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."