participants, but

Information about

Investment

Diversification and

Risk Is Not Required

ERISA Establishes

Disclosure Requirements

for Plan Participants
Page 20 GAO-02-943 Private Pensions

generally required by ERISA. Compliance with this regulation is optional,

but provides employers with a defense to fiduciary liability claims related

to investment choices made by employees in their participant-directed

accounts.

ERISA requires companies to automatically disclose to plan participants

certain information pertaining to their pension plans. These disclosures

are the summary plan description (SPD), summary of material

modifications (SMM), and the summary annual report (SAR). The SPD

tells participants what the plan provides and how it operates. Specifically,

the SPD provides information on when an employee can begin to

participate in the plan, how service and benefits are calculated, when

benefits become vested, when and in what form benefits are paid, and how

to file a claim for benefits. ERISA states that the SPD must be written in a

manner “calculated to be understood by the average plan participant” and

must be “sufficiently comprehensive to apprise the plan’s participants and

beneficiaries of their rights and obligations under the plan.” In other

words, the disclosed information should be understandable and allinclusive so participants can have useful information that will aid them in

effectively understanding their pension plans. New employees must

receive a copy of the most recent SPD within 90 days after becoming

covered by the plan.

In addition to the summary plan description, plan participants are entitled

to receive a summary of material modifications. The summary of material

modifications discloses any material changes or modifications in the

information required to be disclosed in the SPD. Plan administrators must

furnish participants with an SMM within 210 days after the close of the

plan year in which the modification was made.

Participants must also receive a summary annual report from their plan’s

administrator each year. The summary annual report summarizes the

plan’s financial status based on information that the plan administrator

provides to DOL on its annual Form 5500. Generally, the SAR must be

provided to participants no later than 9 months after the close of the plan

year.

Plan participants may also request additional information about their

plans. If plan participants wish to learn more about their plan’s assets, they

have the right to ask their plan administrator for a copy of the plan’s full

annual report. In addition, a participant can request a copy of his or her

individual benefit statement, which describes a participant’s total accrued

and vested benefits. Plan participants can also request the documents and

Disclosures on Pension Plans

Required under ERISA
Page 21 GAO-02-943 Private Pensions

instructions under which the plan is established or operated. This includes

the plan document, the collective bargaining agreement (if applicable),

trust agreement, and other documents related to the plans.

Under the 404(c) regulation, participants receive certain disclosures

pertaining to the plan and its investment options.15 The regulation is a

benefit to plan participants because it allows them to receive additional

disclosure beyond what is generally required under ERISA. The purpose of

these informational requirements is to “ensure that participants and

beneficiaries have sufficient information to make informed investment

decisions.”16 The regulation also benefits employers who comply with its

requirements, because it exempts them from fiduciary liability related to

the investment choices made by their employees in their participantdirected accounts.

The regulation specifically requires that the plan administrator

automatically provide the plan participant with (1) an explanation that the

plan is a 404(c) plan and that the fiduciary will be relieved of liability;

(2) a description of investment alternatives; (3) the identification of any

designated investment managers; (4) an explanation of circumstances

under which the participant may give investment instructions or

limitations; (5) a description of transaction fees and expenses; and

(6) the name, address, and telephone number of the fiduciary to contact

for further information regarding these disclosures. In addition, for a plan

with employer stock, plan administrators are to provide all voting

information and the procedures for ensuring the confidentiality of

participant investment transactions, as well as a prospectus immediately

before or after the initial investment.

Plan participants can also request certain plan information. This includes

(1) a description of the annual operating expenses of the plan’s investment

alternatives, including any investment management fees; (2) copies of any

prospectuses, financial statements and reports, and other information

furnished to the plan relating to investment alternatives; (3) the list of

assets comprising the portfolio of each investment option that holds plan

assets; (4) information about the value of shares or units in investment

 1529 C.F.R. 2550.404c-1. ERISA 404(c) generally relieves employers of liability for fiduciary

error when the employer permits participants to exercise control over their accounts.

16Final Regulations Regarding Participant Directed Individual Account Plans, 57 Federal

Register 46,906, 46,909-10 (Oct. 13,1992) (codified at 29 C.F.R. 2550.404c-1).

Regulation under Section

404(c) of ERISA Establishes

Additional Disclosure

Requirements
Page 22 GAO-02-943 Private Pensions

alternatives available along with information concerning past and current

investment performance of each alternative; and (5) information

pertaining to the value of shares or units in investment alternatives held in

the participant’s account.

Employers choose whether to provide disclosures under the regulation.

Those who comply with the regulation are afforded certain protections

from their fiduciary liability.

• First, compliance exempts plan fiduciaries from responsibility for

investment decisions of employees when employees exercise control over

their investments. However, the regulation establishes conditions

employers must meet in order to be exempted from fiduciary liability

related to investment choices made by participants. Employers must

provide employees with the opportunity to choose from a broad range of

investment options; allow employees to transfer the assets in their

accounts into and out of the various plan investment options with a

frequency that is reasonable in light of the market volatility of those

investment options; and the plan’s investment options must permit

employees to diversify their investments. If the plan meets the

requirements of the regulation and a participant fails to diversify his or her

account and invests all the account assets in his or her employer’s stock,

the employer will be able to assert that the company is not responsible for

any financial losses incurred by the participant because the company has

complied with the regulation.

• Second, participants that manage the investments of their accounts are not

considered to be fiduciaries. The employer is also not subject to potential

fiduciary liability for the participant’s investment decisions.

Plan sponsors are not relieved of all fiduciary responsibilities by

complying with the regulation. For example, they remain responsible for

the prudent selection of investment alternatives and monitoring plan

investments on an ongoing basis.

Because defined contribution plans require that employees assume the

investment risk, securities law protections applicable to investors are

relevant to plan participants. Employees in participant-directed plans

might be given the choice of investing in securities, including employer

securities, as well as a variety of mutual funds. The securities laws require

disclosure of information about investment objectives, performance,

investment managers, fees, and expenses of mutual funds and information

Compliance with Section

404(c) Regulations of ERISA Is

Optional

Under the Securities Act

Certain Pension Plans Are

Required to Register with

SEC
Page 23 GAO-02-943 Private Pensions

about the business objectives, financial status, and management of

companies that are issuing securities. However, distribution of these

disclosure materials to plan participants making investments may depend

on employer compliance with requirements of ERISA’s 404(c) regulations.

In addition, interests in certain pension or profit-sharing plans are

securities subject to the registration and antifraud requirements of the

Securities Act of 1933 (1933 act), which we discuss in further detail in

appendix III. Pension or profit-sharing plans that have the investment

characteristics of securities are required to register under the 1933 act.

Interests of employees in plans are securities where the employees

voluntarily participate in the plan and their individual contributions can be

used to purchase employer stock. This generally includes 401(k) salary

reduction plans and savings plans where participant contributions are

used to purchase employer securities. If employer securities are offered

and sold to employees pursuant to a pension plan, those securities must be

registered also.

The 1933 act requires registration of securities being offered for sale to the

public. The registration statement, which SEC makes publicly available,

must disclose the basic business and financial information for the issuer

with respect to the securities offering. SEC requires companies that offer

securities to their employees under any employee benefit plan to register

those securities on Form S-8. SEC generally makes the companies’

Form S-8 publicly available, but does not routinely review these forms.

The SPD may be used to satisfy the prospectus delivery requirement

applicable to Form S-8.17 However, the SPD is not filed with the SEC as

part of the Form S-8. Although ERISA requires SPDs to be provided to

participants, DOL no longer requires the SPD to be filed with the

Department.

SEC generally limits its review of corporate filings to ensure that the initial

registration of the security and other reporting comply with its disclosure

requirements. As part of its interpretive responsibility, SEC has no

requirement in law or regulation to verify the accuracy or completeness of

the information companies provide. SEC’s review of corporate filings may

involve a full review, a full financial review, or monitoring of certain filings

 17Rule 428 under 17 C.F.R. Section 230.428 specifies what companies must deliver to plan

participants to satisfy the prospectus delivery requirement of Form S-8.

