The Big Uneasy

Accountants are stepping into the financial planni

Illustration By Brian Ajhar

When accountants convened in the Big Easy in January, the theme was financial planning, financial planning, and more financial planning: "Convert your tax clients to personal financial planning clients now," Stu Kessler exhorted the 675 attendees at the AICPA's Personal Financial Planning Technical Conference, held in January at the New Orleans Sheraton. "Five to 10 years from now, most of those tax clients will be doing their tax returns on the Internet, on their television sets, and other ways. If you don't convert them now," Kessler said, "once that umbilical cord of doing their tax returns is cut, you're going to lose them."

Yes, the accountants are jumping into financial planning with both feet. With paradigm shifts at the wirehouses, industry consolidation, and the emergence of the Internet, the planning business is clearly on the brink of a change that will see new and larger players battling for customers. And CPA/planners are doing their part to prepare for the fray, if the goings-on in New Orleans are any indication. (Accountants who do planning differ from humdrum bean-counters in everything from personal appearance - one conference official wore his hair in a ponytail - to the affinity for repetitive work. "Accounting kinda sucks," one attendee said, explaining her motivation for venturing into planning.) The question is: Are they ready for prime time?

Kessler, a partner with Goldstein Golub Kessler LLP in New York spoke as part of a panel on "What to Do - Sell, Merge, etc. - The Future of Your Practice." The session content wasn't nearly as intriguing as the title, but the talk did provide practice management insights as well as a peek into the war rooms of some accounting firms going after planning business.

Both came courtesy of panelist Bart Francis, a partner in Ernst & Young's personal financial counseling group, who urged practitioners to form strategic alliances, given that clients are beginning to demand one-stop financial services shopping.

"You need to be prepared to deliver it. You don't want to end up being the tax preparation solution when everybody else owns the client relationship," said Francis, noting that his Big 5 accounting firm has several alliances in place. "There's a law firm . . . that we did the financing to start up. We outsource our investment consulting services."

Before joining E&Y, Francis had worked for a local outfit. He said point-blank that Ernst & Young is a brand name that gives him entr?e with the high-net-worth crowd. "Being able to say, 'I'm with Ernst & Young' - there's an initial reaction and initial credentialization," Francis has found.

A little later, the audience heard from someone who may provide stiff competition soon. "We're going to be the one-stop shop that we've all been talking about," pronounced Jim Clarahan, with RSM McGladrey, an H&R Block subsidiary. "At McGladrey, our vision is to become the middle-market firm for the U.S. business and high-net-worth marketplace."

Five years from now, McGladrey plans to have offices in America's top 25 metropolitan markets. "We will be have more than $1 billion in revenue," Clarahan said. Some statements (such as "We are working with a PR firm to come out with the message that we're going to use to brand the name RSM McGladrey") made Clarahan sound smug, if not haughty, but his message was clear: These accountants want a piece of the whole financial services pie.

A mini-theme at the conference was the Personal Financial Specialist designation that the Institute awards to CPAs who pass a comprehensive financial planning examination and meet certain other criteria. Attendees with the designation wore a conspicuous ribbon on their conference badges, and it was one of the flashy nametags that sparked the discussion at my lunch table the first day. One CPA said the public doesn't know what a PFS is; that's why he had earned the CFP mark instead. His PFS buddy countered by saying that once Merrill et al. retool for the advisory market, "the PFS will set you apart" from the big firms' legions of CFPs.

The session "Everything You Wanted to Know About the PFS Examination" proved that CPAs haven't given up on the unheralded credential. A crowd of 75 - impressive, considering the session met at the crack of dawn and was clearly marked "optional" in the conference program - showed up to hear exam-preparation expert Terry M. Stock give the gory details.

