A Time Bomb on Executive’s Balance Sheet


What does Circuit City, General Motors, Sprint and Citigroup have in common? They lost nearly all of their value over the last decade. So did Clear Channel, Radio Shack and Peabody Energy. Why? The hidden dangers of concentrated equity positions.

This blog post discusses a new strategy in executive benefits which, we believe, has the potential to defuse a lurking time bomb on your personal balance sheet: substantial holdings of restricted stock or restricted stock units that could suffer significant losses.

According to J.P. Morgan Asset Management, 320 stocks have been removed from the S&P 500 since 1980 due to “business distress” and 40 percent of Russell 3000 stocks have suffered a permanent decline of 70 percent or more from peak value. So this type of downside risk is not unusual.

Many executives, due to their compensation packages, hold large concentrated equity positions. The reasons vary: corporate optics, stock ownership guidelines, restrictions, tax considerations.

Protect Your Downside Risk

  • Many strategies do protect your downside risk such as:
  • Outright sale of the stock
  • Exchange funds
  • Put options
  • Equity collars
  • Prepaid variable forwards
  • Stop-loss orders
  • Securities-backed loans

As outlined in the table below, each of these strategies present significant limitations few executives will find attractive. These limitations include short terms, high fees, high taxes, appearance of disloyalty, complexity and, at times, special attention from the IRS.

Name  How It Works Considerations 
Sell & Diversify Sell shares, pay capital gains tax, reinvest remainder Cap gains taxes (30%)1. Forego subsequent appreciation. SEC filing; reputation/optics risk for insiders. Employment contracts may disallow. Not available for restricted/unvested shares.
Exchange Fund Exchanges your position for diversified portfolio of positions contributed by others. Min. 7-year holding period; tax deferral. SEC filing; reputation/optics risk for insiders. Lock-up/illiquidity. Most funds continually adding other stocks people want to hedge. Expensive.
Put options (AKA “Prospective Put”) Purchase “put option” with strike price below current market, sets a floor for the stock. Option premiums can be very expensive. Employment contracts may disallow. No role for restricted/ unvested shares. Tax on gains and dividends; losses not deductible. Counterparty risk. SEC filing; reputation/optics risk for insiders.
Equity Collar Purchase a put and sell a call on the stock at negotiated strike prices Forfeit significant upside potential. Employer contracts may disallow. Does not work for restricted/ unvested shares. Tax on gains and dividends; losses not deductible. Counterparty risk. SEC filing; reputation/optics risk for insiders.
Prepaid Variable Forward Contract to sell shares in the future in exchange for cash today (~70-90% of current value). Protection floor; cap gains deferral Expensive. Must forfeit significant upside. Employment contracts may disallow. Not available for restricted/unvested shares. SEC filing; reputation/optics risk for insiders
Stop-loss order Place stop-loss order at below current market, protecting further downside by triggering sale. Ineffective for very large blocks. Simple volatility can trigger sale. Employer contracts may disallow. Stop-loss order may fail in times of market stress.
Securities-backed loan Securities-backed loan with stock pledged as collateral; proceeds used to buy portfolio of stocks. Potential margin calls. No floor on downside of pledged stock or securities purchased. Lock-up on pledged shares. Employment contracts may disallow.


Source: Fieldpoint Private Spring 2016 http://www.fieldpointprivate.com/ Disclosure: Executive Benefit Solutions (EBS) or its broker dealer Lion Street Financial does not sell or provide any advice as it relates to these strategies. Readers should seek their own advisors.

  • 1. Long-term capital gains taxes: 20% federal rate + 3.8% Obamacare surtax + 6.1% average state LTCG tax. (California is nation’s highest combined, at 37%).

A New Strategy for Protecting Shares of Company Stock

A new strategy, known as the Stock Protection Fund (SPF), was created recently by StockShield, LLC. An SPF mutualizes the downside risk of your concentrated holding across a group of diversified investors, building a pool of liquidity to compensate for losses.

The process does not touch a single share of the concentrated position; no stock sales required; no encumbrances or lock-ups; no SEC filings or employer restrictions.

While the downside is hedged, you can continue to participate 100 percent in the stock’s upside and any dividends. Or, if you wish, you can sell outright. The secret to the strategy is no more complex than U.S. government bonds and the principal of mutualization.

How it Works – Overview

The SPF consists of 20 investors (see figure below) who participate in a limited offering with a pre-set closing. Each investor protects a different stock in a different industry for diversification purposes. They contribute cash (not shares) into the fund, equal to 10 percent of the value of the shares they wish to protect. The fund is then invested in U.S. Treasuries for a term of five years.

When the bonds mature, the fund is terminated and the cash distributes back to the participants. If the fund exceeds the total of the declines (as illustrated below), those with declines are made whole, and any remainder returns equally to the others.

On the other hand, if declines exceed the value of the fund, the decliners may not be made 100 percent whole but their losses can be substantially reduced. During the term of the SPF, you are free to sell, gift, leverage or do whatever you wish with your shares. When the term concludes, you can renew your protection with a new fund.

Example: SPF Deployed Throughout the Financial Crisis

On June 1, 2006 a protection fund was formed with a 10-percent cash contribution and a five-year term protecting 20 investors who owned and wished to protect stock positions in 20 different industries. Five years later, at the conclusion of the fund, the maximum stock loss was 0 percent, meaning the cash pool eliminated (i.e. reimbursed) all stock losses. Of the cash contribution (or premium), 31 percent ultimately was returned to the investors.

