News from AICPA/AAML divorce conference: Don’t chase the owner—chase the asset
In high-conflict divorce cases, there will always be some business owners who would rather deplete their net worth by transferring assets to their children (or a new spouse) to avoid paying their exes, then claim “drastically changed circumstances” prevents them from complying with court-ordered support or property distribution. Rather than spending precious time and funds chasing the “bad” spouse, says attorney Andrew Schwartz (Schwartz & Kanyock), “chase the asset” and sue the transferee under your state’s version of the Uniform Fraudulent Transfer Act (UFTA) or similar creditors’ rights statute.
The UFTA, for instance, permits creditors to sue debtors as well as any other party who received property from the debtor in an allegedly fraudulent transfer, Schwartz explained to a packed session of attorneys and business appraisers at last week’s AICPA/AAML National Conference on Divorce in Las Vegas. The uniform laws also permit the creditor (an ex-spouse in divorce) to get an injunction against further disposition of the property by the transferor and/or the transferee, who should both be made parties to the suit. Since proving actual intent to defraud is difficult, UFTA also permits the creditor to show “badges” of fraud, such as a transfer for lack of reasonably equivalent value. “If there are any questions about reasonably equivalent value,” Schwartz told the audience, “get a certified expert.” A forensic accountant or BV expert is also going to be “far better at digging through the financial evidence to find the asset.”
Suggest UFTA to your attorney. In a subsequent session on divorce cases that turn into that dreaded “black hole” of cash and conflict, attorney Joy Feinberg (Feinberg & Barry) told of a recent suit in which the business-owning spouse stood in front of the judge and said, “If you make me pay that, I’m turning over my business to my girlfriend,” and “so help me, he did,” Feinberg said. Now that she knows more about UFTA remedies, she plans on using them to recover assets from “bad” spouses in the future.
Daubert challenges to financial experts fall to a record low, but success rate climbs to six-year high, says annual PwC study
Remember how, back in high school, you used to gossip in the hallways after class? That’s what attorneys still do in the courthouse halls after their cases are done, which is why it can be the “kiss of death” for any financial expert to get excluded, says attorney Mark Sobel (Greenbaum Rowe Smith & Davis),who also presented at the AICPA/AAML biennial gathering in Vegas. Attorneys will talk about the exclusion and by the end of the day, that expert will be off of everyone’s referral list.
Over 11,000 challenges in 2011. Last year marked the 12th anniversary of the U.S. Supreme Court’s Kumho Tire decision, which expanded Daubert’s reach to financial experts and their opinion evidence. In 2011, alone, there were 11,262 cases citing Daubert or Kumho Tire, according to this year’s Daubert Challenges to Financial Experts by PricewaterhouseCoopers. Highlights of the current report include:
- The number of challenges to financial experts rose every year from 2001 to 2009, but then fell off between 2010 and 2011 by a total of 40%.
- The percentage of successful challenges has varied widely over the past 12 years, with a low of 29% in 2002 and a high of 59% in 2005. In 2011, 54% of all challenges to financial experts were successful in excluding their testimony in whole or in part, or well above the 12-year average of 45%.
- In 2011 70% of all challenges targeted the plaintiff’s expert. Over the same time, however, just about the same number of experts from both sides were excluded, 46% for plaintiffs’ side and 48% for defendants’.
- Challenges to economists, accountants, and appraisers are still the most frequent, last year accounting for 57% of all challenges to financial experts. Notably, accountants and appraisers were excluded much more frequently in 2011 (64% and 70%, respectively) compared with their 12-year average (51% and 46%).
- Breach of contract actions saw the most Daubert challenges during the past 12 years, but once challenged, a higher percentage of fraud and IP experts were excluded (53% and 52%, respectively) than contract experts (44%) and a broad class of “others” (46%).
- For the 12th consecutive year, lack of reliability was the top reason that courts excluded financial experts (7 out of 10 cases), most often due to the lack of valid data or analytical framework for the data. In 2011, alone, lack of reliability supported 76% of the exclusions.
Download this free discount rate calculator, from Pellegrino
The discount rate creates “one of the most controversial areas in my practice,” said Mike Pellegrino (Pellegrino & Associates), during his recent BVR webinar “Valuing Early Stage Companies,” the latest addition to our Desktop Learning Center and our newest Training Pack.
