We all know that divorce remains not only a contentious process but a lengthy one. Where clients choose to fight, 24 to 48 months is a fairly typical timeframe. For the most part, recent history has been one of real estate and securities markets rising. Divorce economic fights are easier when the assets are increasing. But, when markets turn and things decline, a new fight erupts over “who’s to blame” for the loss.
While markets have been generally favorable, there are some exceptions. They tend to occur among stocks new to the markets. The investment underwriters do their best to promote the stock before it begins public trading and then it rolls down the gangway where markets react sharply to any business news, whether positive or negative.
In 2021 I was retained by an executive of a newly formed tech company which was about to go public. The client held a lot of shares and options to acquire at pennies a share. It was a long term marriage where it would be clear that the client would be facing a distribution of 50% or more of the marital assets. The client had a front row seat to discussions with the investment houses over what the stock would be offered at and those numbers varied widely. In the end, the stock rolled out at $70/share in Spring 2021. The client became an instant multi-millionaire and the stock was now 90%+ of the marital asset portfolio. In the first month, the stock held up well, rising to $80 a share.
As a senior executive in the new business, the client was an “insider” under the SEC trading rules. That means there are regulations governing when his stock can be traded. While the initial stock value news was good, by Summer 2021 the stock started to slip. What vexed the client was the economic news appropos his company was quite good. But, markets make their own decisions when it comes to stock value.
As the stock began to decline, we faced the question of whether the client should start to divest. From a money management view, no one should have 90% of assets tied to any stock. Meanwhile, we had the SEC transfer restrictions to contend with and the fact that markets very carefully track trading by corporate executives.
Meanwhile, we had a spouse in a pending divorce proceeding who was intensely focused on the stock value. That’s entirely fair, but as the stock began to decline her focus became more obsessive. The implied message was: “You are allowing these assets to tank to harm me.” Recall that my client was staring at data indicating the company was growing. The stock market was unimpressed with that.
What to do? There were roughly 250,000 shares. So even a $1.00 decline in share price triggers an “ouch” response. We ran a quick analysis of how the other marital assets (roughly $3 million) would probably be divided and then assessed the likely minimum number share shares of the company stock wife would secure in equitable distribution. Let’s call that 100,000 shares based on the then $70-80 share value.
We notified wife’s counsel that while the shares had to remain in our client’s name until we concluded a settlement, husband would execute sales of up to 100,000 shares in accordance with wife’s written direction. Funds would be set aside to pay the taxes due on those sales. Wife would get the proceeds, all without prejudice.
Understandably, this got a very cautious reaction. Was this a game on husband’s part? We submitted it wasn’t, but was calculated to address wife’s concern about declining stock price. Husband had faith in his company and wanted to hold. Wife did not share that faith and wanted to lessen risk. This arrangement would allow her to do exactly that.
The other objection we got was that our offer was too thin. Wife claimed entitlement to far more than 100,000 shares in the settlement. Our response was that might be true and that we would settle for slightly more than that number of shares. But, that had to be a final settlement. What we were proposing was an interim solution to reduce risk to wife. And, if we didn’t settle and went to trial, each side could argue whatever it wanted in terms of a distribution.
Opposing counsel was wary to put this arrangement in writing, lest a court interpret it as an agreement to limit wife’s entitlement to 100,000 shares. Both sides acknowledged that this could be a risk even though we might put in writing it was without prejudice. So, we kept the writing to an agreement that if husband exercised and sold shares at wife’s request, money would be escrowed for taxes and she would get the proceeds without prejudice. The sales could only take place when the SEC allowed husband to sell and had to be a share quantity that would not rattle markets. If husband sold more than 10,000 shares at a time, investors in the market would soon know our client was the seller and infer the stock was a dog.
A really sound approach, right? Well, it was sound but it did not work well in this case. From a high of $80 in June, the stock kept slipping. By the end of June 2021, it went below the IPO price of $70. After that the stock was losing $10 in value every month. By April 2022, a year after the IPO, the stock was under $20. It has never recovered. Some shares were sold under this arrangement but the parties largely “held” thinking that price recovery was just around the corner. The case settled in Summer 2022, but by that time, the stock had lost 75% of the value Wall Street pinned on it when the IPO went public. Today the stock sits at under $15.
If you see this as a unique case, we had a similar one with an IPO going on a few years earlier. The stock in that second case went public in 2016 at $26. It rose to $80 but the Covid crisis dropped it to $20. By March 2021 it was back above $60. The case went to trial in Summer 2022 when it had declined to $35. Appeals held a final decree in abeyance until Spring 2024 when the stock was under $5. Today it’s at 50 cents. That was a case where there was no cooperation to diversify out of the IPO stock and the stock value bounced a lot between $20 and $80.
The lesson is that markets wait for no one. And, if more than 20% of your marital estate is invested in any one marketable security, both parties should study how they can effectively avoid the dangers of volatile stocks.