Concentrated Stock and Liquidity for an Executive Client
A 58-year-old executive has $6.2 million net worth: $2.9 million in employer stock with a $300,000 cost basis, $1.8 million in a diversified 401(k), $900,000 in a taxable brokerage account, and $600,000 in cash. She plans to retire in seven years, needs $450,000 in 12 months for a home renovation, and wants to leave $1 million to a charity at death. Her employer stock has a 30-day average volume of $4 million, and her position is subject to insider-trading windows and a 90-day blackout. She has moderate risk tolerance and says she is uncomfortable with the concentration but does not want a large tax bill. An advisor recommends an exchange fund that would accept the stock, defer capital gains, and lock her in for seven years with a 0.9% annual fee.
1. Identify the client's key constraints and the main risk in the current balance sheet.
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The dominant risk is concentration: $2.9 million of employer stock is 47% of $6.2 million net worth and is correlated with her salary, bonus, and retirement security. A 30% decline would erase about $870,000-nearly twice the $450,000 renovation need-and could force sales at the worst time. Liquidity is another constraint: $450,000 is due in 12 months, but insider-trading windows and the 90-day blackout limit when she can sell. Tax is a third: the $300,000 basis means a sale of the full position would realize a large gain. The charitable goal and seven-year retirement horizon argue for a plan that diversifies gradually, funds the near-term cash need from cash or the brokerage account, and separates charitable assets from the retirement portfolio.
2. Compare the exchange fund, a 10b5-1 plan, and a charitable remainder trust for meeting liquidity and diversification.
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Exchange fund: contributes stock, defers gain, and diversifies immediately, but locks her for seven years, charges 0.9%, and may not provide the $450,000 liquidity; it also gives up control and may have restrictive redemption terms. A 10b5-1 plan allows pre-scheduled sales during open windows, provides liquidity, and reduces concentration, but triggers capital gains and must be structured carefully to avoid insider-trading issues. A charitable remainder trust can sell the stock tax-free inside the trust, provide an income stream, and meet the $1 million charitable goal, but it is irrevocable and removes access to principal. A sensible combination is to use cash or the brokerage account for the $450,000, adopt a 10b5-1 plan to sell a defined portion over two to three years, and use a CRT only for the charitable slice. The exchange fund is not suitable for the entire position given the liquidity need.
3. What conflicts and suitability issues should the advisor disclose if recommending the exchange fund?
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Disclose that the advisor or firm may receive compensation from the exchange fund, that the fund is illiquid, that valuation is not daily, and that the 0.9% fee plus fund expenses reduce returns. The recommendation must be documented against alternatives, including a 10b5-1 sale and a CRT. Check accredited-investor and concentration limits; do not put the entire $2.9 million into one exchange fund. Because the client is an insider, confirm that the contribution does not violate trading windows or company policy. Finally, show the break-even: deferring tax is valuable only if the lockup and fee do not consume the benefit, and she has a 12-month liquidity need that the fund cannot meet.