News from SEC on IFRS, FASB on disclosure framework, and IRS on transfer pricing
The federal regulators and enforcement agencies were busy last week, dropping several new releases on or before Friday the 13th:
- The Securities and Exchange Commission issued its Work Plan for the Consideration of Incorporating International Financial Accounting Standards Into the Financial Reporting System for U.S. Issuers. Although the SEC Work Plan attempts an even-handed assessment, its introduction says it “did not set out to answer the fundamental question of whether transitioning to IFRS is in the best interests of the U.S. securities markets generally and U.S. investors specifically.”
The international regulators have already pushed back against what they see as a noncommittal response to convergence. “While recognizing the right of the SEC to determine the method and timing for incorporation of IFRSs in the United States, we regret that the staff report is not accompanied by a recommended action plan for the SEC,” says an IFRS release. "IFRSs have already achieved critical mass as international standards and … the momentum behind them becoming global accounting standards is irreversible.”
- The Financial Accounting Standards Board released its Invitation to Comment, Disclosure Framework, which solicits stakeholder input “on ways to improve effectiveness of disclosures in notes to financial statements of public, private, and not-for-profit organizations,” says the board’s announcement. Comments are due by November 16.
Earlier in the week, the FASB also voted to remove the loan loss contingency project from its agenda, indicating it would take no further action, but leave enforcement to efforts other than standard-setting.
- Responding to its well-publicized concerns over U.S. corporations “repatriating earnings” by transferring intangible assets—particularly intellectual property, such as patents—to international affiliates without an appropriate recognition of income, the Internal Revenue Service has just published Notice 2012-39. The new guidance applies to all such transfers on or after July 13, and relevant Treasury regulations will be forthcoming.
Market databases still critical to a majority of BV users, but lack of comparability frustrates many
The number of responses nearly doubled after keeping our online survey open for an additional week. But the percentages allocated among the answers remained the same, indicating a consistency among BV professionals on how they use and view the market approach and data. “I never reject the market approach,” said one respondent, who represents the 95% of BV professionals who use the market approach in their valuations of private companies. But lack of sufficient comparables and/or details behind private transactional data still frustrate some, as this one said:
Given all the complexities that go into what is behind the numbers of the “comparable” companies and given that the accounting I usually receive is not [always GAAP-compliant], it is difficult to ever use market approaches for anything other than sanity checks. You can spend days trying to reconcile the guidelines to your company and still never come close because there is just not enough information available about the guidelines to make useful conclusions.
When asked whether they consider guideline public company data to derive inputs for the income approach—specifically, to help determine a capital structure for the subject company—respondents were split, with approximately 48% saying “yes” and 42% answering “no.” The remaining 10% checked off the third option (“other”), indicating that the answer largely depends on the nature of the subject company and its access to public markets. “Yes and no,” said one in this camp. “If the data are comparable, yes. But many times the nature of the subject is either too small or too specialized to assume that the public company data are comparable.”
Just over three-quarters (76.1%) of respondents do not consult private transactions data to determine cost of capital inputs for a subject company. At the same time, the vast majority (92%) say they do use public company data (e.g., from Ibbotson’s or Duff & Phelps). “Yes!” answered one:
The use of public company data to determine an equity risk premium or size premium is different than the use of public company data in the market method. In the buildup method, for example, public company data are used to determine the risk characteristics of different classes of investments. [The analysis] does not involve comparing specific public companies to the subject private company.
Get current with the uses (and misuses) of the market method: Tune in to The Market Approach Today: Deciphering Messages From Markets, Courts, and Common Appraisal Errors, featuring Robert Schlegel (Houlihan), Alina Niculita (SPV), and Chris Treharne (Gibraltar), on Thursday, August 2.
Expert does not need to know the law before taking a case
After purchasing a company for $45 million—and promising nearly half that amount in newly issued shares—the acquirer failed to register the stock with the SEC. A class of shareholders filed suit, claiming $14.5 million in damages, as calculated by their expert. The defendant first filed a motion to dismiss, arguing that the expert failed to apply the controlling law on damages. After losing that motion, it challenged the expert under Daubert. Since the expert hadn’t even heard of the controlling case before taking on this engagement, the defendant said he could not be considered an “expert on damages.”
As in its order on the motion to dismiss, the federal district court confirmed that the proper measure of damages for a breach of promise to register stock is controlled by Duncan v. TheraTX Inc., 775 A.2d 1019 (Del. 2001). Not only did the plaintiff’s expert correctly apply the law in this case, but “this court does not expect scientific, technical, or financial experts to know of particular cases that recite methods by which damages can be calculated, since the law is not their area of expertise.” Rather, “it is the quantification of inputs into the Duncan formula that fall into [the expert’s] expertise,” the court emphasized, in dismissing the Daubert motion. Indeed, the expert’s selection of inputs regarding the loss period and the pricing of shares, among others, was a matter for the trier of fact to decide.
