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The Business Appraiser Surviving Cross Examination
- 1. SO YOU THINK WE DON’T CHECK? SURVIVING CROSS-EXAMINATION OF THE APPRAISAL EXPERT A Lawyer’s Point of View© Business Valuation Resources and the American Society of Appraisers Present: Divorce: A Hands On Workshop for BV Practitioners
- 10. The 4 Worst Report Writing Errors a) Hedge Words & Equivocation b) Use of Generalities c) Use of Absolutes d) Assumption and Presumptions : Business Valuation Resources and the American Society of Appraisers Present: Divorce: A Hands On Workshop for BV Practitioners
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- Opening Slide: For many years, the business of business appraisal was the sole provenance of CPA practices and business valuators. Business valuation was a mystery to lawyers and laypersons alike. As lawyers, most of us assumed the reports issued by the CPA’s, and business valuators were correct. After all, they looked impressive and were filled with arcane references such as “weighted average cost of capital,” “normalization of earnings,” “discounted cash flow,” “linear regression” and the like. The graphs, charts, statistics and spreadsheets of historical financial data were very impressive and intimidating. 15-20 years ago most lawyers did not have the grasp of business valuation it takes to challenge the appraiser. But, as business valuation became more common in divorce practice we saw different appraisers – both seemingly qualified, coming up with sometimes vastly different opinions of value for the same business. We realized that as divorce lawyers, we needed not only to understand the theory and practice of business valuation and apply it critically to the valuation analysis and reports of the experts – our own experts and the opposition’s - but we needed to be able to effectively cross-examine an expert witness business appraiser Lawyers have learned. Many of us understand the theory and substance of business valuation, including the approaches and methodologies and how they are correctly applied. We are familiar with the appraiser’s data sources and the databases. We subscribe to the valuation profession’s publications and buy the texts. We can analyze, deconstruct and successfully attack a business valuation report. CLICK TO SLIDE 2:
- Slide 2: The Lawyer’s Job At the core, in order to deal effectively with cross-examination,, the appraiser must anticipate what a cross-examining lawyer will do with the valuation report. The foundation for effective cross-examination is critically evaluating the report. The lawyer who understands business valuation will be able to find the report’s weaknesses and vulnerabilities. Click to: Opposing Lawyer’s Job Click to “Discredit the Business Valuation report.” In order to prevail, the lawyer must not only present his or her own appraiser in direct examination in a persuasive manner, he or she must discredit the opposing business valuation report and discredit the opposing business appraiser. Click to: “Discredit the Business Valuation Appraiser” This can only happen if the appraiser provides the raw material for the lawyer to discredit him or her and the opinions and conclusions in the report. The lawyer’s failure or success in being able to discredit the business valuation report and the appraiser or, whether the appraiser can bullet-proof his or her valuation report and testimony is 95% in the appraiser's hands hands.
- Slide 3 What Does a Lawyer Do and How Do They Do It Click to :We Read and Critically Analyze Every Word of the Report We read and critically analyze every word of the report from the cover letter to the certification and bibliography. This is the foundation for identifying all reference and source materials used or relied upon by the expert, the errors in the analysis, application of the methodology, report writing errors and for deconstructing the report without mercy. Opposing valuations can differ by millions of dollars. The stakes are high Click on Slide 3 to: Nothing is Accepted at Face Value Nothing you state in the report will be accepted at face value. Not what you may put on your CV, not your sources, not your computations, not your analysis. All assumptions and data are questioned and tested, Whether your work and writing is original or taken from another source without attribution is questioned. Every mathematical error, grammatical error, typographical error will be found and utilized in some way to build the case that your approach and conclusions are not credible. That the appraiser cannot be relied upon. Click on Slide 3 to: “Nothing is True Until Proven to Be True.” Every source that you footnote, and material that is not footnoted is researched and analyzed for correctness. All transactional data in the merged and acquired method and information regarding guideline companies is tracked down and fact and number checked. From Ibbottson data to Done Deals, we check and verify.
