When dividing assets in a high net worth divorce, few investment vehicles present as many challenges as restricted securities. Unlike publicly traded stocks that can be valued and divided with relative ease, restricted securities come with legal constraints, valuation complexities, and tax considerations that can dramatically impact your settlement outcome. Understanding how to properly handle these assets can mean the difference between a fair division and leaving significant value on the table.
Restricted securities are shares that cannot be freely sold on the open market due to SEC regulations, typically because they were acquired through private placements, employee compensation packages, or pre-IPO investments. These securities carry both tremendous potential value and significant limitations that complicate their division in divorce.
The Nature of Restricted Securities
The defining characteristic of restricted securities is their illiquidity. When an executive receives stock in a private company or participates in a secondary offering under Rule 144, those shares typically cannot be sold immediately on public markets. The SEC imposes holding period requirements and other restrictions to protect investors and maintain market integrity. For divorcing couples, this creates a timing problem: how do you fairly divide an asset that neither spouse can immediately monetize?
In Texas, where community property principles govern divorce, restricted securities acquired during marriage generally constitute community property subject to division. However, the practical challenges of dividing these assets require sophisticated planning and often creative settlement structures that account for their unique characteristics.
Consider a technology executive who received restricted stock units as part of a compensation package. These RSUs may have vested during the marriage, creating community property rights, but they remain subject to company-imposed restrictions on transfer and sale. The executive might face lock-up periods following an IPO, contractual restrictions on sales during certain windows, or company policies requiring pre-approval before any transaction. These restrictions don’t disappear in divorce—they continue to govern both spouses’ ability to access the value of these securities.
Valuation Challenges and Approaches
Valuing restricted securities presents the first major hurdle in divorce proceedings. Unlike publicly traded stocks with readily available market prices, restricted securities often lack an established market value. For private company stock, there may be no recent arm’s length transactions to reference. Even for public company restricted stock, the appropriate discount for lack of marketability becomes a contentious issue between spouses and their experts.
Forensic accountants and business valuation experts employ several methodologies to value restricted securities. Income-based approaches project future earnings and apply appropriate discount rates. Market-based approaches compare the company to similar publicly traded firms or recent transactions in comparable businesses. Asset-based approaches may be appropriate for certain types of companies, particularly those with significant tangible assets.
The discount for lack of marketability—the reduction in value attributable to transfer restrictions—often becomes a battleground in high net worth divorce litigation. Studies have shown these discounts can range from fifteen to forty percent or more, depending on the length and nature of restrictions. A spouse arguing to be awarded other assets in lieu of restricted stock has an incentive to minimize the discount, while a spouse seeking to retain the restricted securities may argue for a larger discount to reduce the equalization payment owed.
Texas courts generally require expert testimony to establish the value of closely held business interests and restricted securities. The trial court has discretion to accept or reject expert opinions, but must make some determination of value to divide the community estate. Courts typically consider the entire financial picture, including liquidity constraints, when fashioning a just and right division.
Tax Considerations in Division Strategies
The tax implications of dividing restricted securities often eclipse the valuation complexities. Different types of restricted securities trigger vastly different tax consequences, and failing to account for these differences can result in an economically unfair division even when the nominal split appears equal.
Restricted stock units, for instance, are generally taxed as ordinary income when they vest, with the company withholding taxes at the time of vesting. If RSUs vested during marriage but before divorce, they constitute after-tax community property. However, if they will vest post-divorce according to a vesting schedule based on pre-divorce employment, proper characterization becomes critical. Texas courts apply a time-rule approach to determine the community portion of such compensation.
Incentive stock options present even more complex tax scenarios. ISOs receive favorable tax treatment if specific holding period requirements are met, with gains taxed as long-term capital gains rather than ordinary income. However, transferring ISOs to a spouse incident to divorce can be accomplished under Internal Revenue Code Section 1041 without triggering immediate taxation, provided the transfer is properly structured. The receiving spouse then assumes the original holder’s basis and holding period, along with the potential for either favorable ISO treatment or disqualifying disposition.
Restricted stock awards that have vested but remain subject to trading restrictions require analysis of whether the original grant was made with or without a Section 83(b) election. If the recipient elected under Section 83(b) to recognize income at grant rather than vesting, the tax basis may be significantly higher than if no election was made, affecting the future capital gains tax burden when restrictions ultimately lapse.
Nonqualified deferred compensation tied to restricted securities creates another layer of tax complexity. ERISA and tax code restrictions on assignment may limit how these assets can be divided. A qualified domestic relations order may be required for certain types of deferred compensation, though not for all restricted securities. Attempting to divide these assets improperly can trigger immediate taxation and penalties that destroy much of their value.
Division Strategies and Settlement Structures
Given the valuation uncertainties and tax complexities inherent in restricted securities, divorcing couples and their attorneys employ various strategies to achieve fair divisions while managing risk.
The most straightforward approach involves one spouse retaining the restricted securities while the other receives assets of equivalent value. This works best when sufficient liquid assets exist to effect an equalization payment. For a spouse receiving a $2 million award of restricted stock, the other spouse might receive $2 million in cash, marketable securities, or real estate equity. This approach provides certainty and allows each spouse to manage their own post-divorce investment risk.
However, when restricted securities constitute the majority of the marital estate or when their value is highly uncertain, creative alternatives become necessary. Some couples agree to a delayed division, with the restricted securities transferred to the non-employee spouse once they become freely tradable. This approach requires trust and continued cooperation, which may be challenging in contentious divorces.
