Committee on Ways and Means, Subcommittee on Oversight, 3-5-02 Testimony

Statement of Richard L. Trumka, Secretary-Treasurer,
American Federation of Labor-Congress of Industrial Organizations

Testimony Before the Subcommittee on Oversight
of the House Committee on Ways and Means

Hearing on Employee and Employer Views on Retirement Security

March 5, 2002

Good Afternoon, Chairman Houghton, Ranking Member Coyne, members of the Committee. My name is Richard Trumka, and I am the Secretary-Treasurer of the AFL-CIO. On behalf of the AFL-CIO and our unions’ 13 million members, I am grateful for the opportunity to express our views on the Enron debacle, its impact on Enron workers and the much broader implications it has for retirement security.

The Labor Movement’s Response to Enron’s Collapse

First, let me begin by briefly describing what the AFL-CIO has been doing since last fall in response to the collapse of Enron. In December, when the House Financial Services Committee held the first Congressional hearing on Enron, I testified before that Committee that Enron’s collapse was due to the combination of the actions of an unaccountable group of self-interested executives with the complete failure of all the structures that are supposed to protect investors and employees.
I said at that early date that Enron’s collapse showed how harmful the structural conflicts of interest in our capital markets and our pension system were to workers and investors.
Every revelation since December has only further highlighted the need for immediate and systematic reform.

Since then, the AFL-CIO has provided direct assistance to workers, including joining with laid-off Enron employees in seeking—and winning—severance payments. Long before Enron was a household word, the AFL-CIO and worker pension funds took steps to try to reform corporate governance and disclosure at the company, and then as the situation worsened to protect workers’ investments in the courts. As the fate of the company and the reasons for its demise became clear, we filed petitions with the SEC designed to ensure greater independence of auditors and of company boards. We have been taking the lead in demanding that members of the Enron board of directors not be renominated from the more than twenty companies where they continue to sit in positions of fiduciary responsibility. Finally, the AFL-CIO and union pension funds have been active in the corporate governance process seeking to ensure that boards of directors, company auditors and Wall Street analysts are independent.

The Devastating Effects on Workers

Today, you will be hearing from the very people who have been affected the most personally and painfully by the Enron debacle, Enron’s workers. Deborah Perrotta and Dary Ebright are two Enron workers who worked for different divisions of Enron’s far- flung corporate empire. Deborah and Dary have much in common, not only with each other but also with workers all across America who have been financially devastated when their companies collapsed and took their workers’ retirement security down with them.

Although shareholders at Enron, including millions of America’s working families and their pension funds, lost tens of billions of dollars, individual Enron workers have suffered the greatest damage. Thousands of them now find themselves with 401(k) retirement accounts worth just pennies on the dollar because their accounts were heavily invested in Enron stock. Workers who thought they had secure retirement investments valued at hundreds of thousands of dollars, or more than a million dollars in some cases, are heading toward retirement with just several thousand dollars in savings. Not only are their paper profits from inflated stock prices gone, but so too are their hard-earned wages that they contributed from each paycheck, thinking that by sacrificing today they were building a secure retirement for tomorrow.

Union members are among those Enron workers who were hit hard. As Bill Miller, Business Manager and Financial Secretary of IBEW Local 125 in Portland, Oregon, told the U.S. Senate Committee on Governmental Affairs in February, just eight of his members who work at Enron’s Portland General Electric subsidiary lost nearly $2.9 million. One of them was Tim Ramsey, a 57 year-old lineman with 35 years of service, who had to put off his plans to retire next year when he lost over $985,000 in his Enron 401(k). Many more of the more than 900 active employees and 550 retirees represented by Local 125 lost money by investing their hard-earned retirement savings in Enron.

Many of the non-union workers based at Enron’s Houston headquarters have been hit even harder. Thousands of those Enron workers have lost their jobs and along with their jobs they have lost their health insurance, dental insurance, and life insurance. On top of all that, many of them have seen their hard-earned retirement savings go up in smoke.

Digna Showers, an 18-year Enron employee who worked as an administrative assistant in the Logistics Department, was laid off last December 3^rd. Her family’s primary wage earner, she lost her savings in Enron stock, which at its peak was valued at more the $400,000, invested through her 401(k) and ESOP. Today, she is struggling to keep her family’s finances together and most importantly to pay for the medical care and medication that her husband, a disabled former schoolteacher, urgently needs.

