Part 1: A Missed Opportunity?

What’s the problem? I talk to advisors all day long. Recently, I was talking with an advisor in Dallas about her approach to options planning. She told me she works with 15 executives with options. What was her approach? She said she waits seven years and then exercises, and she tells me that is what she does with all her clients. It’s ridiculous. It’s poor advising. Good options advice is delivered, first of all, in the context of an overall financial plan. The aim is to create a diversified portfolio and ensure first that you have all the money you need for all your critical needs. I played golf with a guy a few months ago. He’s 62, had 75% of his retirement fund in his company’s stock, and he told me he wasn’t worried because this small, publicly held company had $28 million in the bank. Since talking with him, the stock fell 50%. Maybe it will go back up in three weeks, but it also may not go back up for five years, after his options have expired. He should be systematically diversifying away from that concentrated stock position.

What’s so complex? There are three types of stock options: Incentive Stock Options (ISOs), Non-Qualified Stock Options (NQSOs), and restricted stock grants that behave like options. Typically, an executive will have all three. And often the executive is sitting on 20 different tranches of options and each tranche has a vesting schedule that vests in different time frames. That’s complex. Then, they exercise some of one tranche, and they have some shares at one cost basis and another tranche has another cost basis, and that complicates the tax planning. You may have 40 or 50 lots to think through and ISOs have different tax treatment than NQSOs.

Are the advisors who are trying to help their clients with their options up to the task? It’s hard to generalize and there are many different kinds of advisors. Some are technically competent but not planners. Some are neither planners nor technically competent, and some competent planners don’t know how to do options planning. Some give clients poor advice. For instance, an executive–sometimes with the blessing of an advisor–exercises ISOs and pays for the exercise with a margin loan. Then, he doesn’t sell the stock in the same year he exercises and holds it until the next calendar year in the hopes that it will rise in value and he can have it taxed as a long-term capital gain. But what happens if the stock suddenly drops? Suddenly, that executive is on the hook for the margin loan and needs to pay that back when the loan is called. Plus, he owes the AMT tax. You could wind up not having the cash to pay that tax liability. It’s a fairly common mistake to hold a company stock for a year and a day after you’ve exercised an ISO in order to qualify for a capital gains rate of 20%, rather than being taxed at your income tax rate of up to 38.6%. But what has happened in this bear market is that many options holders, while waiting for the year to pass to qualify for long-term gains treatment, see their savings slip away when the share price on their stock drops. If you exercise an option at $5 a share when your company stock is trading at $10, you owe tax on that $5 profit, that bargain element. Waiting for long-term tax treatment could pay off, but you’re gambling that the share price won’t fall in the meantime.

Isn’t that the reason why more advisors are not giving advice on options? There just aren’t enough individuals holding options that are in the money? There are the Abbot Labs executives, and those at Federal Express, Southwest Airlines, Coke, IBM, GM, and tens of thousands of executives at other companies that do not have stock prices that are lower now than they were five years ago. Executives have been getting options for 40 or 50 years; they’re nothing new. The dot-coms and that whole nuttiness popularized options in the minds of the public but high-level executives have been getting options for many years. But that kind of thinking–that stock options are no longer a very good niche for advisors–is pervasive and needs to be dissuaded. The high-tech company options are just a small percentage of the total outstanding options. Yes, many of those are underwater and you don’t need to do planning for them usually. But even when they are underwater, it is a good time to do planning.

Why should anyone plan on how to take advantage of their options when they are way out of the money? Planning for underwater options is actually a very good idea that advisors should actively encourage. Say you have stock options allowing an exercise at $15 and the stock is now selling for $10. Assuming it’s a stable company that’s been hammered by events of the last couple of years and you believe the stock will go to $20 or $25 in the next couple of years, now is a good time for the executive to figure out when he will start selling his options. An advisor can do that now and track the stock so that when it hits the strike price you exercise and then diversify out of the stock.

And you’re saying you believe that planners are not doing this too often. We know planners are not doing that. We have only 700 users, and our strongest competitor went out of business last November. The other products left out there only have 200 or 300 users. To be candid, we don’t have any real competition, and there is no other software product that provides the rigorous type of options planning that StockOpter does. Now there are advisors that use their own software for options planning, but we think we know most of them because they’ve looked at our software. Sarah Ward, our sales manager, makes 40 or 60 calls a day, and she talks to 20 people a day, and we have a database of 5,000 advisors. So we think we have a good handle on the number of advisors interested in this subject. We’re pretty sure that advisors are not addressing this niche. Corporate executives have a series of advisors. Lawyers and CPAs, for instance, are giving advice on options, and many rely on a wirehouse broker or independent financial advisor. But we know they don’t take them through a process that leads to well-thought-out decisions. A number of companies have hired financial planning firms to provide planning as a perk to top executives who also have options, and these planning firms do give advice on options. But it’s not necessarily in-depth advice. They might simply tell an executive to diversify by exercising 20% of his stock options a year and let’s just pick a few options [randomly]. That’s partially good advice because you would be getting diversified, but it doesn’t optimize which options to sell.