For executives with significant concentrated wealth in company stock, the SPF strategy has the potential to reduce risk without disturbing ownership of shares or requiring disclosure filings, and therefore may be a tool worth investigating.

How to Minimize Disability Risk for High-Income Earners

Seventy-seven percent of workers think that missing work for at least three months because of injury or illness would cause a financial hardship, while half think it would cause a “great hardship.”

Nearly all households, ninety percent, say that they would suffer financial hardship if they were disabled and unable to work for a year.* For this reason, disability insurance remains a long-standing core employee benefit.

Most companies provide their employees with a group long-term disability plan (LTD) that typically covers a percentage of their salary, typically 60 percent. Income Replacement Benefits are paid in the event of a sickness or injury resulting in a disability while employed.

For low to middle-income employees who derive most their compensation from a base salary, LTD can be an effective tool to ensure they can meet their financial obligations in the event of a disability.

By contrast, high-income earners, such as corporate executives, professionals and business owners, often have more sophisticated compensation packages that can include benefits like bonuses, partnership distributions, retirement contributions and restricted stock units. For these individuals, suffering a disability could lead to significant income shortfalls.

Four Types of Non-Salary Compensation

Different forms of non-salary compensation for high-income earners are:

Annual Bonuses

According to human resources consulting firm Aon Hewitt, the percentage of total payroll dedicated to performance-based annual bonuses has increased since the economic downturn of 2008.

Aon Hewitt concludes that companies have become more comfortable with pay-for- performance, as well as limiting their exposure to fixed salary expense in the event of another recession.

This compensation trend presents two challenges to high-income earners regards most LTD programs: 1) often, the base salary of these employees exceeds the maximum coverage amount; 2) bonuses, commission and other incentive payments are not covered.

As an example, ABC Company offers a group LTD plan that covers 60 percent of salary up to a benefit of $15,000 a month. If John Smith of ABC earns an annual salary of $300,000 and an annual bonus of $180,000 (total compensation of $40,000 per month), he is limited to 37.5 percent coverage ($15,000/$40,000), as opposed to 60 percent for lower-earning employees.

Partnership Distributions

Law firms commonly use partnership structures. Equity partners of a law firm are entitled to a share of the company profits, in addition to earning a salary and other employee benefits.

While some law firms adjust their LTD plan to include higher monthly benefit caps to accommodate high-earning partners, exposure still exists in the event of a disability.

To illustrate this problem, let’s examine a mid-size, California-based law firm with 20 partners and total earnings (salary plus partnership distributions) between $500,000 and $800,000 annually. The firm maintains an LTD plan that provides a 60 percent benefit up to a maximum $20,000 monthly benefit; that is, partners earning up to $400,000 realize full coverage. However, LTD plan will only cover between 30-48 percent of the total compensation of the 20 high-earning partners.

Retirement Plan Contributions

A recent Retirement Plan Survey conducted by Aon Hewitt shows nearly 70 percent of employers report that 401(k) plans are the primary retirement vehicle they offer to their employees.

This study confirms the trend of the last 30 years─namely; employees must fund most of their retirement. Highly compensated employees face the additional burden of limitations to how much they can save in 401(k) plans, as well as the amount of benefit they will receive at retirement from Social Security.

In the event of a disability, an employee not only misses the opportunity to defer his income into a 401(k) plan, he also does not receive any match offered by the employer. Depending on the beginning age and length of the disability, this limitation could have a significant impact on future retirement plans for high-income earners.

Restricted Stock Units (RSUs)

RSUs involve a promise by the employer to grant restricted stock at a specified point in the future. RSUs became a prevalent form of compensation in the early 2000s when changes in accounting rules lessened the advantages of offering stock options to employees.

A review of publicly traded company proxy statements reveals that the amount of RSUs paid out to executives can often be three to five times annual compensation. This pay out creates a substantial challenge for highly compensated employees in the event of a disability. To understand the potential magnitude of the problem, let’s review the details of the compensation plan of Mary Miller of XYZ Company.

  • Annual Salary of $750,000 with an annual bonus of $250,000;
  • RSUs of $2,000,000 with 50% vesting at three years and the remainder vesting after four years;
  • Total compensation is $3,000,000; after-tax income (35% rate) is $1,950,000.

Mary’s monthly income, in the event of a disability, would be $30,000 ($20,000 from LTD and $10,000 from individual coverage) meaning she would receive only slightly less than 20 percent of her current after-tax income.

Supplemental Solutions to Consider

As evidenced above, the different forms and magnitude of compensation earned by successful individuals can present a serious gap problem in the event of a long-term disability.

When looking to solve the potential income shortfall, a highly-compensated individual should consult an insurance professional with a thorough understanding of supplemental coverage.

Supplemental coverage options can range from individual disability insurance policies, which can address the needs of those with bonus and other forms of incentive compensation to specialty products that cover those with significant partnership distributions, as well as restricted stock units.

*Source: Consumer Federation of America and Unum, “Employee Knowledge and Attitudes About Employer-provided Disability Insurance,” Opinion Research Corporation Survey, April 2012.

If you would like more information on how to address the disability risk of high-income earners, you may contact Don Curristan, Managing Director at EBS. Voice: 760.788.1321 Cell: 619.318.6620 or e-mail to dcurristan@ebs-west.com.