the day after enron

Download The day after Enron

Post on 15-Jun-2016




0 download

Embed Size (px)


  • Currents: Legal Developments




    2002 Wiley Periodicals, Inc. Published online in Wiley InterScience ( DOI: 10.1002/npr.10035


    Thomas J. Knapp, Esq.

    Thomas J. Knapp, Esq., is an attorney with Paul, Hastings, Janofsky & Walker, LLP, in Washington, D.C., specializing in labor and employ-ment law.

    * * *



    In a recent lawsuit, the plaintiffs attorney litteredhis complaint with the word Enron, which he usedas an adjective to describe various activities al-legedly perpetuated by my client. In a union ne-gotiation meeting, my client was accused of beingEnron-like. After calming down the clients, Iexplained that now any time there is a perceptionof financial slight of hand, mistreatment of em-ployees, less-than-projected earnings, or any per-mutation to a real or imagined problem at acompany, the term Enron will be used to gainleverage or an advantage over an employer.

    This may be a passing fad. But a broader is-sue remains: What will the Enron experience teachemployees and employers?


    Darling of Wall Street, energy market-maker, high-flying business model, and employer of thousandsin the United States and abroad, Enron sent shockwaves throughout the globe by declaring bank-ruptcy. It was forced to do so after a restatementof its earnings reduced previously reported earn-

    ings to the tune of hundreds of millions of dollars.This reduction stemmed from off-the-book part-nerships that had accumulated massive debt. Oncethe debt was moved to the parents financial state-ments, the earnings tumbled.

    As a result of the restatement of earnings,Enrons stock price plummeted. The value of thecompany evaporated before the eyes of the em-ployees and other investors who held Enron stock.For many, selling Enron stock at a few dollars oreven cents meant more than losing their gambleon a hot stock; it meant losing a great deal of theirretirement savings.

    To make matters worse, thousands of employ-ees lost their jobs with little or no severance pay,and learned that senior managers had sold theirEnron stock for tremendous gains, thus walkingaway from the disaster in relatively good shape.In most cases, those same executives had employ-ment contracts that provided for severance ben-efits in the event they left the company.

    In the aftermath of the scandal, there has beena great hue and cry, lawsuits have been filed, gov-ernmental investigations have been started, and leg-


    74 Thomas J. Knapp, Esq.

    islative reforms are being debated. So what are thehuman resources lessons to be learned from Enron?

    The efforts of management and HR profes-sionals to foster open communications, trustingrelationships, and company loyalty in the late1990s may suffer a setback as a result of Enron.Building those relationships, developing bettercommunications, and providing more current andreliable information are some of the overarchinglessons to be learned. The areas of most concernare employee benefits and retirement plans.


    It has been reported, both in the press and inthe lawsuits filed to date, that Enron funded theemployer match of its 401(k) plan with Enronstock. How does that work? Under a typical401(k) plan, employees elect to have a certainpercentage of their salary contributed to theplan. The employer may match with cash orstock up to certain percentages of the employeescontribution. The employers match may be sub-ject to a vesting schedule before it becomesnonforfeitable like the employees contribution.The plans are required to have a diversified setof funds, one of which may be a company stockfund. When the employer matches with com-pany stock, that contribution goes into the com-pany stock fund. Here, Enron annually matchedemployees contributions with Enron stock. Thatstock was placed in the company stock fund, oneof many funds available to employees in thecompanys 401(k) plan.

    It has also been reported that there were re-strictions on employees ability to liquidate thestock and move the money into one or more of theother funds. Employers typically require a certainamount of service with the company before theemployer match can be used by the employee. Thisencourages employees to stay with the company.It also locks the employer match into one invest-ment, for good or for bad.

    Also, it has been reported that at the same timethat Enron was announcing that it would be restat-ing its earnings, it was changing its recordkeeperand instituted a lockdown period of 30 days. Alockdown is a period of time during which employ-ees cannot select or transfer funds in their 401(k)

    plan. This allows the orderly transfer of records fromthe former recordkeeper to the new one.

