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Why would an employer prevent their employees from investing in the employer's stock through the employer-sponsored 401(k) account? I saw that restriction when reading the "Vanguard Brokerage Option (VBO)® Plan Highlights" of a 401(k) Vanguard account sponsored by some US company.

Note: the Self-Directed Brokerage Option (SDBO) previously known as the Vanguard Brokerage Option (VBO).

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    Too much concentration of risk: it's bad enough that your income is tied to the success of one company, but if your retirement savings are also?!? – Ben Voigt Feb 18 at 0:15
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    Is this an actual situation or just a hypothetical? There are many reasons why you might not want to invest in your companies stock, but some companies allow (and even encourage it, so I'm not sure what answer you're looking for here. – D Stanley Feb 18 at 15:23
  • @DStanley Actual situation. I was wondering whether it is the employer's decision not to allow employees to directly purchase the employer's stock in their 401(k)s or some external factors (e.g., laws) explain such restrictions. And if it is the employer's decision, are they trying to protect the employees (e.g., not enough diverse investments or insider trading) or themselves (I don't see what but I may be missing something). – Franck Dernoncourt Feb 18 at 20:14
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    @FranckDernoncourt I found this document on SEC requirements for employers who do allow purchase of company stock through a brokerage window. benefitsbclp.com/… It seems that it is probably OK as long as they don't mention the possibility. I can certainly imagine some companies choosing to simply prohibit such purchases, out of an abundance of caution, or because they wrote their plan rules before the guidance was issued. – stannius Feb 19 at 18:28
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    I'm just speculating here but, I'd say that since the employees had the ESPP available to them to buy the stock at a discount the employer might be open to some liability if a begrudged employee were to buy stock via the 401(k) that the employer should have done a better job directing employees to the ESPP instead because the employee would have gotten a better deal. The easy solution to avoid that liability would be to disallow purchase of the stock in the K. – quid Feb 20 at 6:37
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I found a document on SEC requirements for employers who do allow purchase of company stock through a brokerage window (mirror). I am extrapolating heavily from a document covering only a specific case, but it seems that there is more paperwork and more risk of an employer being sued if they offer employer stock through their 401(k) program. According to that document, the mere availability of employer stock through a brokerage window doesn't require paperwork or introduce risks, with the caveat that they can't point it out (and definitely can't recommend, encourage, or endorse it to employees). I can certainly imagine some companies choosing to simply prohibit such purchases, either out of an abundance of caution, or because they wrote their plan rules before the guidance was issued.

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Because it's a super-bad terrible no-good diversification fail ...that also makes the company all too responsible for the employee's fate after retirement.

That is, after all, exactly how things worked in the Bad Old Days. You get home after V-J day and go to work for the Baldwin Locomotive Works, a stalwart blue-chip who had been in business for 120 years making steam locomotives (uh-oh). Your service will earn you a pension, which BLW pays out of profits just as it did for your grandfather and great grandfather. However, this ever-growing pension burden meant that BLW was becoming a pension company that happened to make locomotives on the side.

Well, fortunately, the pension industry had become savvy to this dangerous practice, and had changed the corporate structure so BLW was paying into a pension fund. The fund was separate, and wouldn't go bankrupt if BLW did. Except the two Boards of Directors were the same people. When BLW needed a loan, they borrowed from the pension fund. If they didn't have cash to pay into the pension fund, they issued it stock. So employee pensions were heavily invested in stock of, or loans to, the employer.

This resulted in a great many employees having their pensions go bust and become a burden to the government. This was landing in the government's lap to such an extreme degree that the government just "made it official", and formed the Social Security system. Later, the concept of a 401K was developed, so employees could direct their own retirement savings instead of fund managers.

However, the idea of investing your retirement in your own company has basically become a four letter word. Retirement should be invested in things that are safe as houses, and the financial industry already knows what that is, because university endowments are invested there. That is: a very broad mix of stocks, foreign stocks, bonds, insured investments, cashlikes, and sometimes a small fraction of real estate. And as the withdrawal time of the investment approaches, slowly roll the asset mix out of stocks and more into cashlikes.

But not just any stocks - the most diverse selection possible, so that no one failure of a business or sector can significantly damage the fund.

The problem with allowing employees to invest retirement in their own company is that companies will be tempted to oblige them to. For instance, my company puts my investments into a Target Fund by default, and I have to log in and positively move it. Imagine of they put it in their company's stock by default? For many employees, it would not even occur to them to change the investment mix to something sane. They would move on to other jobs, then at retirement find their retirement fund was extinguished because all the stock in it went to 0. That would drag us right back to the Bad Old Days.

  • Thanks. "The problem with allowing employees to invest retirement in their own company is that companies will be tempted to oblige them to" -> do you mean employers are not allowed to allow employees to invest retirement in their own company? – Franck Dernoncourt Feb 18 at 1:10
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    @FranckDernoncourt I don't know enough about pension law to say definitely, but it wouldn't surprise me one bit. Regardless, it would require the cooperation of the 401k manager (e.g. Vanguard or Fidelity) and I think it would be difficult finding one who'd agree to it for ethical (the above) reasons, and fear of liability or conflict of interest for recommending such a fund if it tanks. – Harper Feb 18 at 1:48
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    @Harper I work in the US and Fidelity manages our 401(k). They have a special mutual fund holding company stock, which is only available to employee 401(k) accounts. So we are allowed to invest our 401(k) in company stock, AND the entire employer match is in company stock. If Fidelity does it I'm sure it's legal. – Pacman Feb 18 at 3:42
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    @Pacman Thanks for the information. Good to know that's the employer's decision not to allow employees to directly purchase the employer's stock in their 401(k)s. You're welcome to add it as an additional answer. (I'm always afraid that useful comments get deleted) – Franck Dernoncourt Feb 18 at 5:08

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