SEC Makes Registration

Documents Available to the

Public, but Does Not Routinely

Review Them
Page 24 GAO-02-943 Private Pensions

for specific disclosure requirements.18 In our work at SEC, we found that

its ability to fulfill its mission has become increasingly strained, due in part

to imbalances between SEC’s workload and staff resources.19 Like other

aspects of SEC’s workload, the number of corporate filings has grown at

an unprecedented rate. SEC’s 2001 goal was to complete a full financial

review of an issuer’s annual report required by the Exchange Act in 1 of

every 3 years—a review goal of about 30 to 35 percent of these annual

reports per year. However, SEC only completed full or full financial

reviews of 16 percent of the annual reports filed or about half of its annual

goal in 2001. In this post-Enron environment, SEC plans to reconsider how

it will select filings for review and plans to revise its approach for

allocating staff resources to conduct those reviews.

The SEC does not routinely review companies’ Forms S-8 for

completeness or accuracy and has not routinely reviewed these filings for

the last 20 years, according to SEC staff.20 SEC staff said that while they

track the total number of Form S-8 filings each fiscal year. They do not

separately track the number of filings for different types of plans, such as

401(k) plans or stock option plans. SEC staff can, however, take action

against an issuer if it discovers that a Form S-8 does not comply with

applicable law. For example, SEC has taken enforcement actions against

companies that have abused the S-8 short form registration. In the late

1990’s, some companies had used Form S-8 filings inappropriately for

raising capital and not for compensatory offerings for employee plans.

Recently, SEC has placed increased emphasis on clear, concise and

understandable language in prospectuses. SEC requires that in drafting

disclosure documents, registrants should aim to write clearly and to

provide for more effective communication. SEC implemented the plain

English requirement for certain parts of the 1933 act prospectus. For

 18A full review involves an in-depth examination of the accounting, financial, and legal

aspects of an issuer’s filing. A full financial review involves an in-depth accounting analysis

of an issuer’s financial statements and management’s discussion and business plan

disclosure.

19See U.S. General Accounting Office, Human Capital: Major Human Capital Challenges

at SEC and Key Trade Agencies, GAO-02-662T (Washington, D.C.: Apr. 23, 2002).

20According to SEC’s Interpretive Release No. 6188, SEC made revisions to the Form S-8

and revised its procedures for making it effective. The Commission believed that the public

interest would be better served by prompt effectiveness of such filings without the delay

necessitated by the low review priority given to them. SEC substantially revised Form S-8

in 1990.
Page 25 GAO-02-943 Private Pensions

example, with respect to mutual funds, SEC’s rules require that the

prospectus should contain information appropriate for an average or

typical investor who may not be sophisticated in legal or financial matters.

ERISA was enacted in 1974 within the context of defined benefit pension

plans where employers make plan investment decisions; consequently,

ERISA does not require plan sponsors to make investment education or

advice available to plan participants. Moreover, according to DOL officials,

employers that sponsor pension plans are not required to provide

educational materials on retirement saving and investing. Hence,

employers are not required to provide information about the risks involved

in investing in employer securities and the importance of diversification to

a prudent investment strategy. Additionally, under ERISA, providing

investment advice results in fiduciary responsibility for those providing

the advice, while providing investment education does not.

Industry officials that we spoke with said that many companies provide

employees with investment education and plan information. Plan

participants are given a number of investment education materials, such as

newsletters, quarterly reports on participant accumulations, and annual

reports with benefit projections. Companies also provide information to

employees about their investment plan options. Employees are also

provided information explaining the value of diversification. Furthermore,

according to these officials, diversification is a theme that they emphasize

in their investment education programs.

Investment education varies by company in part because ERISA has no

requirements about informing participants about investment risks or

diversification. Industry officials that we spoke with told us that many

companies voluntarily provide some investment education to plan

participants and that they do so because education is needed to improve

employees’ abilities to manage their retirement savings. However, because

there is no standard format for investment education, companies provide

employees with information that they believe is important to managing

their retirement savings accounts and this information varies by

employers.

DOL does not monitor the type of investment education provided to plan

participants and little is known about the accuracy and usefulness of the

Investment Education Is

Not Required, but Is

Sometimes Provided in

Addition to Disclosures
Page 26 GAO-02-943 Private Pensions

investment education programs and materials provided to employees. SEC

provides broad investor education, only to the extent that it affects all

investors, but it does not specifically target pension plan investors.21

Industry officials also said that providing investment education to

employees does not necessarily mean that companies are providing

information on the risks of holding employer securities. These officials

said that telling plan participants that an investment may be risky or that

an employee’s holdings are risky could be interpreted as providing

investment advice. Consequently, companies provide general information

about the benefits of diversification, but little information about the risk of

holding certain investments, such as employer stock.

Some studies also indicate that the type and amount of investment

education varies by company. For example, one study by a benefits

consulting firm found that 24 percent of their respondents reported that

their companies offered investment information on an as-needed basis,

and 11 percent reported that their companies offered no information at all.

The remaining respondents said their companies offered detailed

information, either on an ongoing basis (33 percent), or at plan enrollment

and annually thereafter (32 percent).

Industry officials told us that many companies do not offer investment

advice mainly because of fiduciary concerns about the liability for such

advice if it results in losses to the participant, even if the investment

advisor is competent and there is no conflict of interest. Companies also

have fiduciary concerns about the ability to select and monitor a

competent investment advisor under ERISA’s prudence standard.22

Additionally, ERISA currently prohibits fiduciary investment advisors from

engaging in transactions with clients’ plans where they have a conflict of

interest, for example, when the advisors are providing other services such

as plan administration. As a result, these investment advisors cannot

 21Within SEC, its Office of Investor Education is responsible for disseminating information

to educate the investing public about the advantages and risks associated with investing. In

this capacity, SEC seeks to protect investors by first providing them with pertinent

information to assist in making investment decisions appropriate for their circumstances.

SEC provides web-based links to other federal, state, and related investor education web

sites that contain materials or information useful to investors.

22ERISA’s prudence standard requires a fiduciary to act as a prudent person experienced in

such matters would in similar circumstances.
Page 27 GAO-02-943 Private Pensions

provide specific investment advice to plan participants about their firm’s

investment products without approval from DOL.

Industry officials we spoke with said that more companies are providing

plan participants informational sessions with investment advisors to help

employees better understand their investments and the risk of not

diversifying. They also said that changes are needed under ERISA to better

shield employers from fiduciary liability for investment advisors

recommendations to individual participants. In 1996, DOL issued guidance

to employers and investment advisers on how to provide educational

investment information and analysis to participants without triggering

fiduciary liability. 23 This guidance identifies and describes certain

categories of investment information, and education employers may

provide to plan participants. These categories are (1) information about

the plan, (2) general financial information, (3) information based on “asset

allocation models,” and (4) “interactive investment materials.” According

to DOL, these investment education categories merely represent examples

of investment information and materials that if furnished to participants

would not constitute the rendering of investment advice.

DOL has recently issued guidance about investment advice, which should

help clarify when companies can use independent investment advisors to

provide advice to participants in retirement plans. In 2001, DOL issued

Advisory Opinion 2001-09A. This Advisory Opinion was a response to an

application for exemption filed on behalf of SunAmerica Retirement

Markets, Inc. (SunAmerica) with DOL, which sought exemption from the

prohibited transactions restrictions.24 DOL determined that SunAmerica’s

proposed method of issuing investment advice directly to plan participants

would not violate the prohibited transaction provisions of ERISA. DOL’s

ruling allows financial institutions to provide investment advice directly to

retirement plan participants when the advice is based on the computer

programs and methodology of a third party, independent advisor;

therefore eliminating conflicts of interest. DOL officials said that they

hope the Advisory Opinion ruling helps plans to sponsor the type of

nonconflicted investment advice they are allowed to provide plan

participants.

 23Interpretive Bulletin 96-1.

24The Advisory Opinion prohibited fiduciary investment advisors from engaging in

transactions with clients’ plans where they have a conflict of interest.
Page 28 GAO-02-943 Private Pensions

The Enron collapse serves to illustrate what can happen under certain

conditions when participants’ retirement savings are heavily invested in

their employer’s securities. When the employer’s securities constitutes the

majority of employees’ individual account balances and is the primary type

of contribution the employer provides, employees are exposed to the

possibility of losing more than their job if the company goes out of

business or into serious financial decline—they are also exposed to the

possibility of losing a major portion of their retirement savings. We

presented other concerns about what can happen to employees’

retirement savings under certain conditions to the Congress in our

testimony in February 2002.25 In addition to the issues of diversification

and education, we suggested that further restrictions on floor-offset

arrangements may be warranted.

