Over 30 years later, the judge remembers this expert
The Hon. Peter J. Panuthos, Chief Special Trial Judge for the U.S. Tax Court, still recalls his first experience with expert witnesses and valuation. It was 1978, he told attendees at the 2011 fall meeting of the ABA Section of Taxation and Section of Real Property, Trust & Estate Law in Denver last week. He was a supervising trial attorney for the IRS Office of Chief Counsel. The case was Koffler v. Commissioner (T.C. Memo 1978-159), and the issue: the fair market value of transferred common stock in the privately held American Tourister luggage company.
“There were experts on both sides,” Judge Panuthos recalled, with “all the bells and whistles you’d expect,” including detailed market analyses and suggested discounts. But when a taxpayer’s expert took the stand, he looked around the courtroom and began his testimony with this question: “When you go to the airport baggage carousel to look for your luggage, what do you see?”
The presiding judge “was surprised,” Panuthos said, but he let the witness answer, to the effect that all you’d see back then was soft, inexpensive, imported luggage. American Tourister was still making hard-sided suitcases, and the image—along with its implied assumptions regarding value—“was difficult to refute,” Panuthos said. After all the experts had testified, their numbers and analysis “faded to a fog,” he said, and though the court made sure to lay its factual foundation for rejecting the “unrealistic” value conclusions by the IRS expert, the lesson has endured all these years. “Make sure your expert witness presents understandable, realistic” conclusions regarding value, Judge Panuthos told ABA attendees. “Take a step back—and then take another step back,” because the moment the expert appears to be an advocate in the courtroom, “the judge will become wary.” Rule 702 FRE permits assistance from the expert, not advocacy—and maybe once in a while a surprising but effective turn of testimony.
When does secondary market data trump model-based estimates? Exclusive highlights from AICPA Cheap Stock Practice Aid
Following the slump in IPO markets and the sluggishness in venture-backed exit strategies over the past 10 years, the private secondary markets “have become an increasingly important avenue for liquidity” for certain investors and employees holding private company stock options, says a new chapter from the updated AICPA Cheap Stock Practice Aid. Neil Beaton (Grant Thornton), a member of the Cheap Stock Task Force, gave BVWire a “sneak peek” at the chapter “Inferring Value from Transactions in Private Company Stock,” which is currently under SEC and FASB review.
The proposed new chapter focuses on private stock transactions facilitated through the secondary markets. Whether these transactions provide a relevant indication of fair value for share-based compensation—preferable to model-based estimates—will depend on many factors, the Aid says. Key among them: “whether the market represents an exit market for current employees.” If so—and if repeated transactions occur around a given price level at or near the valuation date, then “there is a presumption that the traded price is the fair value for the stock.” If not, then the trading price may only be another indication of the employee’s primary exit market price. In all cases, it’s necessary to consider the specific characteristics of the secondary market, the Aid emphasizes, as indicated by these factors:
- Timing of transaction data;
- Equilibrium between supply and demand;
- Sophistication of the buyers;
- Supply of information to value the investment and make an investment decision;
- Pattern of trades;
- Possible market biases, costs of holding, hedging, or trading the securities; and
- Employee access to the market.
This is just a glimpse of what’s to come in the updated Cheap Stock Practice Aid, which the Task Force hopes to release by the end of this year, depending on the speed of regulatory review, says Beaton. Be sure to catch his complete presentation on the final proposal at the upcoming AICPA National BV Conference in Las Vegas, Nov. 6-8. Note this—Beaton may be defying the laws of physics, presenting in five AICPA sessions over three days, joining such noted experts as Ron Seigneur, Nancy Fannon, Gary and Linda Trugman, Kevin Yeanoplos, Jim Alerding, Mark Zyla, and others.
Vast majority of BV appraisers still want unified standards
Nearly three-quarters (73.3%) of respondents to our latest online poll believe that there should be a single set of BV standards. This parallels the nearly 80% who answered “yes” to the same question in 2007—but notably, the more recent survey garnered over twice the number of responses, 149 compared to 72 four years ago, indicating that this hot-button issue has grown even more heated.
Importantly, respondents are split over the “ideal” number of BV credentials that the profession could support from one or more professional organizations. Barely one-eighth (12.5%) of survey participants believe that one credential would be best; nearly a third (32.1%) said two would be optimal, while 16.% answered “three” and only 8.9% supported four.
Written comments were even more divided, from one respondent who said, “When there is only ‘one’ of anything there is no motivation or incentive to do anything other than the status quo,” to another who believes, “Unless we unite, the accountants will continue to define valuation standards and make us do their bidding.” Some claim that the market will “force” unification, while several believe that the number of credentials turns on what the market will bear. The multiplicity of credentials may be causing more judges and attorneys to make the ultimate valuation decisions in courtroom cases, says one respondent, while another—who boasts five BV credentials plus a number of forensic certifications—says, “I find that they add to the weight given my testimony by judges and juries,” and that it’s “a hoot” to see opposing experts wasting their direct testimony explaining why they do not need them. Finally, one participant believes the profession would be better off without any credentials, due to the politics of “promoting ideology over good research.” Look for a complete discussion and summary of current opinions in a future Business Valuation Update.
New paper says European ERPs approach 4% to 7%
Authors from the Technical Univ. of Munich have just posted their new whitepaper, “The Equity Risk Premium across European Markets: An Analysis Using the Implied Cost of Capital,” at SSRN.
