BVWire Issue #195-3  | December 19, 2018


Tax Court’s Exelon ruling, turning on compromised appraisals, withstands appeal

In 2016, Tax Court Judge Laro ruled on the legitimacy of a series of Section 1031 transactions involving Exelon, an Illinois-based energy giant. The court agreed with the Internal Revenue Service that Exelon was liable for a deficiency of nearly $432 million as well as an $87 million accuracy penalty. The court’s decision was of particular interest to appraisers because it detailed how Exelon’s lawyers had “interfered with the integrity and the independence of the appraisal process,” rendering the appraisals “useless.” The 7th Circuit Court of Appeals recently upheld all of Judge Laro’s findings.

Improper communications. To minimize the tax consequences of a $1.6 billion gain resulting from the sale of two fossil fuel power plants, Exelon pursued a number of section 1031 like-kind exchanges whereby it entered into “sale-and-leaseback” transactions in which it leased out-of-state power plants from tax-exempt parties for a period longer than each plant’s useful life and then subleased each plant back to the original owner for a shorter sublease term. At the end of the subleases, the sublessees had the option to repurchase their plants. They also received a substantial accommodation fee.

Exelon’s law firm worked with an appraisal firm to achieve a conclusion that exercising the purchase option was not “practically compelled.” The appraiser found the fair market value of the replacement properties at the end of the leaseback term would be less than the cancellation or purchase-back option price. Exelon would later argue that no one would “overpay” for an asset it could easily replace. Consequently, the transactions represented a genuine equity investment on Exelon’s part rather than a financial arrangement.

But the Tax Court found this was not a like-kind exchange of property because the tax payer never obtained true ownership in the replacement plants. Exelon obtained a number of tax benefits (deferral of tax liabilities, depreciation deductions as well as a number of other deductions), but it did not assume any risk because the subleases were structured in a way that it was reasonably likely that the sublessees would exercise the repurchase options. (Exelon did not want the plants.)

The Tax Court considered the appraisals underlying the transactions unreliable. Crediting IRS expert testimony, the Tax Court found the appraiser had used a questionable methodology to achieve a low valuation for the plants at the end of the subleases. A true fair market valuation of the plants was higher and would make it likely the lessees would exercise their buyback options. The 7th Circuit said the Tax Court, as the fact-finder, had discretion to accept the IRS’s expert opinion.

The Court of Appeals also upheld the Tax Court’s finding that the appraisals were not the work of independent valuators. The law firm steered the appraiser and at times provided language the lawyers wanted to see in the final appraisal report. The appeals court rejected the claim that this was not improper communication but was the law firm providing the appraiser with the applicable guidance and tests.

The appeals court agreed with the Tax Court’s imposition of section 6662 penalties. Exelon, as a “sophisticated plant operator,” did not rely in good faith on the law firm’s opinions since Exelon knew, or should have known, the law firm’s conclusions, based on the compromised appraisals, were flawed. In fact, top people at Exelon were copied on the compromising emails and one of those people sent the list of the necessary appraisal conclusions to the appraiser multiple times, the Court of Appeals said.

A digest of Exelon Corp. v. Commissioner, 2018 U.S. App. LEXIS 28023 (Oct. 3, 2018), and the court’s opinion will be available soon at BVLaw. An analysis of Exelon Corp. v. Commissioner, 2016 U.S. Tax Ct. LEXIS 26 (Sept. 19, 2016), and the Tax Court opinion, is available to subscribers now.

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Fernandez on badly explained finance topics

A number of topics relevant to business valuers including CAPM, WACC, betas, ERP, and returns are in the latest paper by Pablo Fernandez (University of Navarra, IESE Business School), "18 Topics Badly Explained by Many Finance Professors." Among his observations:

  • Referring to the WACC as the “cost of capital” may be misleading because it is not a cost;
  • Volatility is a bad measure of risk;
  • Textbooks differ a great deal on their recommendations regarding the equity risk premium;
  • There is a mountain of evidence to support the notion that CAPM and its betas do not explain anything about expected or required returns; and
  • If someone claims to have a model to calculate expected returns that works reasonably well in the real markets, ask whether that person is a billionaire.