As our analysis shows, it is not unusual to find concentrations of employer

securities in the plans of large firms such as the Fortune 1,000 that cover a

significant portion of employees. To the extent these defined contribution

plans become the primary component of employees’ retirement savings;

these plans are most subject to risk of loss, and employees and policy

makers should be concerned about the risks employees face by holding

large portions of their retirement savings in employer securities. This is

especially important as fewer companies are offering defined benefit plans

that could provide some level of guaranteed retirement savings to

employees even if they incur substantial losses in their defined

contribution plans.

Current ERISA disclosure requirements provide only minimum guidelines

that companies must follow on the type of information they provide to

plan participants. In addition, there is little government oversight of the

information companies provide to plan participants. Consequently, the

type and amount of information plan participants are receiving about their

investments is not known. Improving the amount of disclosure provided to

plan participants could help ensure that plan participants are at least

getting some minimum level of information about investing, especially

with regard to employer securities. In addition, providing plan participants

with disclosures on the risks of holding employer securities and the

benefits of diversification in mitigating employees’ losses may help

 25See U.S. General Accounting Office, Private Pensions: Key Issues to Consider Following

the Enron Collapse, GAO-02-480T (Washington,D.C.: Feb. 27, 2002).

Conclusion
Page 29 GAO-02-943 Private Pensions

employees make more informed decisions regarding the amount of

employer securities they hold in their retirement plans.

To address the lack of investment education and information provided to

participants, the Congress should consider amending ERISA so that it

specifically requires plan sponsors to provide participants in defined

contribution plans with an investment education notice that includes

information on the risks of certain investments such as employer

securities and the benefits of diversification.

We provided a draft of this report to the Department of Labor, the

Department of the Treasury, and to the Securities and Exchange

Commission for review and comment. We received written comments

from the Department of Labor that are reprinted in appendix IV. DOL,

SEC, and the Department of Treasury also provided technical comments

on the draft. We incorporated each agency’s comments as appropriate.

Included in the draft for DOL’s review was a recommendation to the

Secretary of Labor to direct the Assistant Secretary, Pension and Welfare

Benefits Administration, to require plan sponsors to provide participants

in defined contribution plans with an investment education notice. DOL

agreed with our conclusion that additional investment education is

necessary, but stated that the Secretary of Labor does not currently have

the legal authority under ERISA to require an investment education notice.

Consequently, we changed our recommendation to a matter for

consideration for the Congress to amend ERISA so that it requires plan

sponsors to provide an education notice.

As agreed with your office, unless you publicly announce its contents

earlier, we plan no further distribution of this report until 30 days after its

issue date. We are sending copies of this report to the Secretary of Labor;

the Secretary of the Treasury; and the Chairman, Securities and Exchange

Commission. We will also make copies available to others on request. In

addition, the report will be available at no charge on the GAO Web site at

http://www.gao.gov.

Matter for

Congressional

Consideration

Agency Comments
Page 30 GAO-02-943 Private Pensions

If you have any questions concerning this report, please contact Barbara

Bovbjerg at (202) 512-7215, Richard Hillman at (202) 512-8678, George

Scott at (202) 512-5932, or Debra Johnson at (202) 512-9603. Other major

contributors include, Joseph Applebaum, Tamara Cross, Rachel

DeMarcus, Jason Holsclaw, Raun Lazier, Carolyn Litsinger, Gene

Kuehneman, Alexandra Martin-Arseneau, Corinna Nicolaou, Vernette

Shaw, Roger Thomas, and Stephanie Wasson.

Sincerely yours,

Barbara D. Bovbjerg

Director, Education, Workforce

 and Income Security Issues

Richard J. Hillman

Director, Financial Markets

 and Community Investments
Appendix I: Scope and Methodology

Page 31 GAO-02-943 Private Pensions

To determine the number and types of private pension plans invested in

employer securities, we analyzed plan financial information filed annually

(Form 5500s) with the Internal Revenue Service and Pension and Welfare

Benefits Administration(PWBA). The annual Form 5500 report is required

to be submitted annually by the administrator or sponsor for any employee

benefit plan subject to Employee Retirement Income Security Act (ERISA)

as well as for certain employers maintaining a fringe benefit plan. It

contains various schedules with information on the financial condition and

operation of the plan. PWBA provided us with a copy of the complete 1998

electronic Form 5500 database and a preliminary 1999 electronic database

for Form 5500s for our analysis. The 1998 database contained information

from over 215,000 Form 5500 reports. We did not independently verify the

accuracy of the Form 5500 databases. In addition, the data we analyzed

were accurate only to the extent that employers exercised appropriate

care in completing their annual Form 5500 reports.

We decided to focus our analysis on the largest 1,000 corporations. In

order to determine the Fortune 1,000 companies for our review, we used

the “Fortune Magazines” listing of the largest corporations in the United

States, which determines the largest corporations by looking at

corporations’ revenue during the preceding year.1

 After determining the

1,000 largest corporations, we analyzed data for the Fortune 1,000

companies (the corporations and their subsidiaries) for plan year 1998,

which was the most recent year for which complete plan-specific Form

5500 data were available for our review.

In order to review the Fortune 1,000’s Form 5500s, we matched the

Fortune 1,000 companies to their pension plans on the basis of their

Employer Identification Numbers (EINs). An EIN, known as a federal tax

identification number, is a nine digit number that the IRS assigns to

 1

All companies on the list must publish financial data and must report part or all of their

figures to a government agency. Private companies and cooperatives that produce a 10-K

are, therefore, included; subsidiaries of foreign companies incorporated in the United

States are excluded. Revenues are as reported, including revenues from discontinued

operations when they are published on a consolidated basis (except when the divested

company’s revenues equal 50 percent or more of the surviving company’s revenues on an

annual basis). The revenues for commercial banks and savings institutions are interest and

noninterest revenues. Such figures for insurance companies include premium and annuity

income, investment income, and capital gains or losses, but exclude deposits. Revenues

figures for all companies include consolidated subsidiaries and exclude excise taxes.

Appendix I: Scope and Methodology

Review of Form 5500

Data
Appendix I: Scope and Methodology

Page 32 GAO-02-943 Private Pensions

organizations.2 We used several methods to identify the EINs associated

with the Fortune 1,000. We started with a list of EINs for over 500

companies that was provided to us by the Pension Benefit Guaranty

Corporation (PBGC). To identify the EINs for the remaining companies we

searched public filings, including 10-K statements filed with the SEC, using

the search tools available through nexis.com. Where we could not find a

company’s EIN and for companies whose EIN was not associated with a

Form 5500, we conducted a text search of the electronic Form 5500 data to

find plans sponsored by these companies. Additionally, we used 10-K

filings for the Fortune 1,000 companies to identify major subsidiaries that

might have their own pension plans. We conducted further text searches

of the electronic Form 5500 data to identify pension plans for these

subsidiaries. Our analysis includes information for subsidiaries to the

extent we were able to identify them during our review. We eliminated

from our analysis any Form 5500 returns that did not report end-of-year

assets and also eliminated plans that did not report end of year

participants. This resulted in a database containing the information of

3,480 Form 5500 returns filed by 996 of the Fortune 1,000 companies or

their subsidiaries. Our totals for the number of plan participants include

double counting of participants because some individuals may participate

in more than one pension plan sponsored by the same employer.

Because master trust holdings accounted for 45 percent of the assets held

by the Fortune 1,000 employer-sponsored plans, we tried to identify

employer securities held outside of master trusts. To calculate the

percentage of pension plan assets held as employer securities, we first

subtracted master trust assets from total plan assets to arrive at “known

assets.” We then calculated the percentage of known assets comprised of

employer securities to determine the percentage concentration of plan

assets in employer securities. Plans holding assets in master trust

accounts reported only the total asset value of these holdings and did not

itemize or otherwise identify any the individual investments held by a

master trust for 1998 Form 5500 filings. As such, we were unable to

determine what fraction of that 45 percent consisted of employer

securities. However, we analyzed preliminary 1999 Form 5500 data for

master trust accounts and found that some of the assets reported by these

master trust accounts were holdings of employer securities.

