"It's one of the most difficult problems we face, to tell you the truth," says Bill Carter of Carter Financial Management in Dallas. "It's one of those things that you have to work with, and it's hard."

A Wrong Approach

Advisors are unanimous in criticizing the stringent proposals as being unfair to the overwhelming majority of corporate executives who are fair and honest people, who could be forced to put their financial futures into jeopardy. Many, they say, already own portfolios that are dangerously concentrated in company stock and options.

"The current era of scandals caused by a few notorious executives has created a climate of suspicion of all corporate executives, but that is very undeserved," says Tim Kochis, CEO of Kochis Fitz Wealth Management in San Francisco. "Most of them are very hard-working individuals who are doing a good job for stockholders and employees. Most of them are not jerks. But there are always some bad apples out there."

Carter says he understands the reasoning behind such proposals, but opposes the across-the-board action. "The proponents of it are saying that if you have more money involved in it you'll put forth a greater effort," he says. "But as a planner, I don't like it. There are a lot of things that can happen that an executive can't control. I don't agree with that. I think it's unfair for those executives."

Such high retention requirements go so far as to contradict safeguards put in place to protect investors, says Alexandra Armstrong, chairman of Armstrong, MacIntyre & Severns Inc., in Washington. For instance, Armstrong says, such a policy "really conflicts" with the prudent investor rule. "Now, that's the guideline for estates and trusts, that you have to be the most conservative and if you don't you're not being a prudent investor. But if you're going to have any consistency in philosophy, then you have to be consistent with it in all respects," she says.

Advisors also see an irony behind the issue: Their problem over the years has been convincing executives to exercise options and reduce heavily concentrated positions in their company stocks. They describe CEOs, CFOs and vice presidents who suffer from "myopia" about the virtues of their company's stock, senior executives who face a corporate culture-without any written policy-to hold options and stock, fears of tax liabilities or running afoul of regulators, and even old fashioned loyalty as constant roadblocks on the path to diversification.

"You have to help them to try to see what is difficult to see-that it's not what they know about their company that makes the stock price, it's what everyone else thinks they know about the company that makes the stock price," says Kochis. "And you can't control that. You are the potential victim of a lot of other peoples' ignorance. You need to protect yourself."

The problem isn't a new one but trends in corporate governance policies are compounding it. "I've been in the investment business for 30 years, and this has been a trend for as long as I've been in it," says Armstrong. "Often you find it was much more a matter of company loyalty."

Many advisors say their clients cite appearances-how selling off stock would be perceived. "Often these people are worried about how it will look to the analysts or on the Street, or to the people under them, " says Carter.

Timothy B. Brown of Brown Wealth Management LLC in Woodbury, Minn., also finds that appearances within the company loom large for many executives. "If you're a senior executive and you're seen selling that stock, you must be looking for a new job. And the same if you're selling your options. A lot of people have that problem-they don't want to be seen selling that stock," Brown says.

From Tax Strategies To Scared Straight

Whether a client is facing a tough new retention policy or has let a concentrated position grow over the years, advisors say the solutions are the same. Recent changes in the capital gains rate and Securities and Exchange Commission regulations can alleviate some of the fears of tax liabilities or regulatory difficulties, while creative-and legal-uses of other strategies can help alleviate other concerns.

But advisors repeatedly say that one of their best tools to convince reluctant clients to diversify is to make them more worried about the alternatives. Call it the financial advisor's version of Scared Straight. "I'm pretty blunt about it," says Brown, whose location in suburban St. Paul means that his clients include a number of 3M employees who are fiercely loyal to the company and its stock. "That's what I see, most of these 3M people have 60% to 70% of their assets tied up in their stock options or straight 3M stock or in their 401(k) plans, and they don't want to sell it. It is a strong company, but they think that means it's going to keep going up."

Brown cited the case of one new client who came to him with plans to take early retirement. When the client initially balked at reducing his heavy concentration in 3M, Brown walked him through scenarios involving even a moderate decline in the stock's price and told him, "You've just thrown your early retirement away. You have to hold it until it rebounds, or you have to work longer, or you have to live with that lower retirement income."

J. David Lewis of Resource Advisory Services Inc. in Knoxville, Tenn., recounts three years of efforts to diversify the portfolio of one client, a hugely successful executive who continually earns piles of options from his company. Nearly half of his $5 million-plus net worth is tied up in the options, and they represent some two-thirds of his investable assets.