Ms. Showers, like more than 5,000 laid off Enron workers, has not received the severance money she was promised because she was laid off the day after Enron declared bankruptcy. In contrast, Enron arranged to wire $55 million in “retention bonuses” to a handful of executives on the last business day before Enron filed for bankruptcy. The AFL-CIO is supporting the efforts of the laid off Enron workers to have their severance paid now. We have had to fight both the new management of Enron and the big banks on Enron’s Creditor Committee like JP Morgan Chase, Wells Fargo and CS First Boston.
These banks seem happy to pay hundreds of millions in gratuitous bonuses to a few executives but have a problem with paying to thousands of people merely what they are owed—people who as a result of their commitment to Enron find themselves in desperate need.

I should note that it is a scandal that our bankruptcy laws allow this sort of conduct by a debtor company.
The AFL-CIO supports changes in the bankruptcy laws that would protect workers and their benefit funds, while we oppose the current bankruptcy bill that essentially benefits those same banks that are trying to deprive Enron workers of their severance.

The speed with which the Enron workers’ retirement savings evaporated is shocking to everyone, but the fact that it happened at all should not be surprising. The same thing happened to workers at companies like Color Tile and Carter Hawley Hale in the 1990s because their retirement plans were heavily invested in company assets and is happening to other workers today at companies like Global Crossing and Lucent.

The harm Enron’s collapse has caused America’s working families by no means stops there. Workers’ retirement funds have lost tens of billions of dollars in the collapse of Enron. Earlier this year, Enron was the 7^th largest company in America measured by revenue. Enron’s equity at its peak was worth about $63 billion, and its bonds another $6 billion. There was almost twice as much money invested in Enron stock as there was in General Motors stock. Most pension funds and institutional investors held some Enron stock or bonds. If any person in this room has an S&P 500 index fund in your 401(k), Thrift Savings Plan account, or IRA, you lost retirement money in Enron—probably about a half a percent of your total assets in that fund. And this is if you invested in index funds—in a strategy designed to mitigate cheaply the risks of investing in any single company.

The Enron Debacle and Retirement Security

Enron is not simply a case of a single company gone bad: It is a broader story about risks and losses for workers who play by the rules. The Enron bankruptcy has exposed major vulnerabilities in working families’ retirement security. It has raised public questions about defined contribution retirement plans. And it has focused attention on the threat posed by proposals to privatize Social Security, which would trade in some or all of the system’s guaranteed benefits for individual accounts like those held by the workers at Enron.

The labor movement feels very strongly that retirement security is best financed by a three-layered pyramid. For most, at the base is Social Security. The guaranteed defined benefits of this family insurance program are the bricks and mortar on which retirement security is built for almost every American family. The next layer should be a defined benefit pension plan—plans that provide a guaranteed benefit financed by professionally managed funds, behind which stands the guarantee of either the Pension Benefit Guaranty Corporation and ultimately the United States Treasury, or the sponsoring state or local government. And the top layer is personal savings—most importantly in the form of tax-favored defined contribution benefit plans like 401(k)’s—savings that varies based on employees’ surplus income and that is at risk in the markets but that still needs to be managed based on sound investment practices and protected against employer manipulation.

The objective of having a diversified portfolio of retirement income sources is to make it reasonably certain that workers will be able to retire after a lifetime of hard work and to sustain in retirement the same standard of living they had during their working years. Workers need Social Security, a pension and retirement savings to achieve real retirement security.

Social Security

As we have said all along, real retirement security begins with a strong Social Security system that provides working families with guaranteed defined benefits. The Enron debacle has important implications for the debate over Social Security’s future and particularly for proposals to privatize Social Security by replacing all or part of its guaranteed defined benefits with private investment accounts.

First, Social Security’s guaranteed defined benefits become even more important if workers’ supplements to Social Security—their job-based retirement plans and personal savings—can simply evaporate in a matter of months. That this can happen—and that national retirement policy as embodied in ERISA and the Internal Revenue Code not only condones but encourages retirement plans in which this can happen—reemphasizes the importance of a secure foundation for retirement security. The risk to workers’ retirement savings is even more troubling when you consider that plans to privatize Social Security invariably result in large cuts in Social Security’s benefits—both guaranteed benefits and total benefits even after counting the new individual account plans.

