BVWire Issue #148-4 | January 28, 2015


DOL scuttles ‘appraiser-as-fiduciary’ rule for ESOPs

The Department of Labor (DOL) will abandon the “appraiser-as-fiduciary” rule from its planned reproposal of a broader fiduciary rule, according to a report in Capital Action, a publication of the American Society of Appraisers. The proposed rule, in limbo for three years, would have classified appraisers as ERISA fiduciaries in connection with valuations of employee stock ownership plans (ESOPs).

Sigh of relief: Opponents of the proposed rule claimed that it would create a conflict between a fiduciary’s strict duty of loyalty to plan participants and professional appraisal standards, which require an appraiser to perform assignments with impartiality, objectivity, and independence. Appraisers also feared that the rule would force them to buy expensive fiduciary insurance, hire specialized counsel, and expose them to unwarranted litigation. “This likely would have made the provision of ESOP valuations cost prohibitive for all but the largest firms,” says the ASA report.

BVWire is pleased to acknowledge the efforts of the ASA and other organizations and individuals who urged the DOL to rethink its position.

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New research backs up idea of a ‘conditional’ size premium

The existence of the size premium has been challenged in recent years. But a new working paper says that a “robust” size premium can be observed after controlling for firm quality.

Control your junk: The size premium, or size effect, is based on empirical evidence that smaller listed firms tend to have higher returns than larger firms over long time periods. The dominant theory explaining these observations is that stocks of smaller firms outperform because they are riskier than larger firms. The authors of the new paper contend that previous evidence on the variability of the size effect is largely due to the volatile performance of “junk” firms, which are unprofitable, stagnant, or poorly managed companies. “Controlling for junk, a much stronger and more stable size premium emerges that is robust across time,” say the authors.

This new research confirms that the size premium is conditional and that it is more complex than the simple notion that smaller firms have higher returns than larger ones. Coincidentally, as this new research was being released, Business Valuation Update released an interview with Michael A. Crain (The Financial Valuation Group), who discussed his own research on the size premium. Crain has also found that the premium exists in listed firms but under certain conditions.

Contrary to theory: “The new paper acknowledges that the size premium diminished or disappeared in the 1980s and 1990s after Rolf Banz first documented it, which triggered important questions about this phenomenon,” Crain tells BVWire. “This study claims that the premium can still be observed conditionally during this period by controlling for the quality of firms. In short, the components of quality are profitability, profit growth, safety, and payout. The research also finds that smaller listed firms tend to be ‘junky’ and larger listed firms tend to be quality. Contrary to risk-based theory, the study finds junky firms (presumably riskier) do not generate higher returns and instead quality firms seem to drive higher expected returns.”

The new paper is titled “Size Matters, if You Control Your Junk,” from AQR Capital Management LLC and researchers from New York University and the University of Chicago. The Crain interview is in the February 2015 issue of Business Valuation Update (subscription required).

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Analysis finds that different BV standards do not conflict

Critics of the business valuation profession sometimes point to the five sets of BV standards that they say are confusing and that conflict with each other. However, a new analysis reveals that this is not the case.

In harmony: Mark Hanson (Schenck SC) and Mark Kucik (Kucik Valuation Group) have prepared a side-by-side comparison of the business valuation standards set by NACVA, IBA, AICPA, ASA, and USPAP. The authors’ intent is to show that all the standards are essentially addressing the same issues and do not conflict. Hanson and Kucik have graciously made the analysis available to everyone via BVR’s Free Resources page.

“We started this chart to address the concerns of the SEC and other regulatory agencies that the standards are confusing and that they conflict with each other,” says Hanson. Taking a look at the standards side by side was an eye-opener. “They’re not really that different,” says Kucik. “Yes, there are some subtle differences but the principles are very close.”

Where the chart shows differences, it can be interpreted as being covered in one of the other standards but worded a little differently. “These standards do not conflict and they all basically say the same thing,” says Hanson.

The authors hope that their analysis can be used as a starting point toward a unification of accepted standards by the various organizations.

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Ruling reveals Delaware Chancery’s skepticism of valuation experts

The valuation opinions of nonexperts can be a useful reality check on the opinions of bona fide valuation experts, says the Delaware Court of Chancery in a case that involves an increasingly popular technique known as “appraisal arbitrage.” The court’s finding applies to other cases involving valuation matters.

Discovery dispute: Two investment firms bought millions of shares in Dole stock as part of an “appraisal arbitrage” strategy. This technique involves acquiring stock in a company that’s a takeover target. Then, the investors try to squeeze more money from the buyers by opposing the takeover and petitioning the court for a fair value appraisal. During discovery, Dole tried to obtain from each of the petitioners internal valuations they had done of Dole prior to the litigation as well as valuations done in connection with buying and selling stock and the appraisal action. The firms resisted production of the documents, arguing that the valuations were not the work of valuation experts and, therefore, were not admissible in court.

