Should divorce courts ‘force’ experts to moderate
Gaetano Ferro (Marvin, Ferro, Barndollar & Roberts LLC) told attorneys and business appraisers at the AAML/AICPA biennial Business Valuation conference in Las Vegas last week that he thought judicial analysis of business valuation testimony (and experts) in matrimonial cases continues to be “rudimentary…the focus is often on the credentials of the valuation expert instead of the substance of the expert opinion.”
Daubert aside, Ferro believes that fewer divorce cases specifically discuss valuation. Some states, of course (e.g., CT) do not require the trial judge to find the value of each asset. But, “to a larger extent, this may be because trial judges simply find a value without explanation.”
One possible explanation, from Ferro’s attorney-perspective: BV may be getting more adversarial, less independent. “Opinions of value are often miles apart,” Ferro said. “Because it is extremely difficult to negotiate a settlement where the business is a significant asset and the experts report widely disparate values, the effect of adversarial valuations is to make trial more likely.”
Would a Major League baseball arbitration “high-low” rule—i.e., one that forces judges to accept the valuation of one appraiser instead of cobbling a value from the two—persuade the experts to moderate their opinions? Maybe not, Ferro said, “but some (many?) judges seem to be doing that, even in the absence of such a rule.
(By the way, a quick search of BVLaw shows that over the past two years, at least 40 valuation-specific divorce decisions have been reported among U.S. appellate courts—with new cases coming in each month. And, there will be a special case law update session, along with a judges’ panel, at the BVR/Morningstar 3rd Annual Summit on Business Valuation in Divorce September 13-14 in Chicago.)
Excess Earnings Method “out of tune” for most engagements, Duffy says
One of the “Dirty Little Valuation Secrets” Bob Duffy (Grant Thornton) shared with AICPA/AAML Las Vegas attendees was his concern about the excess earnings method. “This method is like a guitar,” Duffy described. “A guitar has six strings, the excess earnings method basically has six inputs and you can get it to create any ‘song’ you want it to sing.” He showed an example of a huge swing in valuation conclusions with a $50K reasonable compensation adjustment and a $50K difference in sustainable income inputs. Maybe the method was flawed from the beginning – Duffy reminded appraisers and lawyers at the conference that it was developed during prohibition when distillers had to be paid the value of intangibles. For all its faults, however, Duffy still considers the excess earnings method when valuing professional practices because there really is “no better model” for accounting for the low-risk receivables and high-risk intangibles.
Financial experts now needed in criminal securities cases
Ever since the U.S. Supreme Court’s decision in Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005), federal courts have generally required shareholders in civil securities litigation to use financial experts to prove loss causation, most commonly by conducting event studies or similar, statistical and economic modeling.
Now the courts may be expanding the reach of Dura to criminal securities claims. In United States v. Schiff, an ongoing prosecution of two high-ranking Bristol Meyers executives, the federal district court (New Jersey) required the government to prove loss causation with expert evidence that tied certain public disclosures of the alleged fraud to a substantial drop in Bristol’s market price. But at a Daubert hearing, the government limited the expert’s testimony to only one disclosure. Further, it declined to ask the expert to disaggregate the fraud-related events from other corporate announcements (in the same disclosure) that also could have caused the fraud. The government said it would call fact witnesses to prove this element—and the federal district court expressed serious concerns, not only about the late disclosure of possible lay witnesses, but also that, given the government’s restrictions on its expert, there still could be an “analytical gap” in the expert’s testimony, such that it did not “fit” the case.
Nevertheless, the district court permitted the government to present its lay witnesses at trial and then try to introduce its expert’s limited event study. If the lay witnesses have failed to lay a sufficient foundation for loss causation however, then the court will limit the government’s expert to rebutting arguments of market efficiency and/or external factors causing the fraud. The government appealed the ruling, but the U.S. Court of Appeals for the Third Circuit affirmed in United States v. Schiff, 2010 WL 1338141 (April 7, 2010). Read the complete case digest in the next (June 2010) Business Valuation Update™; the full-text of the 3rd Circuit’s opinion will also be available at BVLaw™.
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Gallagher & Gailor share tips on how to present your
CV in court
BVWire's good friends Carole Gailor, JD (Wallis & Hunt PLLC, Raleigh, NC) and Michelle Gallagher, CPA/ABV/CFF (Gallagher & Associates, Lansing, MI) discussed common weakness they see in valuation reports at last week’s AAML/AICPA conference. “On average I find 20-30 errors in every valuation report I read” shared Gailor. Her three easiest-to-spot mistakes:
- plagiarism – specifically the omission of data source citation
- the lack of a site visit, and
- outdated CVs
Gallagher and Gailor advise appraisers to keep their CVs short – “There’s no need to list your every conference participation, but it is smart to mention your attendance if it’s directly relevant to the case” observed Gallagher. One of her best tips (based on sudden furious notetaking in the session!) was to contain the CV to one page and include a small but recent photo towards the bottom: “Remember, it’s likely been a month or more since the judge or trier of fact has read your report. The picture connects the face with the work.”
