Advice for Couples in 2012, Including How to Balance Power in Your Marriage!
One of the most common problems I see arising in (and sometimes leading to) any divorce action is a lack of financial transparency between the spouses or partners. Often, over time, and for various personal, practical and familial and historical reasons, one party has assumed a dominant or exclusive role in the management of community assets, including depository accounts, real estate, investments, and small businesses.That role effectively puts a managing spouse in a position to have vastly superior information about the family finances, and the power to act on such information in the context of divorce to the detriment of the non-managing spouse. This may wind up prejudicing one party if the relationship ends.
It has been my repeated experience that, in anticipation of a divorce action, an unethical or abusive spouse will take strategic steps to hide assets and obfuscate the methods used to hide them. The ramifications to the non-managing spouse can include not only an unfair disbursement of community assets upon resolution of the case, but also manifest into reduced calculations of temporary and permanent spousal support and child support.
California family law attempts to minimize the potential for financial
fraud during the life of a divorce action. For example, it creates rules
for mandatory disclosures of assets. It creates fiduciary duties for managing
spouses. It creates methods for discovery of financial and asset information
(but only in the context of a legal action, after the relationship has
broken down). It creates pre-judgment and post-judgment penalties for
In a perfect world such legal tools alone would fully prevent the potential for financial dishonestly between separating spouses. But the reality is that the law routinely fails to protect the financial interests of the non-managing spouse in this regard, and the root cause of that failure occurs because non-managing spouses don't take steps to equalize the playing field when it comes to information about family finances during the course of the marriage. Stated another way, individual non-managing spouses are often unable to utilize the tools that the law provides to ensure they receive a just and equitable share of the fruits of the community's efforts during the course of the marriage because they lack the information necessary to have their lawyer fully protect their interests. Too many non-managing spouses wait until the time of separation to learn about the family finances. By then, non-managing spouses and their attorney are playing catch up, and not always winning. As such, it is of paramount importance that a non-managing spouse be proactive in learning as much information about the family finances as possible, and do so not only on the eve of a divorce, but also during the entire course of the marriage itself. In this day and age, knowledge is the coin of the realm.
Economists recognize that one source of market failure (i.e. inefficient allocation of resources) is caused by a phenomenon called asymmetric information. Asymmetric information affects decisions in transactions where one party has more or better information than the other. In adverse selection models, the ignorant party lacks information while negotiating a contract to the transaction. Common examples of information asymmetry include 'insider' trading in the stock market, or buying a 'lemon' used car. Understanding and combating asymmetric information is crucial to economists because market failure leads to net losses for society as a whole. Understanding and combating asymmetric information should be equally important to the non-managing spouse and his/her attorney because of its strong potential to lead to inequitable settlements or trial results. In the economic sense, asymmetric information between spouses about the family finances is a form of market failure. To be sure, if you are contemplating or undergoing a divorce action, you will (in most cases) effectively be negotiating a transaction that will bind you and impact your financial future.
The best way overall way to combat a managing spouse 's tendency to commit acts of misfeasance or non-disclosure regarding financial interests is to equalize the flow of financial information from the very outset of the marriage, with information parity being a non-managing spouse's goal.
Hand-in-hand with the goal of information parity is a mindset that fosters such parity being present throughout the marriage. That mindset is, simply stated, one of equality and mutual appreciation. Two people will divide labor in a marriage so as to maximize their relative strengths and weaknesses, and in so doing the synergy benefits the martial community as a whole to a greater extent than either person could do individually. Economists refer to this phenomenon as comparative advantage, and recognize that such a situation is optimal in the context of maximizing social utility. So too is comparative advantage optimal for managing a household.
As a simple 'traditional' example, assume Chris and Pat are married. Chris has a greater income earning potential due to holding a doctorate degree and having a good network of people to whom Chris is favorably known in the locale. Pat has greater domestic abilities due to having a bachelors degree in nutrition a work background in home decor. Based on these comparative strengths, Chris and Pat decide that Chris will work full-time and Pat will take care of the home full-time. Pat's excellent meals keep Chris energized and in good health. Pat's superior aesthetic tastes keep Chris in style with cool cloths. Chris's boss comes over for dinner and is impressed by the feng shui of the domicile. Over time Chris gets promoted and raises. Chris uses the additional income to make financial investments, go on vacations with Pat, and purchase a better home. By Chris and Pat each doing what they are relatively strong at, they, both individually and as a whole, are made economically better off. But more to the point, it is their interdependence that necessarily caused the mutual gain. The law recognizes this fundamental principal in the context of divorce by creating the concept of community property; that regardless of whether it was Chris's paycheck that allowed for the growth of assets, Pat's contributions to Chris's earned income are equally important and therefore necessitate equal division should Pat and Chris's relationship end. So as to a non-managing spouse's mindset, I strongly encourage all such people who are contemplating marriage, married, contemplating divorce, or involved in a divorce have one that recognizes their contributions to the community and requires takes a role.
On the practical side of things, here is a list of information parity objectives that I believe healthy marital relationships should achieve:
- Spouses should store copies of written financial documents in a safe place and where the other spouse doesn't have access.