Some clients are well aware of the problem but procrastinate. "He understands how far out on the limb he is, if something goes wrong with his company. We talk frankly about it," says Lewis. Summarizing how he tries to steer those conversations, Lewis says, "He's just like a mom-and-pop set up at the grocery store for years, and doing well, until the Krogers moves in."

Other executives seem oblivious to their predicament. Stephen C. Craffen, a partner in Baron Financial Group in Fair Lawn, N.J., recounts a new client who came to his firm early this year with $1 million in stock and options built up over a 15-year stint at the same company, and with little appreciation of his situation.

"We impressed upon him that this is a life-altering opportunity here, and if you let it fall by the wayside you might never have the opportunity again. We convinced him to reduce the position and thank God he did-that stock right now is worth half of what it was worth just four months ago," says Craffen.

The changes in tax rules and SEC regulations have also made their job of preaching diversification easier, advisors say. The 15% capital gains tax is an obvious advantage. Another is SEC's Rule 10b5-1, which went into effect in 2000. It allows executives to put into place an irrevocable plan to exercise options and sell stock in the future, avoiding being enmeshed in charges of insider trading.

"You're putting the diversification transaction on auto pilot and doing it in advance, " says Kochis." This removed a former barrier that a lot of corporate executives seized on. The answer is, you don't have an excuse."

Kochis' clients include a large number of senior executives, and he has worked on concentration issues for years. He is now writing about the topic, in his own book and for a chapter in a book being edited by Harold Evensky of Evensky, Brown & Katz in Coral Gables, Fla.

To begin with, Kochis says, work on everything that's not nailed down in company options and stock. "They should make sure that the balance of their portfolio is very broadly diversified, and particularly in companies and business sectors that are not compounding the risk they are already in," he says. "For example, if you're client is a Microsoft executive and required to hold a very large percentage of his stock, you shouldn't have the rest of his portfolio look like Oracle and Sun and Adobe."

The next step for advisors, Kochis says, is to determine "what can they do to minimize their risks. There are things they can do that are kosher. We work around what the given the restrictions are."

Now more than ever, there are a growing number of ways for executives to hedge positions that need to be explored. "Someone could engage in a prepaid forward contract, in which they would get cash now for a sale that takes place in a year or two," Kochis says. The contract works as a loan, he says, usually through an investment bank, with the seller typically receiving an up-front payment worth 85% of the shares' value and the lender keeping any appreciation. "One other thing that's usually ignored, but we use frequently, is margin. Even if you can't sell your position, you can still use it as collateral with a broker to buy diversified holdings and increase the overall diversity of your portfolio."

Here too, Kochis warns, diversification is the key. "The purpose of margin is not to buy more of the stock that you're concentrated in. The object is to buy something else, to diversify. All the horror stories about margin are about using margin to buy more of the one thing. If you use margin to buy a diversified portfolio, the chances of losing money are very slim. You have to be careful about how much you borrow, and to diversify. There's nothing magic here."

There is no one approach to take, Carter warns, and protecting the client remains the advisor's paramount concern. "There's no cookie cutter. Every individual is different. I look at these not so much as diversification tools as protection tools."

Risks And The Long-Term View

Ultimately, clients have to decide where their best interests lie, advisors say.

"Our job is to give people the best advice we can give them, and it's up to them to take it," Armstrong says. "Sometimes it takes stock going from $90 to $50 for them to say, 'Do it.'"

Often this involves tough choices. Craffen says that in some cases a client may need to move on to protect herself. "Maybe you can say walk away, and exercise your options and capture your net worth."

On the other hand, says Kochis, the client might take the opposite strategy and trade the risk for career advancement. "We talk to them about it-that's the price you pay."

In Texas, says Carter, the Enron debacle and a series of earlier corporate crashes have left executives more sensitive to the risks of concentration and the need to diversify their personal holdings, particularly when dealing with options. "People are a little more open minded about it here."

Cosset says that concentrated positions will remain a concern. But the 30-year veteran advisor adds that he believes the effort to force executives to retain higher levels of options and stock is not likely to be a problem over the longer term. "I've seen public sentiment on these things blow hot and cold. The next thing that's going to happen-I don't know how soon, but I predict in the not-too-distant future-is that we'll have people arguing, correctly, that forcing corporate executives to hold more corporate stock makes them poor corporate officers because it will lead them to be too focused on their own personal risk. They will not be inclined to take the long-term view, to do the risk-taking that's needed, if they're worried that the stock price is going to take a hit in the next quarter. That is not the flavor of the day, but I predict it will be the flavor of the day."