Employee Stock Options Lawyers

The tech boom of the late nineties not only minted a new class of wealthy entrepreneurs and venture capitalists but also significantly benefited mid-level executives, technicians, and support staff. Many in these roles, through dedication and belief in the future of technology, received employee stock options as part or all of their compensation. These stock options became a key instrument for employees to achieve financial goals such as early retirement, paying off mortgages, and launching new business ventures.

Employee Stock Options and an Investment Advisor’s Fiduciary Duty

Employee shareholders frequently turned to full-service brokerage firms for advice on how to exercise their stock options, either on a “cash” or “cashless” basis. However, the lack of experienced supervision and the inexperience of brokers in managing these transactions often led to significant financial losses for the employees. Poor post-exercise management of the portfolios further compounded these issues. This highlights the importance of careful and informed management when dealing with employee stock options, underscoring the potential risks involved without proper guidance.

Following the exercise, people found themselves holding a paper fortune in a single stock and they turned to the brokerage firms for help. Diversification of a single stock position is the simplest way to reduce risk, but is not always the best option. In some instances, employees received shares of restricted stock which could not be sold for a period of time. Other shareholders wanted to qualify for or defer capital gains taxes. Still others wanted to hold concentrated stock positions because brokerage firm analysts were bullish on the particular stock.

No matter what a customer’s financial objectives are, a brokerage firm owes its customer a fiduciary duty which includes the disclosure of information about the different ways a position can be hedged to protect the value of a life’s work delivered to a full service brokerage firm for professional advice.

Hedging Strategies for Employee Stock Options

One of the most popular strategies is a “zero cost collar,” where a put option is purchased and call options are sold. The money raised from selling the calls pays for buying the puts. This will normally allow the customer to sell the stock at 85-90% of current value if the price drops and requires a sale at approximately 115% if the price increases. While this hedge does not cost anything, the trade off is capping the growth potential of the stock.

For someone who believes in the upside potential of a stock, but wants protection from a price drop, purchasing put options may be the best course of action. These purchases can be financed by margin if there are no other funds available.

A prepaid forward sale (also known as a “variable delivery forward”) is a hedge where an investor agrees to sell the stock in two to five years, but receives 75-85% of the current value up front. At the end of the contract, either the stock or the cash equivalent can be delivered.

Another benefit of these hedging strategies is that they may not trigger a taxable event since they usually are not classified as an immediate sale.