By Michael Ruzhansky
Corporate executives are subject to unique issues related to their compensation with company stock. Advisors can’t treat executives like other high-net-worth clients and expect to be successful. Dealing with equity compensation issues requires specialized knowledge and tools, and a very individualized approach to the client.
Senior management often has 80% to 90% of their net-worth tied up in company stock and options. In spite of such concentrated and risky positions, executives often resist guidance on diversification. This could be due to stock-holding requirements, concern with shareholder reactions, rules against insider trading or simply because they feel they have better insights than their financial advisor.
These various concerns can make it very confusing for executives to determine when to sell their company stock. To add to this confusion, some companies grant employee stock options in lieu of outright shares. Stock options require executives to decide when to exercise the option prior to selling the underlying stock. This begs the question “when is the best time to exercise and sell stock options?” Although there is no definitive answer, an adviser who is able to create an option valuation analysis can establish a framework for the decision-making process.
High level executives also face restrictions on the timing of their stock sales due to insider-trading rules. To alleviate SEC infractions, many companies utilize blackout periods generally during earnings announcements that preclude insiders from selling company stock other than during limited trading windows.
To provide an affirmative defense to SEC insider trading violations and enable executives to sell company stock during blackout periods there is SEC Rule 10b5-1. 10B5-1 trading plans allow executives to establish a deferred sales agreement for their stock. These contracts stipulate a formula for when the trade will take place using a specific stock price. Consequently, stock sales can take place during blackout periods without violating SEC rules because the trading plan is made in advance and is publicly disclosed. The result is a more positive market reaction because there is less concern the executive is selling due to negative expectations for the stock. 10B5-1 plans give executives much more flexibility to diversify out of concentrated stock positions in a systematic way.
In summary, financial advisers need specialized knowledge and resources to work with corporate executives, particularly at the senior level. The ability to create/interpret an equity compensation analysis and understand/establish Rule 10b5-1 trading plans are examples of the skills that will enable advisors to engage executives. The good news is that this market is underserved because there aren’t many advisers who have taken the time to acquire the knowledge and tools necessary to work with an executive clientele. However, the investment is generally well worth it because junior executives become senior executives and they receive company stock and option grants over many years. Executives also tend to stick with a trusted advisor because it is too time consuming to switch, so if you can help them manage and maximize the value of their equity compensation you’ll have a high net worth client for life.
Michael Ruzhansky is a Certified Financial Planner at Financial Partners of Upstate New York, a member of MassMutual. He has been assisting Corporate Executives with their equity compensation for over 15 years.