“We don’t look to public companies for discount rates,” Pellegrino added. “We don’t find that they are representative of the market for early stage companies,” due to the “remarkable” survivorship and other selection biases. “Our view—and this is heresy, I understand—is that the regression-based models are ‘Flat Earth’ thinking.” Consider: Implied discount rates currently developed using regression-based analyses are at historic lows. “My question—and it has been a question I have enjoyed asking over the last three-and-a-half years—is why is there a credit shortage among early stage companies?”
The answer: Investors and institutions are not willing to lend a significant amount of capital to startups unless they get a personal guaranty or “something on the side,” Pellegrino observed. “The reason is because the implied rates of return are actually much greater.”
When asked whether he uses a proprietary or prepackaged modeling software, Pellegrino generously offered the simple, one-page worksheet his firm uses to calculate the discount rate, not only to webinar listeners but to the broader BV community, via our free resources page. Download the Pellegrino & Associates’ Discount Rate Calculator here.
Buffett says BV may be boring, but it’s also critical
If business schools could offer just one course, say Berkshire Hathaway executives Warren Buffett and Charlie Munger, it would not be on stock trading, the efficient market hypothesis, or modern portfolio theory. Rather, B-schools should be encouraging students to learn “the boring, but critically important, discipline of business valuation,” the iconic investors told attendees at the company’s annual meeting on May 5 (as reported by the Victoria Advocate). BV is the “heart of investing and risk management, and without it, you are blind.” Their two key takeaways apply as much to business students as business appraisers:
- In valuing any business, “you must be honest with yourself about which businesses you truly understand and those you don't,” Buffet said. “It is impossible to value a business that you don't truly understand.”
- Wall Street and the accounting profession have made the situation worse by developing “standardized models” to quantify corporate risks, according to Munger. There is no such thing, the pair of partners agreed; when it comes to assessing risk and opportunity, “what matters most is your facts and your reasoning.”
Is Rev. Ruling 59-60 a thinly disguised road map for intrinsic value?
Warren Buffett’s name just came up at the recent AICPA/AAML conference, too. In his session on bridging the appraisal wars, Z. Christopher Mercer (Mercer Capital) reminded attendees that the oft-quoted investment tycoon believes that “intrinsic value” is an “all-important” concept that is the “only way to make an investment decision,” Mercer said, because it measures the discounted value of the cash that can be taken out of the business during its remaining useful life. Or, as the ASA BV Standards define it, intrinsic value is the “real” or “true” value that will “become the market value when other investors reach the same conclusion.”
Remember, if you don’t have objective market data, added co-presenter Richard Orsinger (McCurley Orsinger Nelson & Downing), IRS Revenue Ruling 59-60 directs appraisers to use the intrinsic value standard. In fact, Orsinger believes that Rev. Ruling 59-60 “applies a road map for intrinsic value under the rubric of fair market value.”
Top of the class: first annual BVR/SPU Valuation Challenge
“The First Annual BVR/SPU Valuation Challenge started because my friend, Adam Manson, BVR’s financial research manager, was curious,” says Prof. Herbert Kierulff (School of Business and Economics, Seattle Pacific University (SPU)). Why do university finance classes pay relatively little attention to the market method, when it is essential to the work of valuation and business professionals? Why don’t business school cases routinely adjust comps for size when compared with the target companies? “My response was that much of the data and many of the tools needed for dealing with these and other valuation issues are not publicly available,” Kierulff says, “and purchasing them on a per-student or institutional basis is expensive.”
Buffet would be proud. To bridge the perceived gap in the curriculum and make the data and tools available, this year the SPU School of Business and Economics and BVR co-sponsored the first annual BVR/SPU Valuation Challenge. After BVR made such tools as Pratt’s Stats and the Duff & Phelps Risk Premium Report and Calculator available at no charge, the SPU students (senior undergraduate and graduate finance) formed four teams to appraise a company and compete for the best valuation presentations. In addition, Owen Dahl (Moss Adams) provided a “real world” (redacted) case study for the challenge, and Joel Mass (Synergetic Finance) lent valuable analytical tools.
The competition began in March, with the final presentation and reports due on May 31, when three senior valuation managers from Moss Adams will judge the student teams and decide the winner. So far, the competition has proved to be a “significant success,” Kierulff reports. “Our students are really into this. If you can imagine: they graduate in less than a month, it's spring, and they are working their tails off in finance. How about that?! I'm just delighted.” We think Warren Buffet would be, too.
