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.