- Click to Slide 4: The lawyer’s Deconstruction of the Business Valuation Report: the following are some specific points that the lawyer will look for in reviewing the BV report: Click to: As The Appraiser’s CV Accurate : Frequently CV’s are not updated or are inaccurate. On more than one occasion an appraiser has represented that he was an “an ASA candidate” when in fact he was applied for candidacy several years before, never took a course and had abandoned the effort. The representation was a direct violation of the ASA ethical Rules. Another represented that she was an CBA when in fact she had failed to complete the requirements. Misrepresentations, inadvertent or intentional in an appraiser’s CV are self-inflicted wounds. Click to: Are there Typographical, Mathematical or Computational Errors? These are the most easily preventable mistakes and the easiest mistakes for a lawyer to find. While typographical errors, individually, may not seem of much importance, as they accumulate, they can be used as examples of carelessness which may effect credibility. Mathematical and computational errors usually do effect the validity of the conclusion of value, These easily preventable mistakes lead to what I call during cross-examination - “Death by a Thousand Cuts.” It is the impact of cumulative errors that can undermine an appraiser’s credibility and call reliability into question. Every time a report is revised or amended because of errors the appraiser loses credibility. Click to: Is there any Plagiarism? Plagiarism can be intentional, but most often is careless or inadvertent. Either way, if it occurs the consequence to credibility can be devastating. We will talk about this in more depth later on. Click to: Has the Appraiser Complied with Applicable Business Valuation Standards and Ethical Rules . All of the business valuation organizations now have their own business valuation standards: the ASA, AICPA, IBA and NACVA – some standards are more exacting than others. Whatever standards apply, the lawyer will look to see if there is strict compliance with those standards. If not – failure to apply with the appraiser’s own professional standards will be used to discredit the appraiser.
- Click to: Has the Appraiser Complied With Applicable State Law? . Nearly every state has case law with respect to valuation issues; such as the use of post valuation date data or the standard of value which may vary from FMV to fair value to value to the holder or perhaps with respect to whether valuation of personal good will is acceptable or whether only institutional goodwill can be valued. The appraiser must know the key state cases that impact on the valuation. If the appraiser does not know the key cases then he or she should require that the lawyer for whom he or she is working provide them. You can be sure that you will be examined on the key case law that applies to the valuation you have performed. You need to be aware of that state specific case law before you perform the valuation. Click to: Did the Appraiser Correctly Apply the Selected Methodology : This is obviously a key point. A lawyer will question first, whether the methodology is appropriate for the definition of value, second, whether the methodology is appropriate considering the applicable law of the state where the valuation occurs and third, whether the methodology is correctly applied. A for instance where methodology was incorrectly applied is where an appraiser utilized transactions from Biz Comps, Pratts stats and the IBA database and then combined the results without adjustments for the differences in the manner in which the databases reported the data, resulting in a substantially skewed value which was not accepted by the Court. Slide 5: The Lawyer’s Deconstruction of the Business Valuation Report (p. 2) Click to; 7. Is the data used accurate and sufficient to support the opinion of value. For instance are the discount and capitalization rates adequately supported? In the asset method, are all categories of assets adjusted to fair market value as of the valuation date? Or do third party valuations meet professional standards.
- Click to: 8.Did the Appraiser retain the required Documentation in the Work file . Talk more about this later Click to: 9.Did the Appraiser make necessary and appropriate financial statement adjustments and are the size of the adjustments supported? Click to: 10. Are the Economic and Industry Data Utilized, Reliable? Also, has the appraiser reported the data correctly? Click to: 11. Did the Appraiser Conduct a Site Visit and Management Interview? We’ll talk more about this one in a minute Click to: 12. Does the Appraisal Report Indicate Bias or Advocacy? This is a key inquiry. Independence and neutrality is essential. Any indication of bias can be fatal. The insertion of personal beliefs or experience as the basis of an opinion brings into question the reliability of the opinion. Click to Slide 6: As I indicated earlier, the keys to bullet-proofing your business valuation report and testimony is 99% in your hands. The two keys are: The development and documentation of the Conclusion of Value; and The writing of the report.
