BVWire Issue #149-4 | February 25, 2015


Court OKs new disgorgement calculation by SEC

A win-win for the SEC: In an extraordinary securities case involving the billionaire Wyly brothers, the SEC established liability for multiple violations and was able to persuade the court to adopt its disgorgement calculations based on two different theories—one of which was novel and unsupported. The defendants were required to pay approximately $200 million to the court, not counting prejudgment interest.

Flying under the radar: The SEC’s civil enforcement action centered on a 13-year-long tax deferral scheme carried out by the defendants, Sam and Charles Wyly. They created a number of offshore trusts and subsidiary companies on the Isle of Man that they used to trade shares in four public companies (issuers) on whose boards they sat, without properly disclosing their beneficial ownership of the stock. By transferring valuable options and warrants to the trusts, exercising the options and trading in secret, and reinvesting the proceeds in other ventures, the Wylys were able to accumulate tremendous tax-free wealth, the agency alleged.

A jury agreed and found the Wylys liable for nine violations, including fraud under section 10(b) of the Securities Exchange Act and failure to make various disclosures. Subsequently, the federal district court held a bench trial to determine remedies. The SEC initially asked the court to order disgorgement based on unpaid taxes related to profits made from the options and stock transactions of the four companies in which the defendants were “influential insiders.”

The Wylys argued that the Tax Code prohibited disgorgement measured by unpaid taxes. They also pointed to the risk of double recovery and conflicting orders since there was an IRS audit underway covering some of the same years of securities fraud.

The court disagreed, noting that “[m]easuring unjust enrichment by approximating avoided taxes does not transform an order of disgorgement into an assessment of tax liability.” Further, the risk of duplication or conflict was avoidable by crediting amounts disgorged in the SEC case toward any subsequent tax liability the IRS may determine. “Disgorgement is a remedy that gives courts flexibility to determine the appropriate remedy ‘to fit the wrongful conduct,’” said the court, and ordered Sam Wyly to disgorge approximately $123.8 million and Charles Wyly to disgorge approximately $63.4 million.

Alternative disgorgement measure: Anticipating an appeal and wanting to ensure a resolution of “this already aged matter,” the court recently approved the SEC’s alternative way of calculating disgorgement based on trading profits.

The SEC’s expert developed a novel approach that tried to measure the benefit to the Wylys resulting from a lack of disclosure. She pointed out that “because of this invisibility, the Wylys appeared more like a buy-and-hold investor than what they really are.” Comparing their actual trading to a buy-and-hold benchmark was a way to measure the difference between what the Wylys actually earned and what they would have earned if they had been buy-and-hold investors.

The Wylys’ expert said there was no authority supporting the SEC expert’s methodology. The analysis should have focused on whether there were abnormal returns after the Wylys sold securities from the offshore system. This standard approach would have shown that “the defendants received, in the aggregate, no improper gains.”

The court sided with the SEC. “This case is highly unusual—if not sui generis,” it said. Violations went on for 13 years, and the volume of offshore and undisclosed transactions was large. Also, the Wylys were not “garden-variety insiders.” Looking to standard insider trading cases and using the typical approach, i.e., performing an event study for each trade, was not helpful. The SEC‘s expert came up with a method that could reasonably approximate the profits “causally connected to the Wylys’ violations,” the court concluded. But it ordered the SEC to recalculate the disgorgement amount by taking out 38% of gain related to securities the Wylys never actually sold.

Takeaway: As the court hinted, its orders may not be the last word in this protracted litigation. Nevertheless, the court said it was “confident” that the tax-based disgorgement calculation was the best measure of the Wylys’ ill-gotten gains. Parallel bankruptcy and IRS proceedings are also underway. Stay tuned.

Find a discussion of SEC v. Wyly, 2014 U.S. Dist. LEXIS 175940 (Dec. 19, 2014) and SEC v. Wyly, 2014 U.S. Dist. LEXIS 135671 (Sept. 25, 2014) in the April edition of Business Valuation Update; the court opinions will be available soon at BVLaw.

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Value differences in A/E industry

Are architectural practices less valuable than engineering and environmental consulting firms? That seems to be what the data from the newly released 2015 A/E Business Valuation and Merger & Acquisition Transactions Study suggest. The study, which examined actual stock transactions among A/E and environmental consulting firms nationwide over the last three years (over 230 in all) showed a notable difference between valuation multiples (specifically earnings multiples) of architecture firms and those of engineering and environmental consulting firms.


Other valuation multiples showed a similar difference. However, Ian Rusk (Rusk O’Brien Gido + Partners), a contributing editor to the study, gives a word of caution about the results. “One or two valuation multiples don’t always tell the whole story,” he says. “Financial performance metric data from the study also showed that the participating architecture firms had some of the highest profit margins in the sample, and the values of those firms on a per employee basis were some of the highest.”

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Misinterpretation of Stark Law triggers improper valuations

“Some appraisers in the healthcare industry have avoided using traditional methodologies in certain situations in favor of approaches that contradict business valuation theory due to misinterpretation of the Stark Law definition of fair market value,” writes William B. Hamilton, (Pershing Yoakley & Associates, PC) in the March 2015 issue of Business Valuation Update.

For example, some healthcare appraisers have chosen not to consider the income approach in fair market value appraisals of certain hospital-physician transactions because they believe it implicitly considers the “volume or value of referrals.” In other cases, the appraiser transforms an existing business into a hypothetical one for valuation purposes by utilizing benchmarks to calculate the value of a “typical” entity using the income approach rather than relying on the expected future operating performance of the subject. “Our view as appraisers is that each of these methodologies misinterprets the Stark Law definition of fair market value and violates traditional business valuation theory,” writes Williams.

