When the stakes are high, litigators often bring in experienced financial experts to calculate damages and quantify the dollars and “sense” behind a lawsuit. But, how do you make sure your expert’s report is worth more than the paper it’s written on?
Daubert v. Merrell Dow Pharmaceuticals, Inc. (509 U.S. 579, 1993) is the law of the land in both federal and Florida courts. However, this landmark U.S. Supreme Court case regarding the admissibility of expert testimony has been hotly debated within the Florida Bar Board of Governors. Regardless of whether Daubert remains the standard for expert testimony in Florida, the case does provide sound guidelines that all financial experts should follow, regardless of whether or not the admissibility of their testimony is challenged.
According to Daubert, courts serve as the gatekeepers to assure an expert’s testimony is reliable and relevant. PricewaterhouseCooper’s Financial Expert Witness Daubert Challenge Study (2000 — 2014), noted the number of challenges to financial expert witnesses increased in 2014 to the highest level in 15 years. Translation — anticipate a challenge to your financial expert!
Most importantly, when expert testimony was excluded, PwC noted the primary reason cited was lack of reliability. Interestingly, reliability is also a pervasive theme in the American Institute of Certified Public Accountant (AICPA)’s recently released Practice Aid, Attaining Reasonable Certainty in Economic Damages Calculations. In addition, the “general standards” set forth in the AICPA’s Code of Professional Conduct focus on professional competence, due professional care, planning/supervision, and sufficient relevant data — all cornerstones of reliability. Therefore, it would stand to reason that any Certified Public Accountant utilized as a financial expert should inherently pass muster under Daubert, regardless of its applicability in Florida, since he or she must comply with the standards.
But, how do you determine whether an expert’s report is “reliable?” The good news is that when assessing financial expert testimony, reliability is not an elusive quality. In fact, common sense prevails more often than not.
First and foremost, an expert’s credentials lend weight to the reliability of his or her report. Would you ask your family doctor to perform open heart surgery? Similarly, CPAs often specialize in certain areas. Find one that has proficiency in litigation support. Additional designations indicating specializations are beneficial — look for CFEs (Certified Fraud Examiners), CFFs (Certified in Financial Forensics), and ABVs (Accredited in Business Valuations) to name a few.
Second, be wary of client-supplied information. An expert should always consider the best available evidence. For example, on the spectrum of financial data (from best to worst), audited financials are the gold standard, followed by reviewed statements, compiled financials, and internally prepared financials.
Furthermore, experts should never blindly accept client data without testing it for reasonableness. For example: a startup company projecting sales within the first five years to match the entire industry probably has certain unrealistic assumptions. Management-supplied financials need to rest on data that has a connection to reality. Keep in mind that data prepared in anticipation of litigation, or management projections that are consistently inaccurate, should be subject to a greater degree of skepticism.
In addition, while recovery for newly established businesses is not precluded by the courts, experts should view start-up projections with a greater degree of skepticism. Businesses that lack operational history should possess the ability to generate sales and profits, a management team capable of growing the business, and appropriate access to capital and funding.
Lastly, don’t accept that causation is a burden solely on counsel’s shoulders. Often times, counsel asks financial experts to “assume causation.” However, case law has shown that experts who assume causation can and will be excluded when that assumption approaches the realm of “irrational.” See Fashion Boutique of Short Hills v. Fendi USA, Inc. (1999).
Even when confronted with Daubert, such a challenge is far from insurmountable. In fact, of all the Daubert challenges in federal courts during 2014, only 36 percent were successful. This is the second-lowest exclusion rate in the history of PwC’s study. So, what are the tough questions counsel and experts need to ask themselves and each other?
- How clear is the damage causation? Can the damages be quantified at all?
- Did the expert use procedures typically employed by similar professionals?
- Did the expert consider all material facts and evidence?
- Did the expert utilize assumptions that were supported and independently tested?
- Did the expert consider alternative scenarios, explanations, fact, and/or assumptions?
- Is the claim supported by verifiable data? Are assumptions speculative? Does the business have a track record?
- Is lost profits the best measure of damages? Can lost business value be used as an alternative to less certain projections?
If these questions can be answered with conviction, the expert’s report can surpass being simply “reliable, enabling the legal team to effectively litigate their case.”
Sheri Schultz, CPA/ABV/CFF, is Co-Managing Director and Director of Business Valuation and Litigation Support Services at Fiske & Company. Katie Gilden, CPA/ABV/CFF, CFE, CVA is a principal with Fiske & Company. Both focus their practice on Business Valuation, Forensic Accounting and Litigation Support Services.
By Sheri Fiske Schultz
Fiske and Company
Offices in Fort Lauderdale,
Miami, and Palm Beach
South Florida Legal Guide 2016 Edition