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Managing your concentrated stock position

Can awards and grants from your company – even if you think it’s poised for long-term growth – pose potential risks to your portfolio? Here are some ways you might minimize the risk.

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For many corporate executives and key employees, stock option awards or large grants of company stock are critical elements of their overall compensation packages. In fact, in many cases accumulated awards can represent the lion’s share of their investable assets.

But even if you’re optimistic about your company’s prospects over the long haul, holding large amounts of its stock can work against diversification within your overall portfolio, notes Amy Permenter, head of Corporate Executive Planning, Planning Center of Excellence, Bank of America Private Bank. “It’s not only a matter of how much of your company’s stock you own — we look at total exposure,” she says. “In addition to unvested company stock, stock held in retirement plans and perhaps deferred compensation, you’re exposed to the company for compensation and job security.”

Adds Michael E. Stogner, a Private Client Advisor at Bank of America Private Bank, “A large, single stock position has quite a bit more volatility than the broader S&P 500 Index. Having all those eggs in one basket could expose you to sudden — and significant — swings in your net worth, potentially at exactly the wrong time.” As Permenter puts it, “Stock awards provide the opportunity to grow your personal balance sheet while contributing to the success of the company, but by diversifying when you are able to do so, you can potentially preserve that wealth without carrying additional risk.”

Develop a strategy for reducing risk

To evaluate what strategies might be available to mitigate the risks of a concentrated stock position, first determine what restrictions may be placed on your ability to sell company equity. Executives are often discouraged from selling their company’s stock because it may appear they’re betting against the firm, which could raise reputational issues. For the same reason, executives may be precluded from hedging company stock or pledging it against loans. They may also be subject to internal policies requiring the preauthorization of any transaction, as well as to limited windows for making stock trades and public reporting of their transactions — all of which can be additional considerations in developing a diversification strategy.

“If an executive is not able to sell regularly, then we may look to implement a trading plan that can potentially execute sales during open trading windows,” says Permenter. “If they’re restricted from selling altogether, we ask if they’re able to use stock in ways they might otherwise use cash — to gift to their family or to charity, for example.”

Finding suitable ways to diversify

There are several ways you can reduce concentrated stock positions, Stogner says. “The right solution will not be a one-size-fits-all approach but will involve finding the right tools for your particular situation.” The most sensible approach may be a series of diversification strategies.

5 ways to reduce risk

  1. Gradual share sales. If you’re not subject to legal or company limitations on share sales, and if you’re not in possession of inside information, you can implement a program setting up gradual sales of your position in an open trading window. By working with a tax advisor, you can minimize capital gains taxes through strategies such as tax-loss harvesting, which allows you to use losses in your overall portfolio to reduce the tax on gain recognized from share sales. 
  2. A 10b5-1 plan. Executives commonly use these plans to map out the number of shares and price limits as they trade over a period of time.  A 10b5-1 plan allows you to set objective instructions for trades while not in possession of material non-public information (MNPI). You may also continue trading under the plan even if you’re subsequently exposed to MNPI or would not otherwise be able to sell due to company’s closed trading window. If set up correctly, 10b5-1 plans provide a proactive defense against accusations of illegal insider trading.
  3. Gifting to a family member. If an executive wants to provide for a family member in a lower tax bracket, it could make sense to transfer company stock to them rather than giving cash. While there is no income tax deduction to the executive, the family member can then sell the stock — potentially recognizing the profits at a lower capital gains income tax rate.
  4. Gifting to charity. If you plan on making charitable contributions, a gift of stock can be more efficient than cash. By donating highly appreciated company stock to a charity, the charity can sell the stock without recognizing any gain for tax purposes, while you can still potentially take a tax deduction for the fair market value of the stock on the date you transferred it, subject to certain Adjusted Gross Income limitations and other factors. 
  5. Prepaid forwards:  This is an alternative to selling stock outright. In a prepaid forward, an investor receives a fixed amount of proceeds today in exchange for delivering a variable number of shares (or the cash equivalent value) in the future.  Investors are able to reinvest or diversify the prepaid forward proceeds while maintaining exposure to the shares.  Executives implement prepaid forwards because they allow executives to raise liquidity while also maintaining upside exposure in a name they believe in.


Which strategies might make sense after you depart from the company?

Leaving a company is a common catalyst for corporate executives to re-evaluate their concentrated stock positions.  They might seek to reduce a stock position due to limited influence over the company. Or they may feel they’re less likely to grow or recreate wealth at the same rate as when they were employed by the company.  Another important consideration can be that at some point after leaving, they may no longer have filing requirements, company trading policy limitations or pressure to maintain ownership stakes.

Allison Miller, Director in Bank of America’s Single Stock Solutions Group, points to many factors that can influence the timing and ability to sell or otherwise make transactions on shares after separating from a company, including negotiated terms of separation, consulting agreements and the type of shares.

Below are some strategies and tactics former executives may use to meet their objectives regarding concentrated stock positions. You can discuss them with your advisor to see whether they could make sense for you:

3 alternative approaches to diversifying

  • Covered calls. To generate income, investors may consider selling call options against their concentrated stock position. In this strategy, investors collect an option premium in exchange for capping upside appreciation at a selected call strike price. “Covered call writing tends to work best on volatile stocks,” Miller says. “If you are planning on holding a stock position, it’s a way to generate income while keeping some upside exposure.”
  • Equity collars. Collars enable an investor to hedge the value of an equity position while retaining some potential for appreciation in the shares. The investor purchases a put option, which provides downside protection, and sells a call option, which caps upside. Collars can be structured so that the premiums of the options offset each other (known as a “cashless collar”). Collars can be employed by retired executives who like their stock’s potential over the long term, but are concerned about short-term volatility.
  • Exchange fund. This strategy is appropriate when an executive holds a concentrated stock position (typically restricted stock in the company where they are employed) and selling it would cause a significant taxable event. To minimize the concentration risk, the executive can contribute the stock into an exchange fund. This contribution is generally a non-taxable event that replaces the risk of holding a single security with instant, broad market diversification as long as the exchange fund meets certain conditions. The exchange fund holding period is at least seven years, after which time the executive would receive a basket of stocks from the fund, which can be held or sold. The original cost basis from the contributed stock is retained, and taxes on any gain from the contributed stock is deferred as long as the seven-year period is met.1 A possible gain event will occur when the executive sells a stock that was received from the exchange fund.

A key to thinking about concentrated stock holdings is to look at them within the context of your overall wealth. Share values can change, sometimes with surprising speed. By using methods of diversifying and hedging, you can help ensure that the wealth you’ve accrued through hard work will be secured for you and your family for years to come.

Concentrated stockholders face unique circumstances, and their goals and objectives vary. With numerous strategies available, it’s important to partner with a team experienced in handling the complexities and helping coordinate considerations such as individual restrictions, diversification, hedging and wealth planning. Contact your advisor to discuss your goals and explore solutions tailored to your needs.

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