"The afternoon session is intense," Stock said, explaining that the day-long PFS exam is administered in two 3-hour blocks. "You're not going to be energetic when you're through." The head of Stock Financial Services of Lewisville, Texas, offered some test-taking tips - go light on liquids at lunch; you won't have time for restroom breaks in that grueling afternoon session - and reported an exam pass rate of over 80%. "They want you to pass. It's designed to help you pass," Stock said. That doesn't mean the PFS exam is easy, though. "It's a fair test." And interest in it is increasing. Three hundred CPAs sat for the PFS last year, up from the 100-per-year rate prior to that.

It wasn't all serious business in the Big Easy, of course. Any town where the hotel staff say, "Thank you, dawlin'," when pocketing tips is bound to make for conviviality between the movers and shakers.

Under the rubric of extracurricular activities, the AICPA and Fidelity Institutional Advisor Group announced an alliance at the conference. Under the agreement, FIAG is now the exclusive provider of custody and clearing services for the Institute's recently launched Center for Investment Advisory Services, which helps CPA/planners expand their service offerings to clients.

In case you were wondering, the conclave did include educational sessions. The dauntingly titled "Hedging, Monetizing, and Diversifying Concentrated Equity Holdings" was one that packed 'em in, and rightfully so. Katherine DePauw Graham, a derivatives marketing executive at Bank One in Chicago (and a CPA), smartly demonstrated how going to a bank for a privately negotiated options transaction can meet complicated client objectives. Someone, for example, had a big block of restricted stock they couldn't sell for a year. The clients were worried about a drop in value before then, and in the meantime they wanted to borrow against the position - "monetize" it - to invest in another business.

"So what do they do?" Graham posed to the rapt crowd. "They buy a one-year put for the restricted period, and take out a loan with the bank. The client was able to borrow 81% against the stock, set a floor on downside exposure, and not create a taxable event."

How? "Over the-counter products," Graham said. "They're a contract between the high-net-worth individual and a financial institution. I would contrast that to an exchange-traded alternative."

And contrast she did, pointing out that private deals can have much longer expiration dates - up to five years longer - than new exchange-traded options. "We also have the ability to custom tailor to the exact strike level the client's interested in, and to a precise date. So the over-the-counter market offers a lot more flexibility than the listed markets," Graham asserted. (For a review of options basics, see "Windows of Opportunity," November 1998 Investment Advisor, p. 80.)

Each institution that markets over-the-counter options sets different minimums, Graham explained, often depending on the client's net worth. "I've seen them as low as $5 million and as high as $20 million," she said. A specified income may also be required. Regarding size of the transaction, banks' minimums range from $1 million to $10 million. "That would be current value of the single-stock position. And usually an institution is willing to do anywhere from three to five times the daily average trading volume of a stock," he said.

One of Graham's intriguing case studies was about a guy who wanted to borrow as much as he could against a concentrated position while also limiting his downside exposure. "He did a one-year costless collar," said Graham, meaning he simultaneously bought a put from the bank (establishing a floor price at which he could bail out of the stock) and sold a call (placing a ceiling on his upside potential) of equal value. "That, by far, is the most popular hedging tool out there, and it's one that has survived IRS scrutiny," Graham said. By leaving his shares with the bank as collateral, the client was able to monetize about 80% of the value of his concentrated position - compare to the 50% limit on margin borrowing - without having to worry about maintenance calls in the event of a decline in the stock's price.

The hedge element of the transaction plays out like this: At expiration, if the stock is below the floor price, the bank pays the investor the difference, based on the put. If the stock settles between the floor and the ceiling, nothing happens. If the stock closes above the ceiling, the client surrenders the upside by paying the bank the amount over the ceiling. That cash payment is a capital loss, Graham said. "It's deferred, and it is not recognized until the underlying stock is sold."

An even sexier strategy that accomplishes similar results is what Graham's bank calls the variable prepaid forward. "It's really nothing more than a forward sale of stock, where the price is paid up front, but the transfer of ownership doesn't happen until maturity," Graham explained. There's also a collar involved, with a floor and a ceiling. The kicker is the variable delivery mechanism. The specific details are hideously complex, but depending on the stock's price at expiration, the client might have to deliver all the shares that were sold (or the equivalent in cash, to avoid triggering a taxable event) or only a fraction of them.

