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SEC Draft Report on Financial Reporting
Baldwin v. Bader (Daubert Challenges/Personal Guarantees)



SEC Draft Report on Financial Reporting

From Alex Ruden, ASA, M/TS, ARM, Certified General RP Appraiser, Business and Intangible Asset Valuer (Southeast Appraisal, Atlanta, GA):

Seems to this multi-disciplined practitioner very active in fair value accounting, that the SEC, accountants and appraisers all have an issue and a problem.  Each group needs to work on the matter with the others.  The SEC needs to understand the appraisal profession (to create a new profession and/or skill set is absurd).  Auditors need to be trained in all the disciplines of the profession.  And, of course, the appraisers need to get their act together on this matter, not only within each discipline but across disciplines.  The ARMs of the ASA should stand up and take a lead (being senior and multi-disciplined).  The present structure and leadership of the asa is not geared to handle this matter.  At this time the spotlight is on the bv discipline, yet the same general shortcomings of competence, experience and methodology applies to the tangible asset disciplines.  In summary, fingers should not be pointed at others but looking in the mirror is appropriate.  The proper appaisal/valuation techniques for fair value accounting it is a crusade we all need to be on together.      

 From a CPA, ABV appraiser:

In regard to the article in BVWire # 71-2 “Appraiser Send Serious Concern to the SEC,” I would like to add my comments. 

First of all, I agree with all of Don Wisehart’s comments on the issues he responded to.  In addition, a lack of one set of standards is not necessarily the problem since they all achieve the same objective.  The fact that there are four may scare the regulatory body, because it’s not like the accounting profession where there is only one entity to shoot at and hold responsible.  This does not cause concern to the IRS, but if the appraisal organizations agree on one set of uniform standards, that would be resolved.  However, speaking form my conversations with the AICPA they will never agree to that since, as they put it, they are only concerned with the “CPA valuator” who is a member of the AIPCA.  That leaves three organizations to unify if this needs to be done.  Alternatively, the SEC could choose one such as USPAP compliance in its reports.

Regarding the “significant variances in the quality, skill and reports of valuation specialists’, the SEC needs to realize that for one, every appraiser is at different stages of their professional development.  Accordingly, this will reflect in their work.  If the standards are followed though, the reports should contain all of the proper items.  If one report is more detailed than another, this may purely be differences between appraisers who perhaps get to the point versus ones who discuss topics at length.  Both however, should contain all of the pertinent data.  If professionals are not following the standards, then shame on them.  The respective organizations should police their members as Don said.   A second thought is that these recent FAS pronouncements are relatively new and how much training and guidance has the FASB or SEC provided on these issues?  There seems to be from what I hear many questions surrounding their implementation.  So how can someone know how to competently give the SEC of FASB what they want or are looking for?  You can’t confuse an issue on fair value and then blame the profession for trying.  Fair value does not even follow the general process for valuation from what I hear – it’s FASB’s concoction.

Lastly, leaving it to the auditors is definitely not the answer.  An auditor cannot audit their own work.  They need third party evidence to test.  The training and guidance must be provided and appraisers need to get competent with what the SEC and FASB are looking for.  The SEC and FASB need to provide the answers to all the problems that need to be resolved in this fair value hogwash.  By doing this and by all appraisers complying with their respective standards, then the work will get done properly.  If an appraiser is not qualified, they should ethically refer the work to someone else. 

As an Aside:

Thankfully, I don’t do fair value reporting nor will I ever.  The FASB has screwed up enough issues in its history so I am not going to let those bureaucrats dictate how I run my practice.  Letting FASB tell the valuation community how to value something is like letting your dog groomer perform veterinary surgery. 