The paper has received a number of comments, one being that students who are badly taught later make wrong decisions in practice, possible destroying shareholder wealth instead of creating it.

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Don’t be locked into a start year for historical returns

During a recent demo of BVR’s new Cost of Capital Professional, an audience member asked whether he could choose the starting year used to calculate the historical equity risk premium and historical size premium. Yes, the platform is designed to be flexible, so you can choose any starting year you want. You can choose preselected dates (1928, 1963, or 1982), but you can enter a custom year. The CRSP data go back to the 1920s, and Compustat data, used by some analysts, go back to the 1960s. The size premium was first documented in academic research in 1981, and it has diminished or disappeared since that time, hence the 1982 selection.

Another audience member asked: “How do I determine the start date for the historical returns?” That boils down to the analyst’s professional judgement as to what version of the past is best indicative of the future, which is not something that can be determined easily, the presenters said. In essence, the issue is whether something important enough has changed in the markets that changes rates of return. For example, if you look at the past nine years, you logically would have to admit that markets have changed. No laws of nature say that all rates of return for the S&P 500 or size premiums go back to a certain level of equilibrium.

Free trial ending soon. Take a free test drive of the Cost of Capital Professional before the end of the year—the free trial period ends December 31. After that, the annual price will be $295 for the first user and $100 for each additional user. There’s a special offer of 14 months for the price of 12 if you subscribe now. Check out a demo and free webinar that explains the thinking behind the platform. BVR welcomes feedback and comments from all users.

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New edition of exec comp survey released

The 2018 Northwest Executive Compensation Survey, published by Milliman, is now available.

The survey compiles data on 19 top executive positions from 323 privately held and publicly traded companies in Washington, Oregon, and Idaho. While the data are from the Northwest region of the U.S., it can be used to derive reasonable compensation in other regions on the U.S. (click here for details). The survey has an incredible amount of detail including base salaries, equity compensation, bonuses, perquisites, retirement plans, annual pay adjustment trends, long-term incentive plans, and more. Click here to take a look at the Table of Contents, an explanation of the methodology used, the participating companies, job titles, and job descriptions.

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Verizon’s $4.6 billion impairment

What’s in a (brand) name? One day a lot and then maybe zilch. Verizon will take a $4.6 billion write-down on its media brand, Oath, which includes Yahoo and AOL, that was formed in 2017, says an article on CNN Business. When the company last did its goodwill valuation, the brand was valued at $4.8 billion. Is this one of the biggest blunders in corporate history? Interestingly, AOL was involved in another fiasco: the AOL-Time Warner merger.

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Global BV News

European fairness opinions grow in importance

Fairness opinions are increasingly used in complex multijurisdictional transactions, according to a report from Houlihan Lokey. The total value of deals in Europe where fairness opinions were provided reached approximately $131.4 billion in 2017 (up from $27.4 billion in 2014), which included the three largest European public M&A transactions in 2017, the report says.

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RICS issues U.K. supplement

The Royal Institution of Chartered Surveyors (RICS) has issued a U.K. national supplement that sets out specific requirements for members on the application of the RICS Valuation – Global Standards 2017 to valuations subject to U.K. jurisdiction. The material is supplemental to that in the RICS Red Book, global edition, and is not a substitute for it. The RICS global standards adopt International Valuation Standards (IVS) 2017 and also place a number of additional requirements on RICS members.

