April 18, 2012 | Issue #115-3  

Federal Circuit permits discovery of negotiations related to patent licenses—after expert opens the door

After initiating lawsuits against several large cell phone providers for infringing patents related to its 3G technology, the plaintiff settled with all the defendants except AT&T. When AT&T tried to get copies of those settlement licenses, including any information surrounding their negotiation, the trial court initially ruled that only the agreements themselves were relevant and discoverable. But when the plaintiff’s expert issued his damages report, it included reliance on a statement by one of the plaintiff’s executives (made during deposition) regarding the negotiated licenses. AT&T renewed its motion to compel, and this time the court ruled that the expert’s reliance had effectively “opened the door” to discovery of the negotiations, since Rule 26 FRCP requires disclosure of all the bases of an expert’s opinion. Moreover:

Documents related to negotiations could shed light on why the parties reached their royalty agreements and could provide guidance on whether some or all of the licenses could be considered a basis for calculating a reasonable royalty between AT&T and [the plaintiff].

The plaintiff sought an interim review, and last week the U.S. Court of Appeals for the Federal Circuit ruled that settlement negotiations related to reasonable royalty and damage calculations were not subject to a specific evidentiary privilege. In particular, “as a matter of fairness, [the plaintiff] cannot at one and the same time have its expert rely on information about the settlement negotiations and deny discovery as to those same negotiations.” Read the complete digest of In re MSTG, Inc., 2012 U.S. App. LEXIS 7092 (April 9, 2012) in the May 2012 Business Valuation Update; the Federal Circuit’s opinion will be posted soon at BVLaw.

Nath’s article prompts discussions on ERP, size effect, and more

“Has anybody read Eric Nath’s ‘The Biggest Valuation Myth’ … mentioned in a recent BVWire,” asks Michael Molder (Philadelphia) to members of LinkedIn’s BV Professionals group (registration required). “Any thoughts?”

“Yes, I have read it,” says Toby Tatum (Alliance Business Appraisal), who adds that he has “modified my income approach template narrative with [a] quote from his article to introduce and support my size effect adjustment to the discount rate.” Tatum has also written his own article, “A New Method to Develop a Discount Rate for Small Businesses Using SBBI Data,” posted at his website.

To date, there are nearly 50 comments in the LinkedIn discussion thread, with most participants commending Nath for his “profound insights” and for “putting together a great paper” that is well worth the read. As a reminder, Nath’s article on how traditional methods may not reliably quantify the equity risk premium (ERP) is available at his website.

New Deloitte white paper focuses on ERP myths, too

The recent economic crisis should also prompt investors and financial managers to revise their views of the equity risk premium, say Stamos Nicholas and Greg Forsythe (both Deloitte), in their new white paper called “Are You Mispricing the Investment Risk?”:

Since the 2008 financial crisis … we have found that managers sometimes do not fully account for the dynamic and variable nature of equity risk premiums when estimating a cost of capital and evaluating potential investments. A common practice by some has been to solely rely on unadjusted historical ERP statistics or anecdotal support for a chosen ERP. Without appropriate analysis and inquiry, these practices can lead to an incor­rect pricing of risk in prospective projects.

CFOs and others may want to reexamine how they typically value investments by “dispensing with the myth of the static ERP,” the authors conclude. They also cite the benefits of implied ERPs (versus historical estimates) and remind readers that “ERP varies by country markets.”

Chief Judge urges earlier discovery of—and Daubert challenges to— damages evidence in IP cases

In recent remarks to the ABA Section of IP Law, Federal Circuit Chief Judge Randall Rader expounded on the E-Discovery Model Order, unveiled last fall by the Federal Circuit’s advisory council, and recently adopted by the federal district court for the Eastern District of Texas (E.D. Tex). Judge Rader is particularly concerned that the current adjudicatory system overlooks the damages and valuation stage of IP litigation. Since plaintiffs want to postpone damages until they can prove liability—and defendants want to avoid any discussion that hints of liability—that leaves it to “my fellow judges,” Rader says, to “intervene ourselves to get a realistic valuation of the case much earlier.” He recommends:

that trial judges use their authority, including DAUBERT inquiries, to ascertain early in the case the approximate dollar value of the case. With some searching inquiry into the parties’ damages model, the trial judge can get a good idea of the worth of the contested technology and its implications in the marketplace. The parties also benefit from early damages discussions and disclosures because it can provide a realistic evaluation of both [the] defendant’s exposure and [the] plaintiff’s damages calculation and further promote early and effective mediation.

Further, by understanding a case’s “true worth,” Rader says, the trial judge would be in a better position to tailor cases to fit their size and significance. “In colloquial terms, the court may adjust timing and procedures of the case to make sure a billion-dollar case gets a ‘billion dollars’ worth’ of process, and a thousand-dollar case gets … well, less.” Read Judge Rader’s complete remarks on “The State of Patent Litigation,” posted last week by the Gibbons law firm and originally delivered to the E.D. Tex. Judicial Conference, here.

A picture is worth $1 billion (if you’re Instagram)

In just four “simple charts,” the market research analysts at Business Insider (BI) purport to show you (and those who question Facebook’s acquisition last week) why Instagram is “clearly worth” its $1 billion price tag. The first graph gives a snapshot of Instagram’s capital efficiency, comparing its estimated growth in employees to its predicted “tens of millions of users.” The next three plot the future of global Internet access, device sales, and mobile app revenues. The bottom line: “Instagram is the future of startups” and the “future of mobile social networking,” says the BI post. “To us, $1 billion sounds cheap.”