Dole filed a motion to compel disclosure of all prelitigation valuation-related information, even if laypeople prepared it.

‘Battle-of-the-experts’ cliché: The court noted that under the discovery rules generally anything not privileged was discoverable as long as the material was relevant. Importantly, the relevant material need not be admissible but need only appear “reasonably calculated to lead to the discovery of admissible evidence.” The court called this aspect “potential admissibility.”Here, the firms soon realized that they could not claim the valuations Dole wanted were irrelevant. Instead, they argued that none of the material or testimony would result in admissible evidence. The prelitigation valuations were opinions, not facts, and valuation in an appraisal action was “purely a matter for the experts,” they claimed. After all, many courts have talked about “the battle of the experts.” Since the witnesses were not experts under Rule 702, they could only give lay opinions under Rule 701, but these did not fit into the narrow exceptions for the admissibility of lay opinions.

The court said the petitioners presented an “idealized depiction of valuation as a scientific process” when the “martial metaphor suggests the need to consider other evidence as a check on the warring experts’ model.” One piece of evidence was the contemporaneous view of financial professionals “who make investment decisions with real money.” The firms’ internal valuations represented “real-world” assessments by “astute” investors. As such, these value opinions may “be as or even more credible than the litigation-crafted opinions of valuation experts.”

The witnesses in this case “likely” could qualify as experts, the court said. But, even if they were deemed lay witnesses, their opinions could come in under Rule 701 because the assessments would be helpful to “the determination of a fact in issue.”

Takeaway: Valuators should take a look at this case not only because it provides information on what’s discoverable, but also because it gives insight into the court’s perception of the valuation profession. The Chancery finds lots of support for its skeptical attitude toward valuation expert testimony in case law and the academic literature and lays it all out.

Find an extended discussion of In re Dole Food Co., 2014 Del. Ch. LEXIS 258 (Dec. 9, 2014) in the March issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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Appraisal Foundation seeks board candidates

The Appraisal Foundation (TAF) is searching for candidates to serve on its board of trustees. Trustees provide oversight to the Appraisal Practices Board (APB), Appraiser Qualifications Board (AQB), and Appraisal Standards Board (ASB). Four at-large trustee seats are available, with at least one of them earmarked for an individual who represents the interests of consumers. The board meets twice a year, in the spring and fall. Trustees are reimbursed for travel expenses but are not compensated for their time.

Completed applications must be received no later than April 1. The individuals selected for the board of trustees will serve three-year terms beginning Jan. 1, 2016. Click here for an application package.

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BV movers . . .

People: Michael E. Fleenor has been admitted as a shareholder of Dent K. Burk Associates PC and is based in the Bristol, Va., office … Bryan Graiff was promoted to partner in charge of transaction advisory and litigation support at Brown Smith Wallace in St. Louis … Jeremy Smith was promoted to managing director at Financial Research Associates and is in its Bala Cynwyd, Pa., office … Rebekah Smith was named partner of Forensic and Dispute Advisory Services at the GBQ Holdings office in Columbus, Ohio … Michael D. Sullivan was promoted to managing director, business development in the Northeast Region for the Valuation & Advisory Services Division of Gordon Brothers Group, a global advisory, restructuring, and investment firm in Massachusetts.

Firms: Baker Corbett and Geary and King McNamara Moriarty, both servicing the Greater Boston area, have merged … Baker Tilly International has acquired the Barbados accountancy firm, Ayub Kola & Co.

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CPE events

Are you using a biased measure of statistical central tendency? Find out by tuning in to our next webinar, which is Part 1 of BVR's 2015 Special Series on Financial Modeling.

Using Regression Analysis To Value Small Controlling Interests (January 29), featuring Robert Dohmeyer (Dohmeyer Valuation Corp.) and Peter Butler (Valtrend). The harmonic mean is a popular measure of statistical central tendency. However, it should be avoided because it is biased, according to the presenters. They review the statistical fundamentals for use in a business valuation and show how a statistical regression approach is the most accurate way to use statistical data to accurately estimate the fair market value of your subject company.

Then, next week will be Part 2 of BVR's 2015 Special Series on Financial Modeling.

Advanced Lattice Modeling for Equity and Debt Securities (February 3), featuring Jason Andrews and John Sawyer (both with Alvarez & Marsal). In this webinar, the speakers will present several approaches to valuing complex equity and debt securities, including the identification of a security’s features and payoffs that require a lattice model instead of a closed-form solution. In addition, the speakers will share their opinions and potential pitfalls when utilizing lattice models

Another upcoming webinar of interest:

  • Buy-Sell Agreements (February 12), featuring Brian Burns and Chris Mitchell (both with Dixon Hughes Goodman).

Note new date: Valuations for Complex FLPs (February 24), featuring Bruce Johnson (Munroe, Park & Johnson Inc.).

We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Fiduciary rule KO'd

Size effect research

BV standards analysis

Court OKs lay opinions

TAF seeks board candidates

BV movers

CPE events








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