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Preview of the January 2019 issue of Business Valuation Update

Here’s what you’ll see:

  • BVR’s New Cost of Capital Platform Makes Its Public Debut” (BVR Editor). A record-setting audience of valuation experts got the first look at BVR’s new simple, independent service to estimate the cost of capital. The online platform is designed to augment each appraiser’s own professional judgment and his or her other research.
  • Business Valuation Year in Review 2018” (BVR Editor). The new tax law, lively debates, new guidance, a strong protest, and a simpler approach to estimating cost of capital were just some of the highlights in the business valuation profession during 2018.

The issue also includes:

  • An expanded section of “BV News and Trends/Global BV News and Trends.”
  • Regular features: “Ask the Experts” and “Tip of the Month.”
  • BV data spotlight: “DealStats MVIC/EBITDA Trends,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and “Cost of Capital Center.”
  • BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the January issue of Business Valuation Update.

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BV movers . . .

People: Brian Alwine, CPA, ABV, ASA, has joined HBK Valuation Group LLC’s Naples, Fla., office as a senior manager … Chris Brooke, FRICS, is the new president of the Royal Institution of Chartered Surveyors (RICS); he succeeds John Hughes, FRICS, who led RICS throughout its 150th anniversary year … Crowe elected a number of new partners and principals, including Brian Kerby, a managing director in the firm’s Transaction Services Practice and a healthcare specialist … Megan Zietsman has been named the new chief auditor and director of professional standards at the Public Company Accounting Oversight Board (PCAOB) and will assume the role in early 2019; she’s currently a partner at Deloitte & Touche’s professional practice network in the U.S.

Firms: Canfield, Ohio-based HBK CPAs & Consultants has signed a merger agreement with the Spire Group of Clark, N.J.; Spire has 50 team members, five of whom are joining HBK as principals … MNP, Canada’s fifth largest national accounting and business consulting firm, will merge with TW Hawes Inc. effective Jan. 1, 2019 … UHY Advisors, based in Chicago, has expanded its office in the mid-Atlantic region through its merger of the professional services firm Berman Goldman & Ribakow LLP (bgr CPAs), which is located in Columbia, Md.; the merger was effective December 3 … Rochester, N.Y.-based Mengel Metzger Barr & Co. acquired a local practice, Tom Walter CPA, of Canandaigua, N.Y. Chestnut Ridge, N.Y.-based GKG CPAs has joined New York City-based PKF O’Connor Davies, which deepens its expertise in transportation, food manufacturing and processing, employee benefit plans, and not-for-profits; the deal adds six partners and about 40 employees … Rehmann, based in Troy, Mich., is expanding its presence in Florida by combining with Lamn Krielow Dytrych & Co. (LKD) of Jupiter, Fla.; both firms focus on the financial services industry … Lexington, Ky.-based Dean Dorton is expanding beyond Kentucky by adding Massey Consulting of Raleigh, N.C., a firm specializing in accounting software products and services … The Bonadio Group, Rochester, N.Y., celebrated its 40th anniversary with a gala for its employees—congrats!

Please send your professional and firm news to us at

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CPE events

  • Dividing Goodwill: A Case Study in Active and Passive Appreciation (January 2), with Ashok Abbott (West Virginia University).

    An increasing number of marital disputes involve the issue of active vs. passive appreciation of assets. You’ll learn a method to separate passive from total appreciation using empirical evidence and see the supporting data and evidence.

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New and Trending
LinkedIn Discussions

Is a Merger Causing a Culture Clash in Your Organization?

OPM Backsolve and Convertible Debt Financing

Your discussion could be featured here—BVR’s LinkedIn group is a place for valuation professionals to share, discuss, and learn about compelling BV topics. If you’re not already a member, request to join:

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Holiday break

After taking time off for the holidays, BVWire will be back on Wednesday, Jan. 9, 2019. We wish you a safe, joyful, and prosperous holiday season!

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We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden, Esq. (Executive Legal Editor) at:
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In this issue:

Biased appraisals

Finance blunders

Historical returns

Exec pay survey

Massive impairment

Global news

January BVU preview

BV movers . . .

CPE events

LinkedIn discussions



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