- Spouses should have all depository, investment, retirement, and debt account numbers written down in an asset ledger. Annual inventories of all assets with a value over $500.00 should be maintained and signed off on by spouses and kept in the asset ledger.
- Spouses should keep copies of income information, including payroll stubs and other documents showing income such as rental checks from investment property or brokerage statements from securities dealers.
- Spouses should copy and store all financial account information from banks savings and loans, credit unions, particularly monthly statements. Spouses should also copy and store other banking information such as passbooks, check registers, and deposit slips.
- Spouses should agreed to have all financial information statements should be sent to each spouse individually, directly from the applicable financial institution, and be received only at that spouses primary residential address (and not, for example, at a business). If one spouse insists on receiving their financial information from home or stops receiving financial information mail at the residence, it is often a red flag.
- Spouses should maintain copies of tax documents, including personal tax returns and business tax returns, and attached forms, for the preceding five years.
- Spouses should receive and keep business financial statements, including net worth and income statements, in the case of a small business.
- Spouses should keep copies of all wills and trusts, and attachments thereto (such as a grant deed that has been recorded in favor of a trust for the benefit of the spouses).
- Spouses should keep copies of all life insurance policies.
- Spouses should keep copies of all outstanding debts incurred during the marriage that are in either spouses name.
- Spouses should keep a list of all personal and real property owned prior to the marriage.
- Spouses should keep a list of all safe deposit boxes and their contents.
Other tips you should know about and red flags you should watch out for to protect you from an unscrupulous spouse:
- Don't wait until things are going badly in the relationship to achieve financial information parity. Work towards that goal from the outset.
- Conduct asset searches of your spouse's biographical information by professional third-parties on an annual basis.
- Be aware that there is a statistically higher incidence of spouses hiding money in their second, third, or later marriages.
- Its best to have only a certified public accountant prepare the spouses' tax returns (as opposed to 'bookkeepers' of other unlicensed persons acting as pseudo-accountants), as they are subject to professional conflict of interest rules. Do not sign any document seeking your informed consent to waive any conflict of interest rules with respect to accountants without consulting an attorney.
- Particularly in the case of a small business, become knowledgeable about the business's employees, its normal income, its normal expenses, and how it accounts for them. A small business in particular is breeding grounds for accounting tricks to make it appear less valuable. I have seen this occur by the managing spouse: favor/incentivize cash payments from customers, funnel personal expenses as payments from the business, creating and paying fake employees (including the spouses' own children) and then voiding the uncashed checks after the divorce is final, or delaying new long-term business opportunities (i.e. taking new customer orders, signing new clients, or receiving transfers from escrow-like accounts such as paypal.com). It's important to be familiar with the inner-workings of a small business so you can note when something is amiss. Carefully review and copy customer/client payment agreements and accounts where a small business operates on a largely cash basis.
- Review financial statements on a regular basis. It is easier to access and digest three months of recent transactions than five years of relatively distant transactions. Look out for large or out-of-the ordinary deposits or withdrawals, and try to trace the source/end-point of the transaction to the best of your ability.
- Be aware that municipal bonds and certain savings bonds, because they are tax-free, are not reported to the IRS and therefore can be a vehicle for asset hiding because they do not need to be disclosed on tax returns. Look out for large investments in these assets.
- Non-managing spouses should be careful about signing joint tax returns that claim large deductions for various expenses, particularly in the case where a small business is involved. Although it might mean a larger tax burden in a particular year, in the context of a divorce it often results in lower spousal support and a lower business valuation, with attestation proof presented to a judge in the form of your signature.
- Big changes to the administration of finances can be a red flag: applying for large new loans, the closing of a bank account or change to an investment portfolio, particularly without the input of the non-managing spouse, might give opportunity to hide money.
- Know your spouse's boss well, and make sure they like you. I have experienced collusion between employers and employee so as to show short-run decreases (bonus or raise deferral) to income agreed on increases after the divorce is complete. If you separate from your spouse, let your spouse's boss know that event has occurred in writing.
- Do not sign deeds or other papers concerning real estate papers without consulting an attorney.
- Watch out for bank accounts opened in the name of spouse's children, as they do not get listed on that spouse's tax statements they can be a method of hiding community assets.
- Also watch out for overpayments on taxes. A managing spouse may try to receive a tax return later after the divorce is final by overpayment now, or alternatively filing amended taxes.
- Avoid 'loans' to friends or family.
- Be a Missourian, i.e. don't take your spouse's word. Have the managing spouse show you with the documents that corroborate what they tell you about the family finances.
- Don't allow fear of ruining the relationship, cultural values, or laziness prevent your pro-activity in becoming astute in the family finances. Defensive responses to your inquiries and requirements for financial information parity by the managing spouse may indicate diversion of community assets.
- Always remember that the burden of proof rests on the accuser, not the accused, to prove diverted assets to a court. Take all actions to protect your interests with this rule in mind.
These are my thoughts at the end of 2011 - I wish each of you, and each of us, a Happy New Year in 2012, and I hope that we all strive to be transparent and ethical during the coming year!
Michael C. Peterson, Esq. - Indio and Coachella Valley Divorce Attorney