- Slide 7: Document the Work file Key to surviving cross-examination about the development of the conclusion of value is the documentation in your work file. You can be sure that a knowledgeable attorney will at some point – at deposition most likely - send a subpoena which will request every shred of paper in your work file. Most BV standards require that the appraiser maintain in the work file documents that were utilized or relied upon in developing the conclusion of value. Some standards give the appraiser more discretion about what should be included in the file. Click to: Include Everything: My advice is that you should include everything in your work file: irrespective of what the applicable standards require. You should include every piece of data and source material you looked at including copies of data or materials take from on-line sources. The failure to include source materials, work notes and more creates an issue where there may be none. Click to: Do Not Purge the Work File : if your work file is subpoenaed, do not purge it.. I have been in cases where appraiser’s took out emails from retaining counsel, telephone notes, staff notes or other handwritten materials. Purging the work file may not only perhaps constitute a violation of the professional standards with regard to maintaining appropriate documentation in the work file, but could cause a huge credibility issue if discovered. In one case the opposing party hired two appraisers from different companies to value celebrity goodwill. One appraiser’s file was devoid of any handwritten notes of telephone calls with attorneys or the other appraiser and he did not have any independent recollection of any conversations. The other appraiser’s work file was full of handwritten notes regarding conversations with the other appraiser and attorneys discussing things such as the goal of the valuation to be a predetermined conclusion. This circumstance led to a motion to exclude the first appraiser – an ASA – on the grounds he purged his file. This leads to the next point:
- Click to: Do Not Communicate Substantively by Email: When communicating with the retaining attorney do not communicate by email regarding substantive issues about the appraisal; For instance, what the attorney’s goal is, what number his or her client thinks the business is worth; arguments by retaining counsel to get you to lower the value or changing methodology. I have seen all of these types of emails in appraisers’ files. Emails and notes of conversations with retaining counsel lead to dangerous cross-examination and open you to attacks on your independence as an appraiser. Click to: Keep the Work file Organized . This point may seem obvious, but in a surprising number of cases, the appraisers failed to maintain the work file in an organized fashion when coming to deposition or trial. If it is not organized so that supporting materials are easily retrievable in a deposition or court, especially it makes the appraiser look unprepared and sloppy, both of which impact credibility. Slide 8: have Absolute Knowledge of the Relevant Facts Click to: Always Conduct a Due Diligence Interview. A common error made by appraiser’s is inaccurate or insufficient reporting of company historical and financial information. It would be very difficult to have knowledge of the relevant facts about the company if a due diligence interview is not done or a deposition taken of the company owner and key personnel. Important details can be missed which could have a significant bearing on the conclusion of value such as the existence of a key employee or customer. If a deposition is taken you should be there if at all possible. If the retaining attorney does not ask for the interview or plan on doing a deposition, you should insist that it happen. Failure to have knowledge of a key fact or issue regarding the company can torpedo your valuation and your credibility.
- Click to A. Verify Company History/background. The company’s history gives the appraiser a perspective on how the business evolved over time, its growth characteristics, changes in lines of business or ownership over time. The history may have a bearing on how many years of financial data are relevant. T Click to: B. Verify Company Financial Information. In a due diligence interview the appraiser can investigate the existence of off balance sheet assets and liabilities as well as contingent liabilities. Or the interview may reveal whether pension liability is under funded or over funded . The point is that the due diligence interview is an opportunity to obtain relevant information that may not be visible in the financial documents you are provided. Click to: Always conduct a site visit. Whether the company is located in a simple office building consisting of nothing but unrevealing cubicles a site visit should be arranged. In my experience, judges seem to find that credibility and knowledge is enhanced when the appraiser has made an effort visit to the company’s location. Slide 9: Double Check the Data : Click to Reporting and Use of National, Regional and Local Economic Data The old axiom – Garbage in – garbage out” applies here. The data and information that you use to support your opinion of value must be reliable, verifiable and complete. Before the report goes out, you should verify that all the economic data is correctly reported by you and attributed to its source. .
- Click to Reporting and Use of Comparable Transactions: There are multiple sources for comparable transaction data from Pratts Stats and Biz Comps to Done Deals and Mergerstat. In addition there may be prior transactions in the stock of the company being valued. The appraiser should be careful in using the databases. The information in the databases is not only not always correctly reported it is reported in different formats in the various databases. Further, a transaction in one database may be duplicated in another. All of these potential pitfalls requires careful use and reporting of transactional data. Click to: Don’t Use Unverified Material From Internet Sources: Much of the economic data is available online. Either directly from the publishing source or it appears as pre-prepared summaries of data obtained from the original source such as the Census Bureau or the Federal Reserve. It is risky to trust a summary or compilation of data from another source. It is likely that the summary is being prepared by a data processor and not an appraiser and the summary could be erroneous or leave out critical details. Always go to the primary source. If you can’t – verify by using at least two trustworthy secondary sources Click to Slide 10: The 4 Worst Report Writing Errors
- Slide 11: Error No. 1; Hedge Words and Equivocations : Use of hedge words or equivocating by the expert can be an avenue for attacking the credibility of the expert or the opinion. All of these words imply hesitation or fence-sitting, uncertainty with regard to the opinion or any aspect of it. Phrases like “ It appears to be” or “ apparently” sound like the appraiser is unsure of the facts or didn’t take the time to verify it or is uncertain of an opinion. These phrases should be avoided.
