Bad as the investment advice of Kenneth Lay looks now, the former Enron CEO may have felt legally constrained from actually telling Enron 401(k) participants that the company’s share price was about to plummet.
According to some experts, even if Lay knew that the Houston-based company was in bad financial shape, he might have run afoul of insider-trading rules if he told plan participants — and not outside investors — about the troubles at the company. Indeed, no matter how much Lay might have wanted to warn plan members, he would have had “to treat his employees as he would treat any shareholder,” says Richard Drake, co-portfolio fund manager of ABN AMRO/Chicago Capital Growth Fund, which manages 401(k)s. Says Drake: “[He could] only tell them what he told the rest of world.” And it’s doubtful Lay or Enron management wanted to tell Wall Street about the company’s off-balance-sheet liabilities.
Hence, the former Enron CEO might have been caught between a rock and hard place: Don’t tell employees about Enron’s financial woes, and he breaches his fiduciary duty under the Employee Retirement Income Security Act (ERISA); tell employees alone, and he violates securities law.
As you recall, Lay reportedly told employees via E-mail last August that everything was just fine with the company’s stock. That was just a week or so after Enron vice president Sherron Watkins allegedly sent a letter to Lay questioning the company’s accounting practices. In that letter, Watkins said other employees were also expressing concern over the company’s bookkeeping maneuverings.
The day after Watkins’ claims to have sent the letter, Lay reportedly exercised options of 25,000 shares for a total value of $519,500. Did the chief executive cash out because he knew the company was on the verge of implosion? Lay’s lawyer says no, pointing out that the sale was used to repay a line of credit — and thus implied nothing bad or good about Enron.
If Lay did in fact know that Enron was in serious trouble, and he still boosted the company’s stock to employees, he could be prosecuted for having breached his fiduciary duties under ERISA. In such a case, Watkins’ memo “could be a smoking gun,” notes Linda Shore, a benefits attorney in Washington and adjunct law professor at Georgetown. Shore says Lay’s upbeat electronic message to plan members might prove that the CEO breached a fiduciary obligation by knowingly giving inaccurate advice to 401(k) plan participants. At the end of 2000, Enron stock accounted for 62 percent of the total assets in the energy company’s 401(k) plan.
To be sure, ERISA doesn’t compel company executives to provide advice to 401(k) participants. Still, fiduciaries of the plan had “an ongoing obligation to provide updated information” about the plan’s investments, says Shore, who represents employers for Silverstein and Mullens, a division of Buchanan Ingersoll. And if a plan fiduciary does give out information, it’s got to be truthful, the attorney says.