“Using a large data set of companies from 16 European countries over the period between January 1994 and May 2011,” the authors’ summary says, “we estimate the equity risk premiums [ERPs] applying an implied cost of capital approach. We find estimates that are consistently larger than those in previous studies, ranging from 4.4% to 6.9% across countries. Our main conclusion is that a positive trend over our sample period is responsible for the high estimates in comparison to previous studies. The trend is accompanied by declining risk-free rates over our estimation period, suggesting a much greater stability in the absolute return on equity than often assumed by classical asset pricing models.”
Can’t make Vegas? Bet on these winning CLE webinars
If seeing experts such as Mark Zyla (Acuitas) and Nancy Fannon (Fannon Valuation Group) in Vegas is still a long-shot in your professional travel plans, you can still catch them during the same week as the AICPA BV confab (and catch up on year-end CPE) by tuning in to these BVR webinars:
- Supporting Your Case: Discovery and Evidence, featuring Fannon and Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt), comprises part 4 of BVR’s Online Symposium on Litigation & Economic Damages and will air on Tuesday, Nov. 1.
And if you would like to hear more from attorneys and judges—including advice that will make expert appraisals more memorable and credible—then complete your own web-based CLE “conference” with:
- Judges Roundtable: View From the Bench, with Hon. David Laro, Hon. Julian Jacobs, Hon. Mary Ann Cohen (all U.S. Tax Court), moderated by Fishman and hosted by Georgetown Univ. Law Center, on Friday Nov. 4.
$1.33 billion damages fails for lack of ‘real world’ comparables
In another high-profile, high-stakes litigation concerning high-tech IP, a jury awarded the plaintiff (Oracle USA) $1.3 billion in damages against the defendant SAP, the world’s largest business application software manufacturer. Not only was the jury award the largest in 2010—and the largest ever for copyright infringement—but it also equaled the defendant’s 4Q2010 net income, according to recent reports. On appeal in 2011, the defendant claimed the award was “grossly excessive” and based on “fictitious” evidence. In particular, since Oracle admitted that it never would have licensed the software in the “real world” and no comparable licenses existed, its expert simply “invented” the price of a hypothetical license, the defendant argued, relying on factors such as the amount that Oracle executives claimed they would have charged for a license (unsupported by any benchmark deals), and the value of the infringed technology as a whole, including the costs of acquisition and development.
The U.S. District Court agreed, finding the plaintiff’s expert “confused the jury” by presenting “fictitious and speculative negotiating factors” that he purportedly derived from Georgia-Pacific but which actually came from the “self-serving” testimony by Oracle executives. Look for the complete digest of Oracle USA, Inc. v. SAP AG, 2011 WL 3862074 (N.D. Cal.)(Sept. 1, 2011), in the November Business Valuation Update; the court’s opinion is posted at BVLaw.
Accelerated MLP activity means surge in MLP valuations
Master Limited Partnerships (MLPs) have emerged from the recent economic turmoil as one of the strongest asset classes for midstream oil and gas investors, delivering a 42% total return on one industry index and outperforming the broader S&P by roughly 27%, according to a 2010 summary. A more recent report predicts that MLP transfers will continue to dominate the energy sector, as their higher valuations allow them to hunt for “less attractively valued pipeline assets that have yet to be dropped into that structure,” such as last week’s announcement of the $21 billion Kinder Morgan/El Paso deal.
Update your MLP valuation approaches. With the ongoing surge in MLP activity, valuation analysts will want to be current on applicable valuation methods. The two most commonly applied are the income approach (DCF and dividend distribution yield) and market approach (guideline public company and transaction method, focusing on multiples of TIC/EBITDA and Price/Distributable cash flows). However, each of these approaches takes on certain nuances when applied to MLPs, says Brad Edwards (Ernst & Young), who spoke at last month’s ASA-Houston Energy Valuation conference. Taxing considerations along with cost of capital, Capex, and working capital assumptions are critical, Edwards adds. Look for his article on “mastering” the art of MLP valuations in the December BVUpdate.
I-banker says brokers, not BV experts, should value ASCs
“The only way to truly know what your ASC [ambulatory surgery center] is worth is to shift your paradigm from the hypothetical world of valuation professionals to the real world of investment bankers,” says a new post from Becker’s ASC Review. A fair market value [FMV] valuation “likely won't reflect the highest price that could be obtained if you sold your surgery center,” adds author and investment banker Blayne Rush. “On the other hand, market value will reflect that, and it can also influence the FMV. In other words, let the buyers of your surgery center determine the value . . . not the valuation experts.”
Really—are there no uses for a credible FMV valuation, other than telling owners to hire a broker to put their ASCs on the market? Email your thoughts to the BVWire editor.
BV profession is 10,000 strong, and climbing
Business valuation is “booming,” says a new article from the online Accounting Today, which reports that business valuations are the No.1 growing niche service among its 2011 Top 100 Firms. Currently, over 5,000 CPA/ABVs are supporting this growth, along with 3,000 CVAs, the article adds.
This confirms BVR’s independent research, which indicates that there are just over 1,400 ASAs (with a fairly strong list of pending candidates) and 600+ CBAs. In addition, roughly 3,000 to 4,000 CFAs currently perform some level of BV work, plus those who still perform valuations (CPAs, etc.) without BV-specific credentials. Although financial reporting work may have jump-started the profession, says the AT article, estate and gift tax continues to drive it, along with the increasing sophistication and formalization of valuation models and methodologies.
Two new FASB proposals: investment properties and companies
Last week the FASB released two new Exposure Drafts on proposed Accounting Standards Updates:
Comments to both proposals are due by Jan. 5, 2012. For a summary of the FASB’s proposed deferral of certain aspects of ASU 2011-5, Comprehensive Income, issued earlier this year, see this recent FEI post.
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