    Many companies like Enron also offer an em-ployee stock purchase plan as a benefit to employ-ees. Through payroll deduction, employees canpurchase limited amounts of company stock for aprice up to 15 percent below market value with-out paying income tax on the discounted amount.Any purchases through these plans will commonlybe constrained on when and how the employee cansell the shares.


    In a nutshell, the two major lessons learned fromthe Enron collapse are that employees should di-versify and employers should provide protections.

    The records show that 62 percent of Enronemployees held Enron stock: 89 percent of themacquired the stock through the employee stockpurchase plan and 11 percent of the employeesreceived the stock through the employer match ofthe 401(k) plan. Though all companies encourageemployees full participation in 401(k) plans andemployee stock purchase plans, they also com-monly advise employees to protect themselvesfrom market swings in their company stock orother investments by diversifying their holdings.

    Employers typically provide general informa-tion about investment funds offered in 401(k) plansbut stay away from specific investment advice forliability reasons. If employees had heeded the ad-vice of most investment advisersdiversify, di-versify, diversifytheir losses would not havebeen as great as what has been reported. A lessonfor employers in this regard is the value of limit-ing the percentage of employee ownership of com-pany stock through both 401(k) plans andemployee stock purchase plans. Recently, Federal-Mogul Corporation announced that it would nolonger make the employer match in stock becauseof the volatility of the companys stock in light ofasbestos liability claims.

    Compounding the problem for Enron employ-ees who were fully invested in company stock werefour other factors:

    1. Restatement of company earningsTherestatement of Enrons earnings will involve manyinvestigations and hearings before what exactly

  • Currents: Legal Developments



    happened becomes clear. It is difficult for employ-ees to be cognizant of everything going on at thecompany they work for. In this case, Congress andthe regulatory authorities will address whetherthere was any wrongdoing and whether Enron se-nior executives are culpable. Once that is sortedout, employers will look to the results to deter-mine what lessons, if any, they need to heed.

    2. Upbeat statements by senior managementabout the financial health of the companySenior managers rosy projections of the finan-cial health of Enron may expose them to civil li-ability. Employees should be able to rely onstatements made by senior managers about thecompany. On the other hand, those senior execu-tives should not face liability unless they intendedemployees to rely, to their detriment, on thosestatements, and they knew those statements to beinaccurate when they made them.

    3. Sales of stock by senior managementThe disclosures of senior executives stock salesmake their statements about the economic pic-ture at Enron troublesome. The Securities Ex-change Act of 1934 requires that directors andofficers periodically report changes in their com-pany stock holdings. Certain sales or acquisitionsare required to be disclosed on Form 4 withinten days after the month in which they buy orsell their company stock in the open market. Ifthe executives buy or sell company stock fromthe company, such changes in ownership are tobe disclosed on Form 5, which must be filedwithin 45 days after the companys fiscal yearends. The swing in the disclosure could be manymonths. If an employee is checking on the offic-ers and directors and their commitment to thecompany, these disclosure periods may not bevery helpful. Here, the disclosure of stock salesby the very executives who were singing thepraises of the company are problematic.

    4. The lockdown period for the change ofrecordkeepersA lockdown period of longer

    than a few days can be detrimental to employees.On the other hand, there needs to be a period oftime that no funds are transferred by employees toallow for the orderly transfer of records from onerecordkeeper to another. In this case, the lockdownperiod reportedly ran from mid-October to mid-November, roughly 30 days. That appears to be along time for an employee to be handcuffed tofunds held before the lockdown. Many plans offerdaily fund transfer by telephone or website. Theexpectation of being able to move ones moneyfrom a bad investment to a better investment isencouraged by the daily fund transfer option. How-ever, it may encourage employees to invest for theshort term and not the long term, which is the ad-vice most 401(k) plan sponsors provide.

    Unfortunately, without a diversified portfolioto minimize