And, Mercer and Brend reveal “attorney tricks and
Jeffrey Brend (Levin & Brend) and Chris Mercer (Mercer Capital) ping-ponged on how to defend your expert testimony in court at the AAML/AICPA conference in Las Vegas. “Experts underestimate the importance of the deposition,” said Mercer. “It is at this stage that many cases settle.” Brend disagreed, stating that he goes into a deposition believing it will go to trial. He asks appraisers very little at the deposition and tries to impeach them later in court. Mercer shared advice in how to defend your report in a cross examination, such as:
- Look, listen and hear
- Wait and formulate
- Answer the question in full sentences
- Stop and wait for the next question
- Do not anticipate where the lawyer is going
- Be calm!
Brend suggested using “CLASS”: Calmly Listen; Answer Succinctly, and Shut up! He also shared that a great way to learn how to feel comfortable testifying is to do Karaoke! You have the words in front of you; it’s a great way to start!” he said.
Valuing asset-backed securities can often be counter-intuitive, Kahn tells ASA
“The price of senior tranches in asset-backed securities tends to go up as the default rate, and the severity of the defaults, increases,” Daniel Kahn (National Leader, Complex Securities Valuation, Ernst & Young) told attendees at the NYC ASA Business Valuation Conference last week. “This seems illogical, but the senior tranches are not exposed to reasonable losses, so they actually benefit by the early wrapping up of the risk, because of the time value of money.”
Obviously, this makes valuing, and explaining the value of, asset-backed securities more challenging–and it’s one reason many certified business appraisers steer clear of this market segment. In fact, Kahn demonstrates that at reasonable default and “severity” levels (say 10%), even most of the subordinated tranches see price increases. In a case study Kahn prepared for ASA attendees, he showed that even at a 40% loss (severity) rate, junior tranches retain most of their value. Beyond that, they lose value very rapidly.
Where do you go to get “observable market data” to support this rapid change in value, as required by FASB? You can often look at a particular trust in Bloomberg or similar service, Kahn advises. If you can’t find public information, you’re looking at average pricing and yield data from Merrill Lynch or similar institutions. Or, if the underlying collateral is student loans, Sallie Mae has some sources. “The challenge in valuing these securities is to infer market support since it’s often hard to directly observe market prices as FAS 157 would prefer,” Kahn says. So, finding observable market data is a first challenge for appraisers.
Karlitz recommends Verdict Search for modeling litigation contingencies
“You definitely need a high tolerance for ambiguity” when valuing companies with contingent assets, acknowledged Gary Karlitz (Citrin Cooperman & Co.). Gary has established himself as a rigorous decision modeler and he shared several case studies with the audience at the AICPA/AAML Las Vegas conference. He follows a model that meticulously tracks best, base and worst case litigation outcomes – and makes it “easy” to reverse engineer the numbers since probability modeling will deliver a range of answers. Gary also pointed attendees to www.verdictsearch.com, a searchable database useful in determining the value of case. His parting note was to point out that “decision modeling is an extremely effective process for settling cases.”
Hitchner: stay abreast of DLOM valuation studies
Business appraisers “can expect to see a lot of new ideas and concepts, models that are no longer used, and models that haven’t been used but are popping back up,” Jim Hitchner (Financial Valuation Advisors) told attendees at the AAML/AICPA conference in Las Vegas. One area in which appraisers continue to look for the best standards of practice is DLOMs. Hitchner stressed the need to understand the strengths and weaknesses of the following studies prior to valuing any minority interest:
- Trugman Valuation Associates’ Restricted Stock Study
- FMV Opinion’s Detailed Restricted Stock Study
- Valuation Advisors’ Detailed Pre-IPO Database
- Longstaff’s “Look Back” Put Option Model
- Seaman’s Long-Term Equity Anticipation Securities (LEAPS) Method
- Hall’s Chicago Board Opinions Exchange’s Volatility Index (VIX) Comparisons for DLOMs in a Distressed Economy
- Mercer’s Quantitative Marketability Discount
- Finnerty’s Asian Arithmetic Average Strike Put Option Model
- Ashok Abbott’s Liquidity Factor and Data
Indeed. “The discount for lack of marketability is the most important discount in valuation,” said U.S. Tax Court Judge Laro at the second annual DLOM Summit last year (BVU; Nov. 2009). For more discussion on DLOMs, consult BVR’s Guide to Discounts for Lack of Marketability here.
Valuing a construction company? Learn from the experts
Tomorrow (Thursday, May 13, Don Drysdale (Drysdale Valuation) and Keith Prescott (Wisan, Smith, Racker & Prescott) will host “Valuing Construction Companies,” a 100-minute BVR webinar. Listen to these two valuation experts share their expertise in valuing construction companies and earn 2 CPE credits. For more information click here.
Free BVR download: historic trends in private company valuation multiples
The Subscriber Services pages for Pratt’s Stats®, BIZCOMPS®, and Public Stats™ have been updated and include new articles as well as summary information from the databases, such as charts and graphs displaying historic trends in median valuation multiples. A sample report includes “Historic Trends in Private Company Valuation Multiples,” from the Pratt’s Stats® and BIZCOMPS® databases, and is available for free on BVR’s Free Resources page.
Call for presentations on fair value topics
Two opportunities to market your expertise in financial reporting valuation; first, NACVA, IBA and Seattle University issued a call for presentation for their joint conference: Fair Value Measurements and Recognition. For more information: www.NACVA.com or www.Go-IBA.org. Second, BVR’s 4th Annual Fair Value for Financial Reporting Summit in NYC next January 31-February 1 is assembling presentations (NACVA and IBA are also sponsors of the BVR event). Drop a note with your proposal to firstname.lastname@example.org.
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