Estate of Gimbel: The Cloud of Confusion Created in Valuing Large Blocks of Unregistered Stock
In reading the United States Tax Court's memorandum regarding the Estate of Gimbel, I could not help but be reminded of just how important it is to have a thorough estate plan in place. By thorough, I mean that aside from having all the appropriate estate planning documents in order, the estate's assets are arranged so that they systematically and as effortlessly as possible follow the scheme laid out in the estate planning documents.
Georgina Gimbel died owning 3,601,267 shares in Reliance Steel and Aluminum Company, a publicly traded company that had been founded by the uncle of her predeceased husband. Of those shares (which represented approximately 13% of the company's outstanding stock), approximately 3,548,450 were unregistered. This, along with the fact that the decedent held such a large number of shares so as to qualify her as an "affiliated person" under federal securities law, meant that the shares could be sold on the public market only under extremely limited conditions. Taking this into account, the estate argued for a 17% valuation discount, while the IRS was only willing to allow a 9% discount. Inevitably, valuation experts were hired, disagreements as to the proper method for valuing the stock ensued, and the case wound up before the U.S. Tax Court.
In its memorandum, the Tax Court addressed four different methods for valuing the unregistered stock:
- A secondary public offering;
- A private placement;
- a repurchase by Reliance Steel; and
- Selling the shares on the open market over time (the "dribble-out" method)
The court quickly ruled out the first two methods as non-viable options. A secondary public offering was impossible, given the fact that as of the valuation date, Reliance was considering purchasing another company. In order to conduct a secondary public offering, Reliance would have had to disclose that fact; a disclosure that would have been in clear violation of a related confidentiality agreement. A private placement was likewise unfeasible. First, the shares owned by the estate represented only a minority interest in Reliance, and the evidence presented showed market disinterest in acquiring anything other than an entire company. As a further deterrent, the SEC Rule 144 restrictions on the restricted shares would have been applicable to any entity which purchased the shares.
In the end, the court decided upon a complex hybrid method of valuation in which it utilized both the repruchase and dribble-out methods. The court held that, as of the valuation date, it was forseeable that Reliance would have agreed to repurchase 20% of the shares. It went on to calculate the value of the remaining 80% if they were "dribbled-out" onto the open market, over a span of time. For a detailed explanation of the hybrid valuation method adopted by the Tax Court, see its memorandum here, starting at page 19.
In summary, the process of valuing large blocks of unregistered and restricted shares can be a very complicated one that unquestioningly results in a sizeable portion of an estate's resources being utilized for experts' fees. When advising clients concerning their ownership in marketable securties, it is important to keep the Estate of Gimbel in mind, and take preventative steps to ensure the least amount of confusion over valuation.
For additional explanation of the Tax Court's reasoning in Estate of Gimbel, see this article by John A. Bogdanski.
