HOLD ‘EM OR FOLD ‘EM? Volatile Assets During Divorce
The assets we write about are nice ones to own. Philadelphia is home to a significant research and technology investment community. Pittsburgh also hosts these kinds of businesses. They can create special problems in a divorce context because of how the players who run these businesses are compensated. Typically, they earn a salary far less than their brethren at Merck, Pfizer, IBM or DuPont. But then they are handed gobs of stock or stock equivalents in the form of warrants, stock units, or options. These are essentially valueless until the day comes when the private company goes public or sells out to their bigger S&P500 sisters.
When companies like this become publicly traded things can get a little crazy. In coordination with their sponsoring underwriters the company tries to determine a target price at which to go to market. The investment world is standing at the door clamoring to buy the stock, but they want it at the right price. And what is that price? You only know when everyone takes the limo to Wall Street and they ring the gong to announce that there is now a public market for everyone to buy and sell the stock that had no ascertained value a day before.
We have had a couple rounds of this in recent years. At or about the time a couple separates one of the spouses is working for StartUp Inc. The salary is $100,000 but when she joined the company they gave her 200,000 options at $1.00 a share. In April 2021 the company went public at 75.00 a share. In the next few days it dipped to $70 but then rose to its all-time high of $80. The parties had recently separated and until the stock hit the market their balance sheet looked like a lot of other folks. House with equity; 401K plan; IRA and some after tax investments. All in, the sum of these assets was, perhaps $1-1.5 million net. Then, suddenly the 200,000 options came to life and mirabile dictu, this was now a $16 million case. Bear in mind that $15 million of that sum was pregnant with a HUGE tax liability.
Our client was a senior executive and therefore classified as an “insider” when it comes to trading these stocks. Those who are defined as “insiders” by the Securities & Exchange Commission must report their trading to that agency which posts it for the world to see. The people that funded the company during its incubator days don’t want to see their managers dumping the now valuable stock because it signals to the world that they think there is nothing to gain by holding it. So, that’s an issue. Then there are these impediments called “blackout periods” where insiders are not allowed to trade stock. These periods are prescribed by regulation and relate to when the company reports its earnings to the public. Thus, our client might want to sell stock when it hit $80 but was not allowed to do so because of the federal regulations.
The sad news was the couple was getting divorced. The good news is that wife’s hard work starting a company had just yielded an immense (albeit pretax) payoff. The bad news, not so bad really, was that there were both management pressures and regulatory prohibitions on when and how much stock they could sell. Both spouses realized that it’s not wise to have 90% of your wealth tied to what was still a start-up company.
The challenge along the way is that every time the stock goes up $1 you gain $200,000. And every time it goes down $1 there is a corresponding loss. This can be a little daunting when you spent 20 years accumulating the first million in assets. It’s much like the difference between a ride on a carousel and one on a bucking bronco; except there is no easy way off this lucrative animal.
What made the problem in this case more challenging was the fact that after the stock hit $80/share in May 2021 it started to gently fall. It did so despite quarterly revenues and earnings which continued to climb. This produced a lot of inter-client and inter-lawyer traffic about how/when to sell and diversify to broader and less volatile investments.
To remedy this, we proposed to our client’s spouse and his attorney that while the options remained titled in our client’s hands we would trade half of it (100,000 options) in accordance with her spouse’s written instructions. We also agreed to notify the spouse each time our “insider spouse” elected to sell shares. Obviously as an insider, our client had better information from which to assess whether to sell. Our proposal met with blow back. “Why should we not get 60% of the options since that is what a court would order if we were at equitable distribution?” Our response was we would agree to a bit more than 50% as part of an overall settlement but not on an interim basis. Our proposal was never accepted formally but suddenly my client was getting orders from her spouse to sell shares. She understood that she could control whether to honor sales that would rise above half of holdings so this arrangement worked out without a formal agreement in place. We kept track of the trading husband directed.
The reason we did this was to share the pain of the fluctuations in market price. If the stock suddenly tanked, the spouse could claim that we let it happen and did not protect the value by selling sooner. Meanwhile if our client sold on her own and the stock went up after the sale, we would be blamed for not getting enough.
Our story shows how the problem of volatile assets can be dealt with. It does not end happily because both parties chose to believe that the market would respond favorably to the company’s individual economic performance (growth in sales and earnings). Unfortunately, that data never caught fire with the investment community such that by year end 2021 the stock was at $43. In December 2022 it closed at $13. And in December 2023 the price closed at $25. Our news feeds fill with reports about the stocks that took off once offered to the public and never looked back. Alas, in this case the 200,000 options that “opened” at a market value of $15 million are today worth a mere $5 million. The silver lining is that during their divorce the parties did sell a fair portion of their holdings in the $60 price range.
This story is not unique. We have had clients who focused almost all their investments in the once revered General Electric. Their faith was so great that they margined the stock to pay their monthly expenses. As the storm winds of the 2008 recession were starting to form the stock was trading at the equivalent of $230 a share. By the time that recession bottomed out in March 2009 GE was at $60. One afternoon while I was with my client in a judicial conference trying to settle his divorce, the client received a call in the courtroom notifying him that the brokerage was calling the margin loan and selling his stock for 25% of what it was worth when he borrowed against it. The lesson is that the big dogs like GE can fall too. Before the pandemic Boeing traded at over $300 a share. A global travel crisis and some loosely bolted doors have taken it to $211. From October 2021 to November 2022, Meta (Facebook) lost 2/3 of its market value only to bounce back to new highs today.
The general lesson is to maintain a diversified portfolio. Yes, your startup company may confer immense wealth on you when it goes public, but the public is a fickle buyer and sometimes sales and income growth just aren’t enough. If you separate while holding high concentrations of any stock, but especially stock in a newly traded company, you need to pay attention to how you can effectively make your portfolio more balanced. That is a shared interest even if you and your spouse no longer like each other on the way out.