 From Bill Hanlin, Jr. CPA, CFE, CVA, CFD (The Hanlin Moss Group, Seattle, WA):

I too have heard representatives of the SEC, or those who think they speak for the SEC, complain about the valuation profession.  After hearing about some of the problems, I wonder that the SEC had not publicly banned those who are providing bad valuation services to public companies.  For example, one public company hired a valuator who advised his client to use the highest calculated value, even though it was not the most appropriate value.  I remember thinking that a trained valuator would not have given such advice.  Who are these people?

I have been a valuator for 26 years and take my duties, to clients and the profession, quite seriously.  I have watched the US valuation profession evolve from a group of organizations fighting turf battles, to seeing those same organizations morph into a real profession…a real group of professionals.

The SEC does not get to know this profession, because most of the work performed in the valuation arena is connected with the largest accounting firms.  In the US, these large accounting firms continue to find ways to keep valuation to themselves, despite rules, regulations, and ethics codes which forbid such efforts.  This would be OK, but these firms have a long history of not hiring credentialed valuators.  In fact, if you talk to anyone in the “corporate advisory” sections of any of the Final Four, there is an attitude that credentialed valuators are meaningless.  This attitude is, in my opinion, without foundation and usually based on someone merely stating that “…obtaining such a credential is too easy, and therefore worthless.”

Apparently the SEC buys this line of reasoning.  I have not heard of any direct interest being shown by the SEC in having discussions with any of the credentialing organization in order to find out who they are, what it takes to get a credential, and more importantly, what it takes to keep it.  Instead we get the SEC advisory draft that all but condemns the profession as inadequate.  And most frequently, the evidence cited for this condemnation is that each organization has published its own set of professional standards.  I would invite the SEC to objectively study the various standards.  This could only result in their finally understanding that these various standards are really very similar to each other.  So, the problem is not with valuators who have to follow standards, it is the valuators who provide services to public companies that do not follow standards!

Not all CPAs are similarly qualified.  This is true in the valuation profession as well.  Instead of whining about the valuation profession, the SEC should do something constructive to find out who is really out there; who is qualified to perform competently for public companies.  The big firms hire staff that may have finance degrees, but do not have a  comprehensive understanding of valuation theory and models.

A year ago I had heard that the SEC and PCAOB were considering a registration process, much like CPA firms, for valuators who do work for public companies.  I think the idea has merit and should be further explored to a logical conclusion.  THE PCAOB could design a registration process to gather enough information about the valuation firm/valuators to ensure at least a minimum competency.

For anyone who has paid attention and been part of the process, the valuation profession in America has achieved a lot in the last 15 years and has produced many fine practitioners.  We are not hiding and we are available.  The SEC need to get its head out of the office and go looking.  Instead is seem that we will be punished because of their shallow understanding of the US valuation profession.

From a CPA, CVA appraiser:

I would add that this industry has been so driven by its litigation and contentious applications, as “independent” appraisers craft complex economic models to defend their “independent” opinions (using derivatives of open marketplace analyses that they try to impute to restricted market applications), it is no wonder the SEC and other regulatory bodies outside the forensic/valuation sphere are wandering into the oversight territory.  Instead of reasonable professionals working to establish reasonable processes to resolve differences in assumptions (which are generally the only source of our differences) outside the courtroom; we arrogantly take our knowledge and biases into a contentious environment, like some kind of warriors, with the intent to “crush the opponent expert” on the nuances of applied economic models (which have as many varied critics and application failures as the courtroom experts that cite them).  I hardly think that mentality qualifies us as “independent”.

An economic model, with or without critics, applied to situation specific assumptions becomes a theory, not a theorem; because we all know that assumptions applied to circumstantial application – may or may not occur as specified.  Webster defines a theory as speculative in contrast to practical applications.  A theorem, on the other hand, is defined as a logically defined application of a formula or proposition, determined or proposed to be a demonstrable truth.  Case law does not make valuation theorems, especially when nearly every case can find its critics.

