Post-Divorce Cash Flow and Financial Workability: Greed vs. Divorce Financial Planning
The New York case of Simkin v. Blank, infamous for its ties to Bernard Madoff, illustrates one of the common financial mistakes made in divorce. In this case, the parties retained respective ownership of separately-titled properties, including a brokerage account in the husband’s name, managed by the Madoff firm, which had an agreed-upon value of $5.4 million. To balance this exchange and effectuate what they believed to be a fair and reasonable division of marital property, the husband paid the wife $6.25 million and transferred to her $368,000 in retirement assets to equalize their retirement holdings.
Approximately two and a half years later, the Madoff brokerage account was effectively rendered valueless when Madoff’s Ponzi scheme was exposed. The husband asked the court to reform the agreement based on the doctrine of mutual mistake, but the court declined, stating: “This situation, however sympathetic, is more akin to a marital asset that unexpectedly loses value after dissolution of a marriage; the asset had value at the time of the settlement but the purported value did not remain consistent.” As the court emphasized, rescission or reformation of a property settlement is limited to “exceptional situations.”
One Chance to Get It Right
Absent factors such as fraud, collusion or duress, it is well-established that, once a stipulation of settlement is entered into or a divorce has been finalized, courts are reluctant to negate, reform or modify the terms. Without such finality, achieving closure for both litigants and the courts would be extremely challenging. If a client’s complaint is that he or she was uninformed, made a poor financial decision or did not properly handle the assets post-divorce, the likelihood of modification or reformation is, at best, slim.
What Went Wrong?
In retrospect, trading cash for the brokerage account turned out to be a major mistake by the husband. Was this poor judgment on his part? The settlement agreement was apparently prepared with great deliberation. According to the court, “The parties, represented by counsel, spent two years negotiating a detailed 22-page settlement agreement.”
Based on the size of this asset and the length of the deliberations, it would be fair to conclude that both parties had wanted a share of it and had probably fought hard to get it. The account seemed to have been producing 12% annual returns over a long period of time, with great consistency. But were these returns too good to be true? It turns out that the SEC had been alerted about the possibility this might be a Ponzi scheme several years earlier but had failed to act, and since that time, concerns by various financial entities had been publically raised. The problem was not that the husband had been duped, but that he had ignored a basic principle of investing. He had increased his risk by failing to diversify his holdings and had effectively “put all his eggs in one basket.”
Financial Mistakes Are Common in Divorce
Although the mistake made by the husband in the Simkin case was associated with a Ponzi scheme that had yet to be exposed, his actual mistake was that he ignored a basic principle of investing — diversification.
Financial mistakes are fairly common in divorce proceedings, primarily due to the following:
- Divorce, like marriage, is an emotional process. In this case, the husband may have been driven by greed, a need to “win,” a strong emotional attachment to the brokerage account or a whole host of other emotional factors;
- Financial illiteracy, in its various extremes, can make it difficult to understand fully the financial consequences of alternative scenarios or to manage financial outcomes successfully;
- Although outside experts for valuations and other types of investigative work are commonly used, divorce cases are not frequently informed by experts with lifestyle or financial planning expertise. This puts an unfair burden on the attorney, who often has limited financial planning education, training or experience.
A Case in Point: The Marital Residence
Mistakes associated with settling the marital residence, typically one of the largest marital assets, touch upon all three of these potentially problematic areas. Frequently, and often for emotionally driven reasons, one party will want to keep the house at all costs. While a sympathetic situation that can easily drive a case, it can be a serious disservice to the client’s financial (and emotional) health to pursue this course of action steadfastly without the client’s rigorous understanding of its financial consequences.
Housing costs are generally the largest budgetary expense item. As a general rule, the lower the income level, the higher the percentage of expenses that must be dedicated to housing and the lower the percentage available for food, clothing and other necessities. When home ownership and carrying costs are taken into consideration, maintaining the home can consume 50% or more of total household expenses. Aside from normal carrying costs, large and unanticipated expenses can arise, sometimes at inopportune times. And sometimes these expenses cannot be deferred.
To further complicate matters, if the house, generally an illiquid, non–income-producing asset, is taken by one of the parties in exchange for income-producing assets, less income will be available for support. The marital residence is a complex asset, and taxes and other financial issues need to be carefully considered. For example, if the parties continue to be financially connected through a mortgage, there is risk to both parties. Furthermore, if the new homeowner is unable to support the carrying costs on the house, that person, who may have exchanged retirement and investment assets for the home, is at risk for financial ruin, including the ability to become a homeowner in the future.
Need for Financial Expertise
Mistakes affecting post-divorce financial issues occur frequently during the divorce process. When they do occur, they are often difficult or impossible to fix. This article asks the following questions: Should the attorney play a role in educating the client about the post-divorce consequences of financial alternatives, or do the attorney’s responsibilities begin and end with the legal aspects of the case? What should the attorney’s level of involvement be? Given the financial complexities of the divorce process, should the process be informed by specialists with lifestyle and financial planning training and expertise?