For further details, see the March 2015 issue of Business Valuation Update (subscription required).

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Management forecasts, WACC for startups spark Web discussions

Some very interesting discussions are going on in several LinkedIn groups devoted to valuation.

In the BVAN group (almost 9,000 members), a veteran valuation expert is in court and the opposing expert asserts that, if the client cannot or will not prepare projections of future cash flows, then it is incumbent on the appraiser to create and use projections so that a DCF can be included in the appraisal. The opposing side quotes ASA course material as saying: “If the subject company does not prepare forecasts or the prepared forecasts are unreliable, the appraiser should prepare a forecast independently or consider a capitalization model." The appraiser on the other side is not an ASA and needs to know whether that quote is accurate. Turns out it’s not. One commenter provided the actual quote, which says “the appraiser may prepare a forecast.” (emphasis added). The discussion prompted over 50 comments and is still going strong. Says the initiator of this discussion: “I think I created a monster!”

On the BVR LinkedIn page (with over 3,600 members), someone asks advice on what adjustment can be made to an established company’s WACC to identify the WACC of a startup company in the same industry. He asks whether a 30% WACC is too high. One commenter says that a 30% rate is definitely too high: “Venture capital firms in general do not earn even a 30% IRR on their portfolio of deals (including losers), so a 30% required return is too high if you are using proper DCF (with failure probabilities in the analysis).” Another commenter advises that this cannot be easily modeled and he recommends the research done by the Pepperdine private market cost of capital project, where the findings on cost of funds are based on real-world inputs.

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Summary of 2016-17 USPAP changes

The Appraisal Standards Board (ASB) has adopted modifications to the Uniform Standards of Professional Appraisal Practice (USPAP), which will be incorporated into the 2016-17 edition of USPAP. The ASB has issued a 2015 Summary of Actions Related to Proposed USPAP Changes.

Of particular interest are the standards related to reports and recordkeeping. In an earlier exposure draft, the ASB proposed changes that would require that all draft reports be kept regardless of whether they were later superseded. This proposal was later eased somewhat to apply only to final reports. In the last exposure draft, the ASB proposed no changes to the existing recordkeeping rules concerning reports.

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Fifth annual energy valuation conference in Houston

The 2015 Energy Valuation Conference, jointly sponsored by the Houston chapter of the American Society of Appraisers and the Houston TSCPA Foundation, will “provide relevant information and perspectives about current issues in the performance of energy-related valuations,” according to the conference announcement. Sessions include energy derivatives/valuation and fair value, mining processes and valuation issues, offshore drillers/valuation considerations, and more.

The one-day event takes place on Tuesday, April 28, at the Houston branch of the Federal Reserve Bank of Dallas. For more information and to register, click here.

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The Risk Premium Calculator has a
new name

The Valuation Handbook - Risk Premium Toolkit is the new name for the Risk Premium Calculator, a Web-based model that offers defensible cost of capital measures, particularly for small target companies. The model was developed by Duff & Phelps and is offered exclusively through Business Valuation Resources.

Bonus: A subscription to the Valuation Handbook - Risk Premium Toolkit includes a print copy of the 2015 Valuation Handbook - Guide to Cost of Capital and quarterly updates (a $425 value!). For more details, click here.

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Grabowski to conduct advanced workshop on cost of capital

Has the risk-free rate lost its meaning as a building block in cost of capital models? What is the current estimate of the equity risk premium? What are alternative risk measures? These questions—and more—will be addressed in a special four-hour Web-based program with Roger Grabowski (Duff & Phelps) on March 17. He will walk through the essential fundamentals and advanced concepts of cost of capital estimation. Grabowski will also refer to data contained in the Guide to Cost of Capital and Industry Cost of Capital literature.

To register, click here.

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BV movers …

People: Shawn Hyde, manager at Yeo & Yeo in Saginaw, Mich., has been named editor-in-chief of the Institute of Business Appraisers’ nationally distributed professional journal, Business Appraisal PracticeStephen Olvany has joined the CBRE Group’s Stamford, Conn., office as vice president of the valuation and advisory services group … Arik Rashkes has joined Houlihan Lokey’s New York City office as managing director covering deals in the insurance sector … Punit Renjen has been named global CEO of Deloitte Touche Tohmatsu Ltd. and will assume the role on June 1, 2015, at the start of the firm’s new fiscal year. He has been with the firm for 28 years and is currently chairman of the U.S. branch of Deloitte … Sheri Schultz, director of litigation support and business valuation at the Plantation, Fla., firm Fiske & Co., has been elected to the North America board of directors of CPA Associates International … Sean Smith has been promoted to chief marketing officer at the Schneider Downs, based out of the Pittsburgh office … Marissa Pepe Turrell has rejoined Marcum LLP as advisory services director, working from its Needham, Mass., office.

Firms: HLB International, a worldwide network of independent accounting and advisory firms, has added its fourth Dutch firm Blömer to its member community.

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The arcane world of IRPs tops list of CPE events

What do you really know about the IRP, and what does it mean or not mean to your cost of capital and your ultimate value solution? Join Jim Alerding (Alerding Consulting LLC) on February 26 for Industry Risk Premiums: How Do We Get There? Learn how IRPs are determined and what they mean to you, the valuation analyst, as you determine your cost of capital.

Other upcoming webinars of interest:

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Disgorgement case

A/E industry data

Stark Law confusion

BV talk on LinkedIn

USPAP changes

Energy valuations

Risk premium toolkit

Grabowski workshop

BV movers

CPE events








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