IP values are the ‘time bombs’ of the future
Technology is moving at warp speed these days, and many consider intellectual property, such as patents, copyrights, and trademarks, to be the “final frontier” of valuation. Consider the 1969 divorce of Gene Roddenberry, creator of the Star Trek TV series, which (back then) had just been cancelled after three seasons, with a multimillion dollar production deficit. Syndication efforts were under way, and in a handwritten settlement agreement, Roddenberry took all rights to the series, with one exception: His wife took a one-half interest in all future “profit participation income” from Star Trek.
Importantly, “neither term was defined,” observed Ronald Anteau (Kolodny & Anteau) at the AAML/AICPA conference, “and nobody was thinking about the technology we have now.” Shortly after his divorce, Roddenberry remarried and devoted the rest of his life to developing various Star Trek assets; in 1987, his first wife sued his second wife, as well as his production company, claiming half of all the income generated from Roddenberry’s post-divorce Star Trek efforts. (Diehard Trekkies as well as IP analysts and attorneys can read the 1996 California Court of Appeals’ opinion here.)
“The problem in these cases is: who owns the IP if it’s not protected?” commented co-presenter Neil Beaton (Alvarez & Marsal). “Who created the asset? If it’s a patent, then is the patent the value of the company or is the company the value of the patent?” Or think about the “incredible” ways to “slice and dice” the ownership and value of a song, Beaton added. There’s the songwriter, the composer, the producer, and the record company. Tech-related IP is also “rich with land mines,” especially in the volatile, often dangerous context of divorce. “Protect your client and yourself by looking at all variables to identify and value the asset that is divisible by the judge.”
And tune into IP in Divorce: Dividing Patents, Copyrights, and Trademarks, featuring Beaton and Drew Voth (also Alvarez & Marsal), on May 23. The two experts promise to take the emotion out of the analysis, leaving only the logic of IP valuation, as illustrated by recent case law and applied in current best practices and techniques.
IASB proposes to amend 11 IFRS; asks for public comment
This month the International Accounting Standards Board (IASB) issued an exposure draft of proposed amendments to 11 International Financial Reporting Standards (IFRSs). The proposed amendments, published in relation to its annual, due process improvements project, provides “a streamlined process for dealing efficiently with a collection of narrow scope amendments to IFRSs,” says the IASB release.
The effective date for the proposed amendments would be annual periods beginning on or after Jan. 1, 2014, with the exception of the proposed amendments to IFRS 3 Business Combinations and IFRS 9 Financial Instruments, which is for annual periods beginning on or after Jan. 1, 2015. Early adoption is permitted for all proposals. Access the exposure draft on the comment page; feedback is due by Sept. 5, 2012. For more information about the criteria used to determine whether a topic should be added as part of the annual improvements projects, click here.
After Vegas and divorce, AICPA moves onto D.C. and fair value
Kudos to co-chairs David Levy (AAML) and Barry Sziklay (AICPA) for putting together another cutting-edge conference on business valuation in divorce, with up to 400 attorneys, appraisers, and speakers traveling to Las Vegas this year. Equal thanks go to vice co-chairs Carole Gailor (AAML) and Sharyn Maggio (AICPA). We’ll have more quotes and content from AAML/AICPA presenters in the coming weeks.
Next up on the AICPA’s agenda: its conference on fair value measurements and reporting, to be held June 6-8 at the Gaylord Hotel in National Harbor, Md., just outside of Washington, D.C. Key sessions will cover:
- Goodwill impairments, the new standards and the latest, practical application of the qualitative assessments;
- Legal issues related to fair value;
- Fair value and investment companies;
- PCAOB views;
- SEC/FASB update;
Speakers include Ben Couch (FASB), Jay Hanson (PCAOB), David Dufendach (Grant Thornton), P.J. Patel (Valuation Research Corp.), and Mark Zyla (Acuitas). To found out more and to register, click here.
Last (but not least) CPE in May
On May 22, healthcare specialists will want to join Robert Reilly (Willamette Management Associates) and attorney John R. Holdenried (Baird Holm) for Issues in Valuing Tax-Exempt Medical Organizations: Hospitals, Physician Practices, and Converting an Entity, Part 5 of BVR’s online symposium on healthcare valuation.The experts will discuss the regulatory reasons why tax-exempt healthcare organizations retain valuation analysts to appraise transactions, assess the reasonableness of compensation, and perform similar fair market value analyses.
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