 2

The IRS uses the number to identify taxpayers who are required to file various business

tax returns as well as the Form 5500. EINs are used by employers, sole proprietors,

corporations, partnerships, nonprofit associations, trusts, estates of decedents, government

agencies, certain individuals, and other business entities.
Appendix I: Scope and Methodology

Page 33 GAO-02-943 Private Pensions

To address the implications of investing in employer securities, we

identified companies whose pension plans were heavily invested in

company’s securities. We specifically looked for companies where

employees have experienced substantial retirement losses similar to

Enron and ones where the employees have benefited. Given the sensitivity

and nature of our review, it was difficult to find companies that would

speak with us and share their plans’ investment experiences, whether

good or bad. However, we were able to find officials in two companies

that were willing to discuss their pension plan and experiences.

To identify and describe the implications of companies where employees

have experienced significant losses due to bankruptcy or declines in the

market valuations of the company’s stock, we obtained information about

the company’s history and pension plans through U.S. news, trade industry

reports, business journals, and company Web sites. We researched fraud

cases on the world wide web; reviewed legal briefs and opinions outlining

the details of lawsuits filed against the companies; and reviewed

bankruptcy filings and proceedings to describe the history of events that

lead the company to seek bankruptcy protection.

To identify and describe situations where employees have not experienced

significant losses, we interviewed two companies whose private pension

plans are heavily invested in company securities. We developed a set of

structured interview questions to obtain information about the companies,

specifically background information and information about the company’s

pension plans. We also reviewed and analyzed the company’s summary

plan descriptions and prospectus to determine how the plans were

administered and to identify requirements and restrictions of each plan.

To report on the regulatory provisions for disclosures to participants

owning employer stock through their employer-sponsored plans, we

reviewed relevant laws and regulations and spoke with agency and

industry officials. In order to understand the regulatory provisions for

securities, we reviewed the Securities Act of 1933 and the Securities Act of

1934. Similarly, we reviewed ERISA and 404(c) regulations to under

disclosure requirements for pension plans. We also reviewed past reports

on private pension plans, ERISA, Employee Stock Ownership Plans

(ESOPs), and issues regarding investment education and advice. We also

spoke with Department of Labor (DOL) pension and legal experts and

officials from the Securities and Exchange Commission’s Market

Regulation Division, Investor Education Division, Corporate Finance

Division, and the Enforcement Division.

Implications of

Investing in Employer

Securities

Regulatory Provisions

for Disclosures
Appendix I: Scope and Methodology

Page 34 GAO-02-943 Private Pensions

In order to determine the types of disclosures companies were providing

to plan participants, we spoke with officials from the American Benefits

Council, 401(k) Profit Sharing Council of America, the ESOP Association,

the ERISA Industry Committee, the American Society of Pension

Actuaries, the Investment Company Institute, and retirement plan

administrators and financial service providers.

To determine whether the SEC should reconsider its administrative

determination not to explore application of the Securities Act and the

Securities Exchange Act to defined contribution plans, we first researched

what SEC’s determination had been and second determined whether SEC

planned to reconsider its determination. We researched the relevant legal

history and SEC’s position papers. We reviewed relevant securities laws,

SEC regulations, and public SEC statements, as well as pertinent legal

matters. We interviewed and discussed SEC’s position on the application

of the Securities Act and the Securities Exchange Act to defined

contribution plans with SEC’s legal counsel and appropriate SEC staff.
Appendix II: Bankruptcy and Legal

Proceedings of Companies Whose Employees

Participated in Employer-Sponsored Plans

Page 35 GAO-02-943 Private Pensions

Enron was engaged in the business of providing natural gas, electricity,

and communications to wholesale and retail customers. Only months

before its bankruptcy filing, the company was regarded as one of the most

innovative, fastest growing, and best managed businesses in the United

States. However, Enron’s problems did not arise in its core energy

operations, but in other ventures, particularly “dot com” investments in

Internet and communications businesses and in certain foreign

subsidiaries. Rather than recognize these problems, the company assigned

business losses to unconsolidated partnerships and other vehicles, which

reportedly inflated its income.1

 On December 2, 2001, the Enron

Corporation filed for Chapter 11 bankruptcy protection.

The decline in Enron’s stock price and its subsequent failure substantially

reduced the value of many of its employees’ retirement accounts. Under

Enron’s 401(k) type plan, participants were allowed to contribute from

1 to 15 percent of their eligible base pay in any combination of pre-tax

salary deferrals or after-tax contributions subject to certain limitations.

Participants were immediately fully vested in their voluntary

contributions.2

 Enron generally matched 50 percent of all participants’

pre-tax contributions up to a maximum of 6 percent of all employee’s base

pay, with matching contributions invested solely in the Enron Corporation

Stock Fund. Participants were allowed to reallocate their company

matching contributions among other investment options when they

reached the age of 50.

On April 8, 2002, a class action suit was filed on behalf of the plan

participants representing 24,000 current and former Enron employees who

participated in Enron’s plans. The lawsuit alleges that the Enron

Corporation Savings Plan Administrative Committee and other persons

responsible for safeguarding the assets of the employee’s plans are liable

for breaching their fiduciary duties under ERISA. In addition, the

Department of Labor (DOL) has opened an investigation to determine

whether there were any ERISA violations in the operation of the

company’s employee benefit plans. DOL also reached an agreement with

Enron to appoint an independent fiduciary to assume control of the

 1

In late 2001, Enron revealed it would incur losses of at least $1 billion and would restate its

financial results for 1997, 1998, 1999, 2000, and for the first quarters of 2001, to correct

errors that inflated Enron’s net income by $586 million.

2

Employees hired after July 1999 are fully vested in their company contributions after

1 year of service.

Appendix II: Bankruptcy and Legal

Proceedings of Companies Whose Employees

Participated in Employer-Sponsored Plans

Enron
Appendix II: Bankruptcy and Legal

Proceedings of Companies Whose Employees

Participated in Employer-Sponsored Plans

Page 36 GAO-02-943 Private Pensions

company’s retirement plans. SEC had not taken any enforcement actions

as of August 1, 2002.3

Color Tile’s financial problems began as a result of a 1993 business

transaction that left the company undercapitalized, without the ability to

service its debts and operate in a competitive fashion. In 1995, the

company defaulted on a $10.4 million interest payment, forcing the

company to seek relief under Chapter 11 of the bankruptcy code. In 1996,

after 44 years in the floor-covering business and failing at several attempts

to remain competitive in a changing flooring market, Color Tile sought

Chapter 11 protection. One day after filing for bankruptcy protection, the

company closed 234 of its 621 company-owned stores nationwide. After

several attempts to save the company, Color Tile closed the remaining of

its stores a year later affecting some 3,900 employees. Company

executives blamed its financial troubles on slow flooring sales and

competition from other centers.

In 1996, a former Color Tile employee sued Color Tile, alleging

mishandling of the plan assets, including investing the plan assets in Color

Tile property. The employee won, and the settlement required the plan

trustee and fiduciary carrier to pay about $4 million to Color Tile’s

$34 million 401(k) plan. In 1993, DOL investigated Color Tile and found no

violations. SEC did not open an investigation of Color Tile.

The company began to experience financial difficulties as a result of a

failed 1987 leveraged buyout. The value of the company’s stock declined,

and the company found itself under $4.9 billion of debt, which it had

incurred as the result of the 1987 leveraged buyout. In addition, the

company lost $1.3 billion and then suddenly ran out of money to pay the

interest on the debt, forcing the company to sell 58 of its convenience

stores to a Japanese retailer. Southland’s pension plans included a 401(k)

 3

SEC has taken few enforcement actions to date against companies concerning their

pension plans. SEC staff advised that the SEC had not taken actions to safeguard or

recover assets of retirement plans triggered by situations where—in the last 10 years—

employees have suffered substantial losses because plans that held employer stock had

declined in value or had limited employees’ ability to diversify investments or sell company

stock. According to SEC staff, these matters do not deal with disclosure or registration

issues that are under SEC’s authority. Instead, these matters are more related to the merits

of the plans and how they operate under ERISA, thus, falling under DOL’s regulatory

authority.