- SLIDE 12 : Death By A Thousand Cuts (Error No. 2) Generalities: The use of generalities by appraisers is perceived by a lawyer as an effort to shore up absent or dubious analysis by implying that the point being made by the appraiser is consistent with the analysis or methodology typically used by the knowledgeable or majority of well informed business valuation professionals. CLICK TO :” In General” and following phrases.” I can’t think of a situation where you really need to use a generality. If you want to support a point by reference to a source you believe is authoritative and supports your position, cite directly to the source. The use of the word “substantially” is a dangerous adjective as in such phrases as “substantially true” or “substantially well known.” The lawyer will require you to prove and explain what you mean by “substantially.” CLICK To SLIDE 13:
- Slide 13: Error No. 3: Absolutes Absolutes should be avoided by an expert unless there is 100% certainty. A good cross-examiner will be able to attack the expert’s credibility if he is caught in exaggeration, hyperbole – or is simply wrong. In one case an appraiser who utilized an “Industry Rule of Thumb” in his market approach was forced to concede to Jay Fishman’s opinion that “Rules of Thumb are poor substitutes for the Direct Market Comparison Approach.” Click to Slide 14
- Slide 14: Error No. 4: Assumptions and Presumptions: Words such as ”It is assumed” or “we assume” say to me that the appraiser does not know and maybe didn’t take the time to find out. In a recent case the appraiser “assumed” an interest rate at 6%. On the actual valuation date, the interest rate was 5.0%. Did the end result change significantly? By about $65, 000. The fact that it changed, and the appraiser made an incorrect assumption made the appraiser look sloppy and the conclusion of value unreliable. The same applies to the use of presumption. If the appraiser presumes a fact to be true for purposes of reaching an opinion of value – he better be right. You should anticipate that the appraiser’s use of factual presumptions will be questioned. The appraiser who states in his report that “ He believes” something to be true is at risk for looking poorly informed or showing personal bias. The first and obvious question is ‘What is the basis of your belief?” With some appraisers you get answers such as “ I would have to look in my file..” Usually there is trouble finding it. Or the appraiser may answer “I don’t remember” . When asked “Who is your source of this information” “the response is “I don’t recall” Did you write it down? “No”….. The same kind of questioning will occur with the use of phrases such as “It is understood” or “It is implicit that…” Expect tough cross-examination if you use these phrases.
- Slide 15: Plagiarism: In business valuation, the acquisition and analysis of economic, industry and financial information from multiple sources is critical to the development of the opinion of value in every report. Often the analyst derives national, regional and local economic information from multiple governmental and private resources, easily available on the Internet. Specific industry information is easily available through trade publications and, more recently, from companies such as First Research, which develop and update industry profiles for sale. All too frequently, appraisers cut and paste entire or substantial sections of these third-party materials into their appraisal reports without attribution. Footnotes and quotation marks are notably absent. Worse, too many analysts make little or no effort to analyze the copied information and evaluate its relevance and impact on the subject company. One example of plagiarism occurred in an appraisal of a closely held insurance company. This report contained a section captioned “Industry Analysis,” consisting of three pages of single space narrative. Searching the terms “industry analysis” and “industry research” on Google turned up First Research, and an industry profile which the appraiser had purchased and cut and pasted into the report without attribution. On cross-examination the appraiser, who had authored a book on business valuation, was forced to admit to plagiarism. If you are in doubt as to the rules for avoiding unintentional plagiarism, an excellent resource is The St. Martin's Handbook , which provides a very useful chart summarizing when attribution is or is not required. .
- Summary Slide: To summarize, the top 4 Don’ts for appraisers who want to bullet proof their reports are (see slide)