To summarize the strategy's benefits, the investor retains all rights of ownership (e.g., dividends) until expiration, the up-front sale generates a maximum amount of cash for diversification, and the collar provides downside protection on the entire position while placing a ceiling on only a percentage of the shares. Graham told of a customer who might end up parting with as little as 83% of his concentrated holding. "So on 17% of the shares, they get all the upside, and that is the element that makes this product so appealing," she said.

Another high-level session replete with practical tips was Marvin R. Rotenberg's "Estate Planning for Large Balance Retirement Plans." Rotenberg, in the Private Clients Group at Fleet Bank in Boston, is a perennial presenter at the AICPA's annual technical planning gala, and he began this year's talk by referring to the Taxpayer Relief Act of 1997. It gives a break to those holding employer stock in a 401(k) plan, or ESOP. "There's a little-known provision that when I retire or I leave, I can take a distribution in kind of company stock," Rotenberg told accountant/planners. "I have to pay ordinary income tax only on its cost basis, not on its market value. If you have clients that have large appreciation in company stock, think about using this technique."

At separation, the participant asks for the company stock in the plan to be delivered in certificate form. The employer responds by making distribution in kind, which causes the employee to incur income tax on the cost basis of the shares received. ("I need to be 55 years or older to take money out of a qualified plan in company stock to avoid a 10% penalty," Rotenberg cautioned. "If I take a distribution in kind before that time, the penalty is only on the cost basis.")

When the shares are sold, their net unrealized appreciation gets capital gains treatment, Rotenberg said, then gave an example. Suppose a client owns $100,000 of employer stock, with a basis of $30,000. Therefore he has net unrealized appreciation of $70,000, so he'll pay ordinary income tax on the basis, plus a 20% capital gains tax on the net unrealized appreciation (when the shares are sold), for a total tax on the stock of $25,880. Not bad, and a lot cheaper than paying ordinary rates on the full market value of $100,000, which is what would have happened had the client rolled the employer stock into an IRA, sold it in there, and then taken distributions.

"The savings are very, very compelling," Rotenberg told everyone. Later he noted that keeping the stock out of a traditional IRA helps keep mandatory distributions at age 70 1/2 to a minimum. "The value of my IRA is a little bit less." There's good news on the record keeping front, too. "The company will identify, for their participants, what their cost basis is."

Rotenberg's presentation featured all the things - caveats, common pitfalls to avoid, devices to engage the audience - that make for a cerebrally rewarding session. And he didn't hesitate to delve into finer points, like how beneficent clients can plop the company stock into a charitable remainder trust - say, a CRUT with a 6% payout rate. "The CRUT can sell the stock (without triggering tax) and diversify," he said. "Meanwhile, I've guaranteed myself a 6% return for the rest of my and my spouse's life."

Gifting the shares to the charitable trust begets the client a tax deduction, and in an example offered, the charitable deduction saved as much as taking the shares in certificate form had cost in ordinary income tax. "Ladies and gentlemen, it's just about a wash," Rotenberg showed. "I took $100,000 of market value stock and put it into a CRUT with basically no income tax consequence."

Not all of the conference's educational sessions were quite so advanced. In fact, one Florida CPA grumbled that things were "too basic."

Perhaps. But in the larger scheme, that may work to accountants' collective advantage. "This conference is deliberately intended to offer a broad scope, because attendees have a diversity of experience in the personal financial planning area," says Colorado Springs CPA/PFS Jim Shambo, the pony-tailed chair of this year's do. "The conference is for people who are considering starting, as well as for more seasoned people."

Clearly, accountants are readying themselves for the new competitive environment. More CPAs are exploring the advisory business, new organizations are forming to help them succeed in it, and an annual conference keeps them abreast of it all. Looks like accountant/planners are a lot more ready to do financial planning than ever before: They're educated, they're professional, and they have they're clients' trust. Hopefully, financial planning will be better for it, as well.

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