Color Tile

Southland
Appendix II: Bankruptcy and Legal

Proceedings of Companies Whose Employees

Participated in Employer-Sponsored Plans

Page 37 GAO-02-943 Private Pensions

plan and a profit-sharing plan. Fifty-eight percent of the assets in

Southland’s 401(k) plan was used to buy 1,100 7-Eleven stores and then

leased back to the company. After its bankruptcy, Southland reduced its

holdings in 7-Eleven stores to 46 percent of Southland’s 401(k) plan assets.

In 1991, Southland’s Japanese partners acquired 70 percent of Southland’s

common stock for $430 million. The cash infusion allowed the company to

emerge from bankruptcy with its debt load reduced by 85 percent.

Southland emerged from bankruptcy protection on March 5, 1991.

Lucent Technology, which spun off from AT&T in 1996, at one time held a

dominant position in the telecommunications equipment market. During

the first quarter of fiscal year 2000, the company’s revenues began faltering

as a result of the company’s inability to develop and deliver new products

as the market required. In addition, Lucent developed problems with

AT&T, its largest and most important customer. As a result, Lucent shares

began falling in January 2000, when the company said its fourth-quarter

profits would fall short. In subsequent quarters, the company kept cutting

forecast and the shares kept plunging. Between December 31, 1999, and

July 2001, Lucent shares declined from $70 to $6. In fiscal year 2001,

Lucent posted a $16 billion loss and anticipated a large-scale layoff.

Employer contributions to Lucent’s management 401(k) plan were made in

the form of employer stock. For nonmanagement employees, about

one-third of the Lucent’s workforce, the employer 401(k) match was in the

form of an ESOP contribution made in employer stock. It is not clear to

what extent participants were able to diversify their employer

contributions. With some 30 percent of the company’s 401(k) plan invested

in company stock, employee account balances declined when Lucent’s

stock price fell.

The collapse of Lucent’s stock sparked a class-action lawsuit by Lucent

employees whose 401(k) accounts suffered losses. The suit alleges that

Lucent breached its fiduciary duty for allegedly failing to inform

employees that investing in Lucent stock was imprudent. The lawsuit also

alleges that Lucent executives knew the company’s business was

deteriorating, but continued to encourage participants and beneficiaries to

make and maintain substantial investments in company stock. The case is

currently pending the in the courts. SEC had not taken any enforcement

actions as of August 1, 2002.

Lucent
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 38 GAO-02-943 Private Pensions

The federal securities laws regulate the securities markets, the companies

issuing securities, and market participants. The securities laws can relate

to employee benefit plans in several ways. The interests of employees in

the plan itself can be securities, or the plan may invest in instruments that

are securities, such as stocks, bonds or interests in mutual funds. Finally,

the plan may have investments in collective investment vehicles such as

interests in pooled investment funds, bank common and collective trust

funds, or insurance company pooled separate accounts.

In most cases, participation interests in pension and profit-sharing plans1

are not required to register under the Securities Act of 1933 (1933 act).

Registration is not required unless participation in the plan is voluntary

and employee contributions can be used to purchase employer securities.

Thus where a plan includes a 401(k) arrangement and employees can

choose to invest in employer securities through voluntary salary

reductions or deferrals, participation interests will be securities. Pension

and profit-sharing plans that are required to register are permitted by SEC

to use an abbreviated registration form and may use various documents,

including a Summary Plan Description2

 as the prospectus deliverable to

employees.

The company securities offered to employees through such a voluntary

and contributory employee benefit plan must be registered under the 1933

act, unless an exemption is available. These offerings qualify for an

abbreviated registration statement. Interests of plans in collective

investment vehicles are also securities, but may be exempt from

registration.

 1

“Pension” and “profit sharing” plans are generally qualified under §401(a) of the Internal

Revenue Code, and receive favorable tax treatment. Qualified plans must satisfy coverage,

participation, vesting, and benefit accrual standards that are intended to ensure that plans

are established for the exclusive benefit of employees and prevent discrimination in favor

of highly compensated individuals. A pension plan is established and maintained by an

employer primarily to provide systematically for the payment of definitely determinable

benefits to its employees over a period of years, usually for life, after retirement. 26 C.F.R.

§1.401-1(b)(1)(i). A profit-sharing plan is a plan established by an employer to provide for

participation in profits by employees pursuant to a definite formula for allocating the

contributions and distributing accumulated funds. 26 C.F.R. §1.401-1(b)(1)(ii). A profitsharing plan is a defined contribution plan because the employer’s contribution is set at a

percentage of profits.

2

29 U.S.C. §1021(a) requires the administrator of an ERISA plan to furnish each plan

participant a summary plan description.

Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 39 GAO-02-943 Private Pensions

The 1933 act requires the registration with the Securities and Exchange

Commission (SEC) of all offers and sales of securities, unless an

exemption from registration is available. The registration regime is based

on the premise that investors are protected if all relevant features of the

securities being offered are fully and fairly disclosed. Full disclosure is

believed to provide investors with sufficient opportunity to evaluate the

merits of an investment. A registration statement that meets the 1933 act’s

disclosure requirements must be filed, unless one of the exemptions under

section 3 or 4 of the 1933 act is available. The 1933 act also prohibits the

use of fraud or misrepresentation in the offer or sale of a security, whether

or not registration is required.

Section 2(a)(1) of the 1933 act contains a broad definition of security,

which includes any note, stock, treasury stock, bond, debenture, evidence

of indebtedness, certificate of interest, or participation interest in an

investment contract.3

The Securities Exchange Act of 1934 (Exchange Act) also imposes

registration and reporting requirements upon issuers of certain securities.

These requirements keep shareholders and markets informed about the

issuer. Section 12(a) of the Exchange Act requires that all securities traded

on a national exchange be registered with the SEC.4

 The Exchange Act

also requires an issuer to register if it has a class of equity securities held

by more than 500 shareholders of record and more than $10 million in total

assets.5

 An issuer with a class of registered securities must file periodic

reports, including quarterly and annual reports.

 3

17 U.S.C. § 77b(a)(1).

4

15 U.S.C. § 78l(a).

5

15 U.S.C. §78l(g)(1); 17 C.F.R. §240.12g-1.

Registration

Requirements Under

the Securities Act and

the Exchange Act
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 40 GAO-02-943 Private Pensions

With respect to the definition of security, the Supreme Court in SEC v.

W.J. Howey Co. determined that “an investment contract for the purposes

of the 1933 act means a contract, transaction or scheme whereby a person

(1) invests his money (2) in a common enterprise and (3) is led to expect

profits (4) solely from the efforts of a promoter or a third party.”6

In International Brotherhood of Teamsters v. Daniel,

7

 the Supreme Court

found that an interest in a compulsory (all employees automatically

participate), noncontributory (the employer makes all the contributions)

defined benefit employee pension plan is not a security under the 1933

act’s definition. In determining that the interest in the plan did not meet

the commonly understood definition of an investment contract, the Court

focused on the factors set out in the Howey test. First, the Court found

that an employee who participates in a noncontributory, compulsory

pension plan makes no payment into the pension plan, and the employer’s

payments into the plan do not relate to the individual benefit received by

employees. Therefore, the investment portion of the Howey test is not

satisfied in the case of a defined benefit plan. In addition, the Court found

that because a major part of the retirement benefits were to be derived

from the employer’s contributions, rather than from the efforts of the

plan’s managers in investing the income, the plan did not have sufficient

profit aspects to fall within the test for an investment contract in Howey.

The Court also pointed out that the fact that ERISA comprehensively

governs the use and terms of employee pension plans severely undercuts

all arguments for extending the securities laws to noncontributory,

compulsory pension plans. The Court explained that ERISA regulates the

substantive terms of pension plans, setting standards for plan funding and

limits on the eligibility requirements an employee must meet as well

requirements for disclosure of specified information in a specified manner.