Contingent payment structures offer another solution. The spouse retaining the restricted securities might agree to pay the other spouse a percentage of the net proceeds when the securities are eventually sold. This aligns both spouses’ interests in the ultimate value realized and eliminates disputes over current valuation. For instance, the settlement might provide that the non-employee spouse receives forty percent of the after-tax proceeds from any sale of the restricted securities within five years of divorce, with the payment obligation terminating if no sale occurs within that timeframe.
Some sophisticated settlements use trusts to hold restricted securities for the benefit of both spouses until restrictions lapse. The trustee manages the securities and distributes proceeds according to the agreed formula once restrictions terminate and sales can occur. This approach works particularly well when both spouses want to participate in potential upside but need a neutral party to manage the asset.
For divorcing executives in pre-IPO companies, the uncertainty of future value requires particularly creative structuring. The spouse retaining the securities might provide a guaranteed minimum payment to the other spouse, with additional payments if the company successfully goes public and shares can be sold above certain thresholds. These arrangements function similarly to contingent earnouts in business acquisitions, allocating risk and reward between the parties based on future events.
Restrictions on Transfer and Compliance Issues
Beyond valuation and taxation, the actual mechanics of transferring restricted securities in divorce require careful attention to securities law compliance and contractual restrictions. Many restricted securities are subject to shareholders agreements, right of first refusal provisions, or outright prohibitions on transfer. Violating these restrictions can void the transfer or trigger company remedies including forced buybacks at unfavorable prices.
Private company stockholder agreements frequently require board approval before any transfer, even between spouses in divorce. Some agreements prohibit transfers entirely except to the company or to approved buyers. When restricted securities cannot be transferred to the non-employee spouse due to such restrictions, the settlement must account for this through other means—typically through the employee spouse retaining the securities with an equalization payment from other assets or through a contingent payment arrangement.
Federal securities laws add another layer of restrictions. Rule 144 under the Securities Act of 1933 governs the resale of restricted securities and requires, among other things, holding periods and compliance with volume limitations. Even after divorce, a spouse receiving restricted securities remains subject to these requirements. Transfer of securities as part of a divorce decree does not reset holding periods, but proper documentation is critical to preserve this treatment.
In Texas, transfers of restricted securities incident to divorce should be clearly documented in the divorce decree or property settlement agreement. The decree should specify that the transfer is made pursuant to the divorce and qualifies for tax-free treatment under Section 1041. It should also address who bears responsibility for compliance with securities laws and company policies, and who will manage any required filings or approvals.
Planning Considerations for Business Owners
For business owners anticipating divorce, advance planning around restricted securities can prevent many complications. Prenuptial or postnuptial agreements can specify how restricted securities will be valued and divided, potentially eliminating the need for expensive expert battles. These agreements might establish formulas for determining value, specify discounts for lack of marketability, or provide that one spouse will always retain business interests with equalization through other assets.
Stockholder agreements should anticipate divorce scenarios. Well-drafted agreements might give the company or other shareholders a right of first refusal if restricted securities must be transferred in divorce, or might establish valuation mechanisms that will apply in such situations. These provisions protect the business from unwanted new shareholders while providing clarity for divorcing spouses about how their holdings will be handled.
For executives receiving restricted securities as compensation, maintaining clear records of grant dates, vesting schedules, and tax elections is essential. This documentation becomes critical for properly characterizing which portions of restricted security holdings are community property versus separate property, and for allocating tax basis correctly between spouses. Time spent organizing these records before divorce can save substantial legal and accounting fees later.
The Role of Expert Advisors
Successfully navigating restricted securities in divorce almost always requires a team of specialized advisors. A business valuation expert can provide credible opinions on the value of private company stock or appropriate lack of marketability discounts. A tax advisor can model the tax consequences of various division strategies and ensure compliance with Section 1041 requirements. A securities attorney can review transfer restrictions and advise on compliance with SEC regulations and contractual limitations.
In Texas, parties in high net worth divorce cases increasingly use collaborative divorce or mediation specifically to address complex assets like restricted securities. These alternative dispute resolution processes allow the couple to engage joint experts who can provide neutral valuations and tax analyses, often reaching agreement on technical issues more efficiently than through litigation. The informal setting also facilitates creative settlement structures that might not be available or practical in court-imposed divisions.
Restricted securities represent one of the most challenging asset types in high net worth divorce, requiring attention to securities law, tax code provisions, valuation methodologies, and creative settlement design. With proper planning and the right team of advisors, however, these assets can be divided fairly in a manner that respects both legal requirements and each spouse’s financial interests. The key is recognizing early in the divorce process that restricted securities demand specialized expertise and cannot be handled like ordinary investment assets.
How Anunobi Law Can Help
At Anunobi Law, we bring extensive experience in high net worth divorce cases involving complex financial assets and sophisticated legal issues. Our firm has successfully represented clients in matters involving valuation and division of restricted stock units, stock options, and private company equity.
Our team includes board-certified family law specialists and maintains relationships with forensic accountants, business valuators, tax professionals, and international legal counsel to provide comprehensive representation in the most complex divorce cases.
Contact Anunobi Law today to schedule a confidential consultation. We serve clients throughout Texas in high net worth divorce matters, including cases involving business ownership, executive compensation, international assets, and complex property division.
Legal Disclaimer
This article is provided for informational purposes only and does not constitute legal advice. The information contained herein is general in nature and may not reflect current legal developments or apply to your specific situation. No attorney-client relationship is created by reading this article or contacting our firm through this website. For legal advice tailored to your particular circumstances, please schedule a consultation with a qualified family law attorney. Laws vary by jurisdiction and change over time, so you should not rely on this information as a substitute for professional legal counsel.