Many valuation professionals are “independent” professional servants, whose valuation credential is second to a license that specifies that the “public” is the benefit of their knowledge and practice.  And those that are not so licensed, would certainly benefit from a perception of their role as public servants.   As such, perhaps we need to ask how the public benefits when independent “experts” use the court room to create situation specific standards to create and support their own theories.  Furthermore, in this environment, it is often not the analysis that carries the day, but rather the varying abilities of the “experts” to articulate their particular interpretation of various economic models – thus these are forms of theories.  Even worse, much like tax law, bad facts make bad law that is imputed to a broader public case.  As we continue to promulgate interpretations of standards and practices (from a multitude of sources, organizations, credentials, and theoretical bases often without agreement among ourselves) through court room decisions, we can expect nothing but an amorphous body of knowledge to grow beyond comprehension.  The result will be some attempt to simplify the process to something that can be more uniformly applied (as some form of theorem).  Unfortunately, that will be assigned to bureaucratic environments, and we will not have benefitted those that we serve in the best possible way .  However, several groups of appraisers and authors will be able to tout the glory of their vanquished opponents and court cases, which does, nonetheless, make for interesting discussions in CPE sessions.

From a Michael A. Crain, CPA/ABV, ASA, CFA, CFE (The Financial Valuation Group, Fort Lauderdale, FL):

Accounting regulators and the valuation profession are operating on two different planes.  Valuation practitioners mostly live in the world of finance theory.  That is our training.  On the other hand, regulators operate on three principles for financial reporting: relevance, reliability, and verifiable.  Accounting standard setters and SEC follow these principles in a balanced form whereas the valuation profession does not.  Appraisers focus on reliability but give less attention to relevance and verifiability. When valuation practitioners correctly use finance theory in fair-market-value projects, they also use much judgment.  Too much for the comfort of regulators.  Furthermore, the capital market system relies on auditors and they find it hard to do their job in verifying valuation judgments.  So do SEC staffers.  A high degree of judgment may also lead to intentional and unintentional misstatements in financial reporting by shifting judgments that affect a firm’s earnings.  Regulators know this and their job is to try to prevent it.  The valuation profession needs to understand that accounting regulators will always follow the three principles.  It’s non-negotiable.  This is at the heart of the SEC message.  If appraisers are to understand that message, we need to see it from SEC’s perspective. 

From Edward Belanger, CFA, ASA (American Appraisal):

Almost three years ago at the last joint AICPA-ASA Conference, Scott Taub of the SEC gave a speech that can be paraphrased as follows (my words):

The accountants have a single regulatory body over the profession (the AICPA), with a single set of standards, a single set of accreditation criteria, robust oversight and enforcement of professional standards, uniform technical standards, and effective peer review.  If the valuation profession expects to continue to do work for financial reporting purposes in the U.S., it had better raise its performance to the level of the accountants on all these points.  If not, expect to be shut out of doing financial reporting work for public companies.  Regulate yourselves effectively, or we will impose it upon you from above.

Sitting in that ballroom with several hundred of my professional colleagues, a chill ran down my spine.  We were warned.  None of us should be surprised at what the SEC Advisory Committee has said.  While our profession has countless meetings to discuss the future intent to somehow work better together some day, and valuation standards and practices converge at geologic speed, the train is leaving the station and we're not on board.  If the SEC shuts us out, we have only ourselves to blame.

From Stephen M. Reiss, CPA, CVA (Berger/Lewis, San Jose, CA):

At a recent meeting of the California CPA Litigation Steering committee I brought the SEC Draft to the attention of the committee.  I also provided a copy of the ASA/Appraisal Foundation response.  It is my understanding that the subject has been referred to the senior members of the California CPA society for response.  Clearly the business appraisal profession needs its voice to be heard just as strongly as the real estate contingent.

From an ASA, CPA, ABV, MCBA appraiser:

“…highly trained professionals who meet rigorous valuation-specific requirements involving experience, education, training and testing; who adhere to the Uniform Standards of Professional Appraisal Practice; and, who observe strict ethics and independence mandates” and that they “encourage greater understanding of professional appraisal designations and the body of knowledge of our profession.”