 6

328 U.S. 293, 298-99 (1946).

7

439 U.S. 551(1979).

The U.S. Supreme Court

Has Determined That an

Employee’s Interest in an

Involuntary,

Noncontributory

Retirement Plan Is Not a

Security
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 41 GAO-02-943 Private Pensions

In 1941, the SEC first stated its view that employee interests in pension

and profit sharing plans generally are securities, but did not require

registration of interests in the plans unless the plan provided for purchase

of the employer’s stock.8

 In SEC’s view, the burden of preparing a

registration statement in connection with a pension plan could result in

many employers not sponsoring pension plans. However, a registration

requirement is justified if employer stock can be purchased, because the

employer has a direct financial interest in the solicitation of employees’

contributions. This conclusion was based on the view that where employer

stock is among the investment options, “it is not unfair to make the

employer assume the same burdens which corporations typically assume

when they go to the public for financing.” According to the Supreme

Court’s opinion in the Daniel case, after 1941, SEC made no further efforts

to register plan securities other than voluntary, contributory plans where

the employees’ contributions were invested in the employer’s securities.

Subsequent to the Daniel decision, the SEC issued two major interpretive

releases,9

 the first of which set forth views on when a participation interest

in a pension plan is an investment contract and thus a security. Release

No. 6188, dated February 1, 1980, reiterated the SEC’s view that, while

employee interests in pension plans generally are securities, employee

interests should be registered only when the plan is both voluntary and

contributory and may invest in stock of the employer an amount greater

than that paid into the plan by the employer. The release defines a

“voluntary” plan as one in which employees may elect whether or not to

participate, and a “contributory” plan as one in which employees make

direct payments, usually in the form of cash or payroll deductions.

This administrative practice is based on the SEC’s opinion that

(1) registration serves no purpose where a plan is involuntary, since in that

situation the participant is not permitted to make an investment decision,

and (2) the costs of registration are a significant burden to an employer

and should be imposed only where the employer has a direct financial

interest in soliciting voluntary employee contributions.

 8

Opinion of Assistant General Counsel, CCH Fed. Sec. L. Rep. [1941-1944 Transfer Binder],

para. 75,195.

9

An interpretive release sets forth the views of the SEC or its staff on questions of current

concern, without stating them in the form of legal requirements. They are general public

statements of policy.

SEC’s Position That

Interests in Voluntary

Contributory Plans Are

Securities and Must Be

Registered if Employee

Funds Can Be Used to

Purchase Employer Stock

Is Reiterated in

Interpretive Releases
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 42 GAO-02-943 Private Pensions

The 1980 release found that voluntary, contributory plans where an

employee is permitted to invest in employer securities met the four parts

of the Howey test defining an investment contract. First, the payment of

cash or its equivalent by an employee satisfies the “investment”

requirement. Second, the “common enterprise” requirement is met where

the interests of employees in the plan are “separable” and possess

“substantially the characteristics of a security.” In both defined

contribution and defined benefit plans, there is a separate account

maintained for each participant to the extent of each person’s contribution

to the plan. Third, the “expectation of profits” requirement is met when the

employee voluntarily contributes his or her own funds to the plan and can

expect that the funds will generate profits through the efforts of the plan

managers. In the Daniel case, the Court suggested that unless a defined

benefit plan has a substantial dependence on earnings, as well as vesting

requirements that are not excessively difficult to satisfy, there might be no

expectation of profits. The 1980 release stated, however, that a voluntary,

contributory defined benefit plan could meet the expectation of profits

test because it may depend on earnings to pay promised benefits and

because the vesting requirements under ERISA are much less strict than

the requirement that was present in the Daniel case. Finally, the 1980

release stated that the “from the efforts of others” test was easily satisfied

because the earnings generated by a plan would result from the efforts of

the plan managers.

SEC’s analysis concluded that the interests of employees in voluntary,

contributory pension plans are securities within the meaning of the 1933

act. The staff also concluded that the interests are offered and sold to

employees within the meaning of the 1933 act. Consequently, the interests

are subject to registration requirements unless one of the exemptions from

registration applies. Antifraud laws apply to all sales of securities.

Section 3 of the 1933 act exempts various types of securities from the

registration requirements, generally based on the nature of the issuer and

the terms of the security. The statutory exemptions apply to the 1933 act’s

registration requirements, but do not apply to prevent potential liability

under the antifraud provisions.

Section 3(a)(2) of the 1933 act exempts collective funding vehicles

maintained by banks and insurance companies for employee benefit plans

Most Types of Pension

Plans Are Exempt from

Registration under Section

3(a)(2) of the 1933 Act
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 43 GAO-02-943 Private Pensions

and the interests of employees in qualified plans, unless any employee

funds can be used to purchase employer securities.10 In addition, if the

plan does not restrict the plan’s overall investment in employer securities

so that it cannot exceed the employer’s contribution, the exemption is not

available, and the interests offered by the plan must be registered.11 Under

the SEC’s analysis, registration will generally be required in connection

with any plan that permits contributions from participants and permits all

or any portion of these contributions to be applied to the purchase of

employer stock. The SEC’s view that the 3(a)(2) exemption extends to

pension plans is based on its reading of the legislative history of the

provisions and its view that the section should be given a broad

interpretation so as to exempt most plans.

On January 15, 1981, the SEC issued Release No. 33-6281, an interpretive

release providing further guidance on the application of the 1933 act to

employee benefit plans. In the 1981 release, the staff expanded on the

definition of a voluntary, contributory plan, explaining that the

determination of whether a plan is voluntary and contributory depends

solely on whether participating employees can decide at some point

whether or not to contribute their own funds to the plan. The release also

discussed the amendments to the section 3(a)(2) exemptions made by the

Small Business Investment Incentive Act of 1980. The 1980 amendments

broadened the scope of the exemption by including certain insurance

contracts and governmental plans within its coverage. In addition, the

amendments make clear that any security arising out of a contract with an

insurance company will be exempt under section 3(a)(2) in connection

with a plan specified in the section.

In the 1981 release, the staff also discussed cash or deferred arrangements

qualifying under section 401(k) of the Internal Revenue Code.

Arrangements considered in the 1981 release allowed employees to elect

to receive immediate payment of the employer’s plan contribution or to

defer receipt and have it invested in a plan where it will accumulate for

 10In the Daniel decision, the Supreme Court read the 3(a)(2) exemption to refer only to the

plan’s interest in the investment vehicle. SEC’s view that the exemption also applies to

interests of participants in the plans themselves is based on its reading of the exemption’s

legislative history and the practical consideration that many plans would have no

exemption without a broad interpretation.

11Comdial Corporation, SEC No-Action Letter, available May 28, 1984. A “no action letter” is

an SEC staff response to private requests for an indication that certain contemplated

transactions will not trigger SEC enforcement action.
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 44 GAO-02-943 Private Pensions

later repayment. The staff determined that these arrangements are not

contributory on the part of employees because they did not involve

out-of-pocket investments by employees of their own funds in employer

stock. Instead, the plans are funded by employer contribution.

However, subsequent to the 1981 release, the Treasury Department issued

rules12 under section 401(k) that allowed plans to provide for pre-tax

employee contributions through salary reduction. In a salary reduction

plan, the employee elects to reduce his compensation and have the

amount contributed to a plan. This type of salary reduction is considered

to be an out-of-pocket contribution into the plan. Because such a plan is

voluntary and contributory, plan interests would be securities.

Registration of 401(k) plan interests in a salary reduction plan would be

required if employee contributions are permitted to be invested in

employer stock.13

Other Securities Act exemptions may apply to offers and sales of employer

securities. In 1988, SEC adopted Rule 701 to exempt from 1933 act

registration employee plans of employers that are not subject to the

Exchange Act’s periodic reporting requirements. Rule 701 is available to a

number of types of employee benefit plans.14 During a 12-month period, an

offering may be exempt for an amount up to the greatest of $1 million,

15 percent of the total assets of the issuer, or 15 percent of the outstanding

amount of the class of securities being offered and sold in reliance on

section 701. Securities acquired under a Rule 701 offering are treated as

restricted securities and may not be resold unless the 1933 act’s

registration requirements are complied with or unless another exemption

applies.

 12Certain Cash or Deferred Arrangements Under Employee Plans, 46 F.R. 55544, (Nov.10,

1981). A 401(k) feature can be appended to a qualified plan. The Treasury regulations refer

to 401(k) features as “qualified cash or deferred arrangements.” The cash or deferred

arrangement can be in the form of a salary reduction agreement between an employee and

the employer under which a contribution will be made only if the employee elects to

reduce his compensation or to forgo an increase in his compensation. 26 C.F.R. 1.401

(k)-1(a)(3)(i).