Is that really how you reliably value startups? On April 26, join Mike Pellegrino for Valuing Early Stage Companies and a discussion of the truly difficult aspects of appraising startup companies and new ventures, including intangible asset valuation, treatment of small revenue streams, and how to assess unproven business plans, new product concepts, and management growth forecasts.

New paper proposes ‘better’ approach to stress-testing bank assets

Under the proposed Dodd-Frank Wall Street Reform and Consumer Protection Act, banks with more than $10 billion in assets may be required to conduct annual stress tests on their loan portfolios. Given the current credit environment and increased pressure from regulatory authorities, even banks with assets under $10 billion—as well as insurance companies—are considering implementing systematic stress-testing programs, says a new white paper by DebtX, “Stress Testing and Fair Market Value: Increased Transparency for Risk Management and Regulatory Examinations.”

“By estimating each loan’s market price under a variety of market conditions, lenders can improve upon stress-testing methodologies that rely on collateral values, indirect measures or undisclosed valuation techniques,” says the introduction. To illustrate its valuation methodology, the DebtX paper also presents two mark-to-market stress-testing scenarios that use loan-by-loan valuations based on loan sale trade data.

2012 ‘Red Book’ available

The International Accounting Standards Board (IASB) has just published the consolidated text of its authoritative pronouncements in the annual 2012 IFRS Red Book. Published in two volumes, the new edition contains:

  • four new standards—IFRSs 10, 11, 12 and 13;
  • one new Interpretation—IFRIC 20;
  • seven revised standards—IFRSs 7 and 9 and IASs 1, 12, 19, 27 and 28;
  • amendments to IFRSs that were issued as separate documents; and
  • amendments to other IFRSs resulting from those amended standards.

Note: This edition includes amendments to IFRSs that have an effective date after Jan. 1, 2012; it does not contain superseded documents that remain applicable if the reporting entity decides to forgo early adoption of the newer versions.

Can CPA/experts help private companies transition to IFRS?

To date, just a limited number of companies have decided to switch to IFRS, but “2012 may be remembered as the year when IFRS were adopted by U.S. private companies,” says a new article in Business Finance. Various factors will play into the management decision, critical among them the realization that the cost of the transition is “definitely not as expensive as it would be for a public company.”

Financial executives should manage any transition to IFRS as a project with “specific responsibilities, tasks and milestones,” the article recommends. In particular, “efforts made by the AICPA to incorporate IFRS to the CPA exam will lead to young professionals becoming more knowledgeable about these topics than was the case a few years ago.”

New, reduced price for remaining Healthcare Symposium

On April 24, BVR’s Online Symposium on Healthcare Valuation continues with Part 4: Valuation of Medical Laboratories, featuring Curtis Bernstein, Kyle Rudduck (both Altegra Health), and Amy Graham.

Since BVR is now one-quarter of the way through the 2012 Online Symposium on Healthcare Valuation, new subscribers may register for the remaining programs at a just-reduced price. They will also receive access to the Healthcare Desktop Learning Center, an online library of all past BVR healthcare webinars. For more information, click here.

FASB proposes three new standards updates

This week the Financial Accounting Standards Board (FASB) issued three new proposed updates to accounting standards:

  • Entertainment—Films (Topic 926): Accounting for Fair Value Information That Arises After the Measurement Date and Its Inclusion in the Impairment Analysis of Unamortized Film Costs
  • Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution
  • Statement of Cash Flows (Topic 230): Not-for-Profit Entities: Classification of the Sale of Donated Securities in the Statement of Cash Flows

Comments on each of the exposure drafts are due by July 16, 2012; for complete copies—and an overview of all the FASB’s open exposure documents—click here.

Last chance to register for all May conferences

Just as the busy tax season ends—the busier BV conference season begins. Book your professional education, networking, and travel calendar now for any of these May offerings:

  • On May 7, the ASA and its New York City Chapter host the 20th anniversary of the Current Topics in Business Valuation, to be held in New York City. Sessions will cover effective tactics related to IRS audits, selecting the optimum capital structure for a subject firm, navigating the WACC versus the IRR in business combinations, and an analysis of quantitative DLOM models outputs. For more information, click here.

  • On May 10-11, the AICPA/AAML will once again sponsor their biennial national conference on divorce in Las Vegas. As in prior years, each session will feature an attorney and a BV appraiser speaking to both the legal and valuation sides of a particular issue; for more information and a complete conference agenda, click here.

  • On May 15, the national ASA hosts its 7th Annual Fair Value Conference, to be held at the Los Angeles offices of PricewaterhouseCoopers. The roster of speakers includes nationally recognized experts such as Ben Couch (FASB), Tony Aaron (Ernst & Young), and Jon Isler and Adam Smith (both from PwC). To register, click here.

  • On May 17, the Los Angeles Chapter of the ASA hosts the U.S. Tax Court Cases Symposium, a multidisciplinary event to be held in Cerritos, Calif. Offering “the inside scoop” on what goes on inside the federal Tax Court, the event will feature speakers from the IRS as well as appraisal experts Dennis Webb (Primus Valuation) and Carsten Hoffman (FMV Opinions) and attorney Chuck Morris (Albrecht & Barney). To register, click here.


Last week’s BVWire should have identified Morningstar’s Kevin Piccolo as the sole author of an article entitled, “The Dangers of Normalization: An Interest Rate Perspective.” In an online video, Morningstar’s Mike Barad interviews the author, who sourced Roger Ibbotson in support of the article and its research. Morningstar will post the complete article at its website this week.



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