The President’s Social Security privatization commission tried to fudge this issue by assuming that trillions of dollars would flow into the Social Security system from the rest of government to cover the huge transition costs required to fund the commission’s costly proposals. But the prospect for this happening is dubious given the rapid deterioration of the federal budget outlook for both the short and long terms during the Bush Administration. As a result, retirees, disabled workers and surviving spouses and children will face severe reductions in Social Security benefit amounts in the future. Also, part of their benefits will vary greatly depending on the performance of the financial markets.

Second, a privatized Social Security system will, sooner or later, allow workers to invest in individual stocks. Yes, privatization advocates have been quick to point out that their plans would limit workers’ investment choices to diversified investment options. Even if they are sincere about these claims, however, it is difficult to see how these assertions are grounded in reality. A representative of the Bush Administration, appearing before the full Ways and Means Committee just last month, declared that “[e]mployees who determine their own investment goals do not want a government to restrict the amount of their investment that can be invested in specific funds.”[1] If you believe this is true for private job-based retirement plans, then you must also believe that workers will feel just as strongly about privatized individual accounts that replace Social Security benefits. A privatized Social Security system eventually will become part of employers’ campaigns to use their employees’ retirement savings as a corporate finance tool—it will just be a matter of time.

Pensions and Savings

Social Security is the critical base for workers—nearly two-in-three older Americans count on it for half or more of their income—but it does not provide nearly enough to maintain working families’ pre-retirement standard of living.
Workers need something more. We believe that something must start with a real defined benefit pension and should be supplemented by defined contribution savings.

When workers have Social Security and a defined benefit pension plan, they can afford the risks involved in having a defined contribution supplement. But when workers have no defined benefit plan and only a defined contribution plan, they are at risk of a catastrophic loss. This is a risk most workers cannot bear, and which tragically tens of thousands at companies like Enron, Lucent, and Global Crossing have all experienced in the last several years.

Unfortunately, over the last twenty years, employers and policy makers have together worked to collapse the three layers of retirement security. As a result, many workers have to rely only on Social Security and their personal savings, savings that are fully at risk in the capital markets.

Defined benefit plans by their very nature require employer cash contributions. If a defined benefit fund has losses in its investment portfolio, employers must make up the shortfall. Naturally, employers have come to prefer 401(k) plans. In these plans, when there are market losses, the employee bears all the risk and has lower benefits.

Many employers are using worker retirement savings as a corporate finance tool. Employers can make their contributions to workers’ individual accounts entirely in company stock, a practice barred by ERISA’s 10 percent limit on employer securities for defined benefit plans. When employers make their contributions in stock, it is a cash-positive transaction for the company as there is no cash cost to the employer and the employer is able to take a tax deduction for the contribution. Furthermore, as the law stands now, employers can force workers to keep part of their accounts funded by employer contributions invested entirely in company stock.

When employers completely control the management of 401(k)’s and other defined contribution plans, they act on these perverse incentives to make workers’ retirement savings imprudently diversified. Employers combine their ability to make the employer match in company stock with workplace campaigns to pressure employees to place their own contributions in employer stock. Campaigns that we saw at Enron included pitches by senior officers through email and in person and the use of company newsletters to encourage workers to concentrate their retirement assets in company stock. Great for the bottom line of the company, but not so for the individual plan participant.

The Committee has heard today from a number of firms that are very pleased with their use of their own stock to finance worker benefits. I suppose one could say their testimony is proof of my point—employers love to put their employees’ money at risk in their stock. But it is important for this Committee to understand the different implications of different uses of employer stock. For example, the employer who provides no retirement plan other than one funded by employer stock is simply not acting in their employees’ interest. They are asking their employees to stake their well being in retirement on only one stock – it’s akin to putting all your money on a single hand in a card game.

But an ESOP or other employee stock plan makes sense as a supplement to a defined benefit plan and a properly diversified defined contribution plan, or as a medium term investment. Union sponsored ESOPs typically have this structure – they are supplements to defined benefit plans whose objectives are job preservation, worker voice, and medium term investment returns. This type of ESOP can have the positive attributes the employer witnesses here have discussed while workers’ retirement security remains in the hands of properly diversified plans. As I will discuss further below, Congress needs to act to protect workers from employers who are more interested in their corporate finance goals than in their employees’ retirement security, while continuing to support the proper use of ESOPs and other employee stock ownership vehicles.

An Agenda for Action to Strengthen and Protect Worker Retirement Security

Defined benefit plans remain the best and soundest vehicles for building and safeguarding retirement income and security. Defined contribution plans, such as 401(k) plans are not substitutes for pensions, but to the extent they provide additional savings for retirement, our laws and regulations must include at least minimal safeguards to enhance protections for workers and stop corporate abuses.