13Diasonics, Inc., SEC No-Action Letter, available December 29, 1982.

1417 C.F.R. §230.701. The Rule 701 exemption applies to purchase plans, option plans,

bonus plans, stock appreciation rights, profit sharing, thrift, incentive, or similar plans.

Other Exemptions from

Securities Act Registration
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 45 GAO-02-943 Private Pensions

Private and limited offerings also are exempt whether or not the company

is subject to Exchange Act reporting. Under Section 3(b) of the 1933 act15

SEC may adopt regulations exempting issuers in the amount of $5 million

or less. Under section 3(a)(11), “intrastate” offerings are exempt from

registration where all aspects of the offering are within the confines of one

state and are purely local in nature.16

Section 4(2)17 exempts transactions by an issuer not involving any public

offering. This exemption applies to offerings to sophisticated institutional

and individual investors who do not need the protections of federal

registration. In SEC v. Ralston Purina Co.,

18 the Supreme Court

determined that an offering to employees was not necessarily exempt as

not involving a public offering. Ralston Purina made its stock available to

all employees regardless of their connection with the company or

knowledge of the business. Citing the design of the 1933 act to protect

investors by promoting full disclosure of information necessary to

informed investment decisions, the Court found that the employees were a

class of persons that needed the protection offered by registration because

they were not able to fend for themselves in connection with the

transaction.

An ESOP is a defined contribution plan that invests primarily in employer

securities and usually distributes the securities upon the employee’s

retirement. Under SEC’s analysis, an employee’s interest in a voluntary,

contributory ESOP is a security. In Uselton v. Commercial Lovelace Motor

Freight19 the Tenth Circuit held that an interest in a contributory and

voluntary employee stock ownership plan was a security and that ERISA

did not provide sufficient protection to displace the application of the

federal securities laws. However, an interest in a mandatory stock

 1515 U.S.C. §77c(b).

1615 U.S.C. §77c(a)(11).

1715 U.S.C. §77d(2).

18346 U.S. 119 (1953). In more recent cases, the ability to fend for oneself has been

interpreted to mean that the persons to whom the securities are offered must be

“sufficiently sophisticated to demand and understand the information that is available to

them.” Thomas Lee Hazen, 1 Treatise on the Law of Securities Regulation 406 (4th ed.

2002).

19940 F. 2d 564 (10th Cir. 1991).

Registration Requirements

That Apply to ESOPs
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 46 GAO-02-943 Private Pensions

ownership plan completely funded by the employer was held not to be a

security in Matassarin v. Lynch.

20

In May 1992, the SEC’s Division of Investment Management issued a study

entitled, “Protecting Investors: A Half Century of Investment Company

Regulation.” The study proposed that all pooled investment vehicles for

participant-directed defined contribution plans be required to deliver

prospectuses for the underlying investment vehicles to plan participants.

The study reviewed the legislative history of the 1970 amendments to

Section 3(a)(2) of the 1933 act and found that the basis for the exemption

was concerns expressed by both the banking and insurance industries that

the lack of a clear exemption under the securities laws for pooled

investment vehicles might expose banks and insurance companies to civil

liabilities. Congress exempted these pooled investment vehicles, in part,

because they were subject to oversight by bank and insurance regulators.

The interests issued by the pooled investment vehicles in question were

still subject to the anti-fraud provisions of the 1933 act, notwithstanding

the amendments. In addition, Congress assumed that the person making

investment decisions for a plan (the sponsoring employer or a professional

investment manager) was a sophisticated investor able to fend for itself

with the application of only the 1933 act’s antifraud provisions. The study

highlighted, however, that since the passage of the 1970 amendments, the

character of employee benefit plans has shifted from defined benefit plans,

in which the plan sponsor bears the investment risk, to participantdirected defined contribution plans, in which the plan participant bears

the investment risk.

Finding that the information received by plan participants was far less

than the information received by investors who invest directly in securities

issued by investment companies and other issuers, the Division of

Investment Management expressed its view that disclosure to these plan

participants should be improved. It recommended that the SEC send to

Congress legislation that would: (i) remove the current exemption from

registration in Section 3(a)(2) for interests in pooled investment vehicles

consisting of assets of participant-directed defined contribution plans; and

(ii) require delivery of the prospectuses and other disclosure documents of

the pooled investment vehicles (other than mutual funds) to all plan

participants.

 20174 F. 3d 549 (5th Cir. 1999).

A 1992 Study Recommends

Disclosure to Plan

Participants Who Make

Their Own Investments in

Pension Plans
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 47 GAO-02-943 Private Pensions

Subsequent to the issuance of the study, the DOL issued voluntary rules

under Section 404(c) of ERISA that provide plan fiduciaries with a safe

harbor from liability under certain conditions when plan participants

exercise control over the assets in their individual accounts. One of the

rule’s specific guidelines allowing fiduciaries of participant-directed plans

potentially to avoid fiduciary liability is that plan participants who invest

in securities that are subject to the 1933 act receive at or about the time of

a participant’s initial investment in the securities a copy of the issuer’s

most recent prospectus.21 In general, the guidelines obligate the plan

sponsor to provide or make available to plan participants sufficient

information so that they may make informed investment decisions. While

the disclosures required by the 404(c) rules generally make more

information available to plan participants by encouraging plan sponsors to

provide or make available more information about the underlying

investment options offered by the plan, the view of the Division of

Investment Management is that plan participants have a continuing need

for information in order to evaluate their investments, and decide whether

to maintain or reallocate those investments. Accordingly, the approach of

the Division of Investment Management would go farther by requiring

delivery to plan participants of a current mutual fund prospectus on a

continuing basis as well as delivery of annual and semi-annual shareholder

reports by mutual funds and other underlying investment vehicles.22

If Securities Act registration of employee’s interests in an employee

benefit plan is required, then Form S-8 is generally the appropriate form

for use. Form S-8 is also used for registering employer securities issued in

connection with employee benefit plans. Form S-8 is available only if the

employer is subject to the Exchange Act reporting requirements. Form S-8

utilizes an abbreviated disclosure format that reflects the SEC’s distinction

between offerings made to employees primarily for compensatory and

incentive purposes and offerings made by registrants for capital-raising

purposes. The SEC has exercised its rule-making authority to reduce the

 21Final Regulations Regarding Participant Directed Individual Account Plans (ERISA

Section 404(c) Plans) 29 C.F.R. §2550.404c-1.

22Mutual funds must send semiannual reports to their shareholders. These reports are

required to include information concerning the investments’ aggregate value, a listing of

amounts and values of securities owned; an itemized income statement; a statement of the

remuneration paid to all directors and members of an advisory board. In addition, SEC

applies certain requirements to the mutual fund prospectus, including a requirement that

mutual funds provide shareholders with after-tax performance information.

Interests in Employee

Benefit Plans That Are

Securities May Be

Registered Using Form S-8
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 48 GAO-02-943 Private Pensions

costs and burdens incident to registration of employee benefit plan

securities.

The SEC substantially revised Form S-8 in 1990.23 The revisions included

making the registration statements effective automatically upon filing.24 A

prospectus is customarily part of a registration statement, and contains

the basic business and financial information about the issuer with respect

to a particular securities offering. Investors use the prospectus to appraise

the merits of the offering and make educated investment decisions.

However, Form S-8 is the only registration form that does not require the

registrant to prepare and file with the SEC a separate document to satisfy

the prospectus delivery requirements under the federal securities laws.

Instead, Form S-8 requires only that certain specified current plan

information be delivered to employees in a timely fashion. No particular

legal format is specified. The information could be provided in one or

more documents prepared in the ordinary course of employee

communications. Registrants can deliver materials required to be prepared

for plan participants by ERISA and could deliver the Summary Plan

Description as a basic disclosure document.25 The issuer must also supply

participants with a written statement that certain documents are

incorporated by reference into the prospectus, and advise the participant

of their availability on request. These documents include the Exchange Act

filings containing issuer information and financial statements.