I don’t know whose reports they’re reviewing every day, but they sure don’t meet these criteria.  (And yes, I’m talking about “credentialed” appraisers.)

From a fair value appraiser:

Enough whining already………Define, create, improve and distribute proper FAS 157 guidance, education and training or concede the business to an accounting equation (at worst) or the ABV community.  I can attest – from my attendance - that the only current in-depth coverage of Fair Value relates mostly to statutory dissention appraisals.  Hello legacy BV community: 59-60 and the myriad of associated “creative interpretations” means nothing in the FAS 157 space!  Adapt your practice to this type of work or step aside.

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Baldwin v. Bader (Daubert Challenges/Personal Guarantees)

From Donald J. Schaffer, CPA, ABV, CVA (CJBS, Northbrook, IL):

Once again the Courts fail to recognize that there may not be a plethora of expert articles debating a matter to which the answer is relatively obvious.  How does one argue that the risk on debt guaranteed by an investor is not substantially comparable to the risk of an investment in equity?  The only question is the degree of similarity, not whether the start point should be the required return on equity or some other measure. 

One need not go far beyond ordinary logic to conclude that the risk of an unlimited loan guarantee, by an investor who has provided the lender with a method to easily collect against his personal wealth without undue delay, is substantially equivalent to the risk of an equity investor.  How would you differentiate such risk from that of an investor who personally borrowed the amount in question and invested it in the enterprise as equity or as a loan.  Such debt is more equivalent to a class of stock than it is to debt not guaranteed by an investor.  Any variance in terms the terms of the debt from these assumptions are refinements of the calculations, not proof that the principle is incorrect.  The Court got it wrong.  They should have allowed the argument to be presented.

From John Kinross-Keennedy, CPA, ABV, CVA:

The court relied upon the premise that Daubert precludes methods not already accepted by the valuation profession.   This leads to fossilized thinking.  It precludes the development of thought. We have a new situation in Baldwin v. Bader not yet covered in the literature.  The Court had a wonderful opportunity to allow the advancement of  knowledge, but they turned a blind eye.  In strictly applying ‘stare decisis’ with Daubert they missed the opportunity to make law themselves, and advance the valuation profession.   

From Art Rosenbloom (CRA International, New York, NY):

I believe that the position of an insider (officer/director) who provides a personal guarantee on a loan is not to be likened to that of an equity holder. In its capacity of guarantor (as distinguished from its position as one whose equity might or might not increase as a result of the application of the loan proceeds) the insider acts only as a credit enhancer, with liability limited to the amount of the loan and no upside appreciation possibility. The limitations of both downside risk and upside potential are unlike the position of the equity holder who has virtually unlimited liability and unlimited opportunity.

From a CPA, ABV appraiser:

In response to you request for some preliminary thoughts on the Baldwin v. Bader case, I believe the court may have in fact set the bar too high.  Although I have not read the case yet, there is a big problem with holding the viewpoint that “Daubert does not permit a valuation technique that no expert has ever used before, and for which there appears to be no direct support in the BV professional literature” (quoted from your article in BV Wire 71-3).  It would seem from that perspective that many valuation questions are unanswerable, because unless it is explicitly in a book, it simply can’t be done.  And for that matter, there is much that is not explicitly in texts.  There needs to be a balance of understanding valuation theory by the court and what the valuation expert is trying to accomplish through application of valuation principles and approaches taken from cited texts and articles written on the subject if they exist.  Most valuation issues can be resolved through that framework.  However, it seems in this case that the court would prefer to point to a law or a cited regulation which says you should do A, B, and C, which essentially removes them from the judgment seat.  Unfortunately for them, any expert of any kind can sit in a courtroom and it is their job to judge the credibility of the testimony, weigh the facts and render their decision – or the court’s opinion. 

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