The digest of the court’s first decision in Stuckey v Online Resources Corp. appeared in the February 2012 issue of Business Valuation Update; the court’s more recent Daubert ruling will be digested in the August issue. Both decisions are posted at BVLaw, as is the 2001 Duncan decision and its digest.
The FMV Restricted Stock Study—now updated!
We’ve just updated The FMV Restricted Stock Study and FMV DLOM Calculator with restricted stock transactions through 2011, so that both now include 744 screened transactions with up to 60 data fields for each. The database and the calculator are scheduled for updates every quarter. Highlights of the improvements include:
- Streamlined interface and reporting of summary statistics and transactions (view samples);
- A newly updated and expanded 2012 Companion Guide;
- Unlimited use of the FMV DLOM Calculator with a subscription to the database (one-time use is also available);
- Comprehensive and regularly updated FAQ page; and
- A selection process that reports the most relevant discount to the transaction (additional discounts are displayed in the detailed Excel download).
To learn more about the updates, please contact your account executive at (503) 291-7963, ext. 2, or email@example.com.
A new adjustment to value: the 'DLOU'
“I’ve just finished spending several hours participating in a lively online discussion about discounts for lack of marketability and controlling interests,” writes Rick Warner (Great Lakes Valuation). “But how many of you have heard of the DLOU: ‘discount for lack of understandability’?” That’s the adjustment judges often apply after reading an appraiser’s opinion, Warner explains. “And you can see how this might happen.” The judge receives two well-reasoned reports from otherwise qualified individuals. Here’s what the appraisers wrote about the marketability discount:
We relied upon the total revenues of the company issuing the restricted stock as a proxy for “size”; we then sorted the 597 transactions into quintiles and for each quintile determined the median size and median discount as of the transaction month as reported by the [blah-blah-blah database]. This analysis demonstrated that as the revenues of companies issuing restricted stock increases, the size of the discount associated with the restricted stock decreases.
What the appraiser meant:“Larger companies have smaller discounts than smaller companies.”
What the judge read: “Die großer Gesellschaften haben kleiner Diskonten als kleiner Gesellschaften.”
Read the rest of what Warner has to say about the little-known (but unfortunately oft-applied) DLOU at BVWire News. Followers can enjoy more wisdom from Warner along with “real-time” updates and reports from the BV world.
Delaware appraisal law is ‘broken,’ says noted prof
The Delaware statutory fair value standard expressly excludes any “element of value arising from the accomplishment or expectation of the merger," writes Professor Stephen Bainbridge (UCLA School of Law) in a recent blog. “Does that language make control premia irrelevant?” he asks. More importantly, in tracking Delaware decisions from the well-known Weinberger and Technicolor cases to the more recent Gearreald v. Just Care, Inc. (noted in last week’s BVWire), Bainbridge believes that “appraisal is now a crap shoot in which one can end up with less than the price offered in the merger.”
Consider: If the statutory fair value standard must exclude synergies, then “why would the target ever have a higher value as a going concern post-merger than pre-merger?” Bainbridge asks. Can you really square the use of market-comparable valuation method with the need to exclude synergies? And how does one credibly measure the amount of synergies to be backed out of the value?
In the end, Bainbridge questions why any “sane investor” would invoke appraisal rights when they seem to directly conflict with modern economic realities and serve no “useful purpose.” In fact, the law governing appraisal rights “appears to be broken,” he says, with the Delaware courts just “making this stuff up as they go along,” so that “perhaps the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.”
RICS publishes guidance on applying its standards in the U.S.
This week, the Royal Institution of Chartered Surveyors (RICS) issued Application of RICS Valuation- Professional Standards in the U.S. Guidance Note 1 (USGN1). The new note will help RICS members apply the most current “Red Book” in compliance with U.S. jurisdiction, a RICS release explains. “The Red Book ensures that valuations are produced with high standards of integrity, clarity and objectivity and fully incorporates the new International Valuation Standards (IVS),” says the RICS release.
"USGN1 will be of immediate practical use for members, ensuring clear and consistent implementation in a specifically U.S. context, and so providing further assurance to clients of the benefits of using RICS-qualified expertise," adds David Park, chair of the RICS Global Valuation Standards Board. "It has been a privilege and a pleasure to work with RICS Americas colleagues on developing the document."
RICS members (or subscribers) can download USGN1 here.
More summer CPE
Catch up on all your much-needed CPE this summer, with these BVR webinars:
- On July 24, BVR’s Online Symposium on Healthcare Valuation and Online Symposium on Litigation & Economic Damages continues with Lost Profits in Physician Practices, featuring Mark Dietrich and covering the analysis, determination, and defensibility of assessing damages for medical firms.
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