At the same time, the SEC also permitted 1933 act registration of an

indeterminate amount of plan interests; simplified the calculation of filing

fees; and amended Form 11-K, the Exchange Act annual report for

employee benefit plans, to require only plan financial statements.

 23See Release No. 33-6867 (July 13, 1990).

24A registration statement is generally effective twenty days after the later of the filing of

the initial registration statement or the most recent amendment to the registration

statement.

25Release No. 33-6281, pt. IV (C) outlines staff interpretive positions regarding the

incorporation by reference in a Form S-8 prospectus of plan information contained in an

ERISA summary plan description.
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 49 GAO-02-943 Private Pensions

Section 12(g) of the Exchange Act26 requires that registration statements

be filed by issuers that have both a class of equity securities having more

than 500 shareholders of record and more than $10 million in total assets.

Companies must register their stock and satisfy all reporting requirements

of the Exchange Act if these criteria are met. For purposes of determining

the number of record holders of a class of securities, an employee benefit

plan holding employer securities is counted as only one record holder.27 If

the employer’s securities must be registered under the Exchange Act, the

employer will incur periodic reporting obligations, including annual and

quarterly reports, as well as filings reporting certain specified material

changes in the issuer’s condition or operations.

If the interests of the plan participants are considered securities, the plan

may be subject to registration under the Exchange Act. However, interests

in qualified plans are exempt from registration under the Exchange Act

because Rule 12h-1 exempts from registration all interests in employee

stock bonus, stock purchase, pension, profit sharing, retirement, incentive,

or similar plans that are not transferable by the employee.

Employee plans that are owners of securities that are registered under the

Exchange Act may be subject to different Exchange Act reporting

requirements. A plan that becomes the beneficial owner of more than

5 percent of a class of equity securities registered under the Exchange Act

must file a report with the SEC on Schedule 13G.28 When a plan acquires

stock for the benefit of officers and directors of an employer, the officers

and directors are required to follow the Section 16 reporting requirements.

Transactions of these company insiders may be subject to the short swing

profit recovery rules if the insider switches into or out of an employer

stock fund or takes a cash distribution from the fund in a “discretionary

 2615 U.S.C. §78l(g).

27Rule 12g5-1(a)(2). Of course, the number of beneficial owners (plan participants) will be

far more numerous.

28The reporting requirement is intended to notify SEC of a potential change in control,

however, because employee plans are not the beneficial owners of securities, they may

qualify for an abbreviated reporting requirement. Rule 13d-1(b)(1)(ii)(F) permits employee

benefit plans subject to the provisions of ERISA to file the short-form 13G if the securities

are acquired in the ordinary course of business and not with the purpose or effect of

changing the control of the issuer. Beneficial ownership is defined as the power to vote

and/or exercise investment power over the security. 17 C.F.R. §240.13d-3. Defined

contribution plans generally pass through voting rights.

Registration and

Reporting

Requirements Under

the Securities

Exchange Act
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 50 GAO-02-943 Private Pensions

transaction” if the transaction occurs less than 6 months after any

previous “opposite way” transaction.29

Section 10(b) of the Exchange Act30 prohibits the use of any manipulative

or deceptive practices in connection with the purchase or sale of a

security. Rule 10b-531 makes it unlawful for any person to make a material

misstatement or omission in connection with the purchase or sale of a

security. Section 10(b) and Rule 10b-5 will apply to material

misrepresentations and omissions made to plan participants in connection

with plan transactions that involve securities. Violations of Rule 10b-5 can

be asserted by plan participants if the plan is making material

misstatements or omissions in the materials the plan provides to

participants in connection with a sale of company stock to plan

participants. Rule 10b-5 can also apply to the purchase or sale of a security

on the basis of material nonpublic information about that security in

breach of a duty of trust or confidence.32 This could apply where an officer

or director buys or sells shares through a plan and was aware of material

non-public information when the transaction took place.

Section 17(a) of the 1933 act33 prohibits fraud, material misstatements and

omissions of fact in connection with the sale of securities. Section 17(a)

applies whether the sale is registered or exempted from the 1933 act

registration. Neither section 17(a) nor Exchange Act Rule 10b-5 imposes

an affirmative duty to disclose, but can impose liability for omissions that

make statements materially misleading.

 29Section 16(b) of the Exchange Act requires insiders to disgorge to the company any profit

realized from a short swing transaction. A discretionary transaction is generally at the

volition of the participant.

3015 U.S.C. §78j(b).

3117 C.F.R. §240.10b-5.

32Rule 10b5-1 defines “on the basis of” to mean the person making the purchase or sale was

aware of the material nonpublic information when the person made the purchase or sale.

However, Rule 10b5-1(c ) establishes conditions whereby a person’s purchase or sale is not

“on the basis of” material non-public information if another person is instructed to make

the purchase or sale for the instructing person’s account and at the time of the original

instruction the instructor was not aware of the material nonpublic information. This could

include a situation where a person enrolls in a plan and agrees to have a payroll deduction

invested in employer securities.

3315 U.S.C. §77q(a).

Anti-fraud Rules

Applicable to Employee

Benefit Plans
Appendix III: SEC’s Application of the

Securities Laws to Retirement Plans

Page 51 GAO-02-943 Private Pensions

Historically, SEC has taken the position that interests in employee benefit

plans can be securities for purposes of the 1933 act requirements to

register offers and sales of securities. However, SEC has taken the view

that offers and sales of plan interests are not subject to registration unless

the plan allows employee funds to be used to purchase employer stock. In

1979, the U.S. Supreme Court decided that interests in plans where

employees had no choice concerning participation and where employees

did not make contributions to the plan were not securities and did not

have to be registered. In the wake of the Supreme Court’s decision, SEC

issued two releases indicating that only voluntary, contributory plans

where employee funds could be invested in employer stock would be

required to file registration statements.

SEC’s position is based, in part, on its interpretation of the registration

exemptions contained in section 3(a)(2) of the 1933 act. In SEC’s view, in

light of the Daniel opinion, the 3(a)(2) exemption applies to all qualified

employee plans, except those that allow the use of employee funds to

purchase employer stock. While SEC’s 1980 release indicated that it did

not favor a broader registration requirement, this release was issued when

the prevalent plan was a defined benefit plan. SEC has not reconsidered its

position as expressed in this 1980 release and believes it is bound by the

Supreme Court’s decision in Daniel.

Conclusion
Appendix IV: Comments from the Department

of Labor

Page 52 GAO-02-943 Private Pensions

Appendix IV: Comments from the

Department of Labor
Appendix IV: Comments from the Department

of Labor

Page 53 GAO-02-943 Private Pensions (130114)
The General Accounting Office, the investigative arm of Congress, exists to

support Congress in meeting its constitutional responsibilities and to help

improve the performance and accountability of the federal government for the

American people. GAO examines the use of public funds; evaluates federal

programs and policies; and provides analyses, recommendations, and other

assistance to help Congress make informed oversight, policy, and funding

decisions. GAO’s commitment to good government is reflected in its core values

of accountability, integrity, and reliability.

The fastest and easiest way to obtain copies of GAO documents at no cost is

through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and fulltext files of current reports and testimony and an expanding archive of older

products. The Web site features a search engine to help you locate documents

using key words and phrases. You can print these documents in their entirety,

including charts and other graphics.

Each day, GAO issues a list of newly released reports, testimony, and

correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site

daily. The list contains links to the full-text document files. To have GAO e-mail

this list to you every afternoon, go to www.gao.gov and select “Subscribe to daily

E-mail alert for newly released products” under the GAO Reports heading.

The first copy of each printed report is free. Additional copies are $2 each. A

check or money order should be made out to the Superintendent of Documents.

GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a

single address are discounted 25 percent. Orders should be sent to:

U.S. General Accounting Office

441 G Street NW, Room LM

Washington, D.C. 20548

To order by Phone: Voice: (202) 512-6000

TDD: (202) 512-2537

Fax: (202) 512-6061

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm

E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800

U.S. General Accounting Office, 441 G Street NW, Room 7149

Washington, D.C. 20548

GAO’s Mission

Obtaining Copies of

GAO Reports and

Testimony

Order by Mail or Phone

To Report Fraud,

Waste, and Abuse in

Federal Programs

Public Affairs