You’ve begun a training program to help advisors exploit this niche. You have changed the way you are selling your software by going far beyond training people in how to use your software and are guiding advisors in business development. We talk about how they will acquire prospects and market. We are trying to empower advisors to successfully tap this opportunity in a way that will be highly beneficial to the client they are trying to serve. We’ve broadened what we do. The software is only a tool. To use the tool, you must understand the underlying subject matter and need to figure out the process for the client and your business model. Our business is to help our customers develop that opportunity to the benefit of their customers. This was our business plan two years ago, but we had not implemented the training piece or the consulting services piece. To implement the training, day two of our three-day training is now devoted to business development, where we facilitate a planning session for an advisor that results in their developing a business to pursue giving advice on what we call high-value stock options planning. It’s comprised of 15 different exercises. First, is envisioning where they want their business to be in five years. Then, we look at strengths and weakness, opportunities and threats. And then we have them focus on their market. Will they pursue executives in the pharmaceutical industry with options? Or those with privately held companies who are about to experience a liquidity event? We encourage them to pick a niche because you cannot succeed unless you focus. The process, which is interesting, is that we network all their laptops for this session and we have them brainstorm over the network. They type in all the niches to consider, for instance. We have advisors who are attorneys, and some who are CPAs, and they learn from each other, and you have 20 different ideas. The next exercise is business forecasting, and we have embedded an Excel spreadsheet to forecast your bottom line revenue.

Explain the new consulting model that you have been developing. Some advisors are very good at establishing a relationship but don’t want to do the analytical work. It’s not their highest value and they may not have someone with the capabilities on staff. So we now provide that capability. For instance, American Express advisors can access StockOpter through their home office in Minnesota, where American Express has trained StockOpter users who are familiar with the planning strategies and who have been through our training and know how to deliver high-value stock options planning. Along the same lines, we’re creating a “lite” version of our software for advisors who want to explore this niche without a large investment in time and money. Our consulting services are available at $250 an hour. The typical engagement costs between $1,000 and $5,000. Planners can enter data and ship it to us in Excel to reduce our fees. If they find they have a complex case, we will do the planning and provide the presentation materials for them to give to the client. And if an advisor has been through training and is still a little shaky and wants us to check his work, it may just cost $500. In fact, starting out in this niche by leaning on our consulting services may be a good way to go.

So I guess you think that for an advisor with one or two clients who needs help, dabbling in stock options could be a mistake. But I guess you also believe that advisors who are willing to make a serious commitment can succeed. Planners that have two or three or four clients and who try to deliver high-value stock options planning on their own for high-level executives could get in over their heads. If you have someone with $20,000 in NQSOs who wants to buy a boat, that’s pretty straightforward. But if you have directors and executive VPs who have accumulated different tranches of options and have complex circumstances, you need to have a service center in your company or come to us.

This is a complicated subject, and you are dealing with high-level executives and attracting a number of them to your practice, so it really requires thought and planning so it pays off for you. Most advisors don’t have 20 or 30 clients who are executives at big publicly held companies. To pursue this as a business opportunity, you need to make a conscious decision. It is not just another deal, like giving advice on 401(k)s or 529 plans, where you spend a day and learn the strategies and then you’re out there doing it. Giving high-value stock options advice requires thought and marketing and development of technical expertise. It’s like a high-end estate planner, who becomes very proficient and attracts high-net-worth clients because he understands estate planning vehicles in depth. It requires education and marketing yourself; success does not come overnight. To get 20 or 30 executives and become successful, you need to make an investment. Our business model is that we want to attract the very top level of advisors who want to pursue high-net-worth individuals and we plan to provide these advisors with the training and software to serve their clients. Ultimately, we want to attract 20,000 of those advisors who want to spend a lot of money with us for a high level of service. We have a list of 1,600 companies likely to have in-the-money options, and we’re happy to provide that to advisors so that they know which companies to target in their vicinity.