In particular, the AFL-CIO supports wide-ranging reforms in 401(k) plans designed to address the public policy failings that led to the devastating impact of Enron’s collapse on its employees’ retirement security. The labor movement supports giving workers a right to sell company stock contributions to their defined contribution retirement plans and we support requiring 401(k) plans to provide independent investment advice to all participants from an advisor whose only interest is in providing good advice.

But just giving workers a right to sell the employer’s stock is not enough. To be effective, any reform must address efforts by employers to encourage and induce workers to invest heavily in company stock.

Companies that do not try to protect their own workers’ retirement security by giving them an adequate defined benefit pension should be given a choice with regard to company stock. If the employer does the right thing and provides its employees with a good enough defined benefit plan, in addition to a 401(k) plan, the employer should be allowed to make its contribution in company stock and offer company stock as an option for employees to invest their contribution.
But if an employer insists on having a 401(k) plan as the only retirement security vehicle, then the employer should have to choose between making its matching contribution in company stock and offering company stock as an investment option under the plan, but it cannot do both.

While these measures could have made a difference for Enron employees, one of the lessons we should learn from Enron is that employer sponsors of 401(k) plans have myriad ways of managing the plan to suit the employer’s interests rather than the plan beneficiaries’ interests. And the current general fiduciary duties, limited as they are by section 404(c) of ERISA, are not an adequate constraint on this tendency. What we need are meaningful changes in 401(k) plan governance that empower employees as an effective counterweight to the conflicts of interest involved in exclusive employer control of these plans.

That is why the labor movement strongly supports the provisions of Rep. Miller’s reform bill that would require equal participant representation on the boards of 401(k) and other defined contribution plans. This provision recognizes that workers have an enormous stake in how their retirement plans are run and that they should at least have a say in how the plans are managed. This should also apply to both public and private retirement plans, regardless of whether they are defined benefit or defined contribution plans.

Currently, most benefit funds that are sponsored by unions have half their trustees made up of beneficiaries. This arrangement not only gives workers a voice, but it also sets up a dynamic in the governance of the fund in which outside experts, because they are not solely beholden to the employer, are better able to give independent advice to the fund, advice to which the trustees are more likely to listen.

These changes could have made a real difference for Enron employees had they been in place last year. They also leave in place ERISA’s current protections against conflicted investment advice. The House has passed a bill seeking to remove these protections, a bill which President Bush endorsed as a solution to the problems of Enron. As representatives of the labor movement have warned Congress in the past, letting the very money mangers who have an interest in selling high-fee products give advice is a measure that would expand the conflicts of interest already besetting worker funds. One would hope after Enron that we would all understand that the last thing we need to do is create more opportunities for companies, be they employers or investment managers, to exploit 401(k) participants.

Understandably, the short-run focus in Washington is on finding ways to protect workers against the kinds of abuses and intolerable risk workers bore at Enron, but Congress must go beyond fixing 401(k)’s. Workers need real pensions on top of Social Security. Yet, employers have been replacing valuable defined benefit plans with 401(k) savings plans at an alarming rate. This trend has been a long time in the making and will not be reversed easily, but it lays down an important challenge. It is critical that policymakers also find ways to provide greater incentives for defined benefit plans by changing national retirement policy, to level the playing field between defined benefit and defined contribution plans.

Conclusion

In conclusion, Enron was not an aberration, and it was not about one or two rogue executives. Enron was just what its executives and its boosters in the press said it was – one of America’s leading companies – and it was leading us down the road to ruin. It took advantage of conflicts of interest that had been allowed to grow unchecked in our capital markets, and retirement policies that allowed employers to use workers’ retirement savings as their corporate piggy bank.

The labor movement supports comprehensive, systematic reform of our capital markets and our pension laws now. In Congress today on both sides of the aisle there are those who understand that there must be change, and are ready to act. America’s working families and their unions are behind that effort 100 percent. Obviously, as part of that commitment we stand ready to assist this Committee in its efforts to contribute to both understanding what happened at Enron and to seeing it doesn’t happen again. Thank you for the opportunity to appear here today.

[1] Statement of the Hon. Mark Weinberger, Assistant Secretary for Tax Policy, U.S. Department of the Treasury, before the House Committee on Ways and Means, hearing on “Retirement Security and Defined Contribution Plans” (February 26, 2002).