Jeffrey Dorman: Statistical Evidence is a Powerful Weapon, Not a Magic Bullet

 Written by Tom Hagy

 

There are endless uses for statistical evidence.  It is great for estimating damages, providing quantitative proof of the extent to which conduct had an impact, or rebutting or cross examining an expert.  But, attorney Jeffrey Dorman says, “Just as important to knowing how to use statistical evidence is knowing when not to use it.”

 

Speaking on a live recording for Mealey’s Litigation Conferences and Business Valuation Resources LLC, Dorman said statistical evidence is not a magic bullet that should be used in every case.  “Sometimes it’s inappropriate, irrelevant or even inadmissible.” 

 

And if anyone should know it would be Dorman.  In addition to being a 30-year litigator and a partner with Freeborn & Peters LLP, he has extensive training and experience in statistical estimation, mathematical modeling, parametric estimating, system dynamics programming, and financial analysis. 

 

As a general rule it is only necessary to use damages experts when it is necessary to estimate damages, Dorman said.  In many cases there is no need to estimate, such as in cases of liquidation.  When a contract is broken, the damages generally comprise the cost of covering the contract.  In the case of theft, generally speaking it is the cost of the item stolen, unless it is something rare or unique.  In both cases, damages can usually be computed directly, without the need for estimation, and can be presented through a fact witness, as opposed to an expert witness.

 

In contrast, where damages depend upon future economic variables like profits, sales, demand and cost, or future commissions, competitive harm, or patent infringement, there is no way to avoid the use of a damages expert, he said.

 

In between these categories you have the cusp, Dorman said, like a class action where back pay is involved and data are available to directly calculate the lost back pay of each class member.  When in this situation, he said, if feasible, you should perform the direct calculation of damages; this will be better than a class-wide estimate based on regression sample because even a good approximation will miss the true value in virtually every instance.  A properly chosen random sample, while methodologically acceptable, will have sampling errors. 

 

Dorman warned:  If you chose to base your damages calculation on a sample and the opposing party correctly performs a direct calculation, there will be credibility problems because “an estimate is just that – an estimate.”  However, if the class members are in the tens of thousands so that it is impractical to perform a direct calculation, the use of a sample might be the only practical way to assess damages. 

 

It is a judgment call as to whether to perform a direct calculation or estimation, he went on.  You have to look at what data are needed, whether the data are available, and whether there is someone who can perform the direct calculation.  You also need to examine the cost and the likelihood that the opposing party will perform a direct calculation. 

 

Besides expenses there are other tactical reasons to consider when employing a financial expert.  You need to weigh the necessity against the impact on discovery  – the subject of another post.   

 

Dorman spoke for Mealey’s Litigation Conferences and BVR along with Dr. G. William Kennedy PhD, CPA/ABV with Anders Minkler & Diehl, LLP.   This is an excerpt from the session.  To receive more information about how to receive a copy of the recording, the materials and transcript of the presentation, contact Customer Service at (888) BUS-VALU, (503) 291-7963 or write to me directly at tom.hagy@bvresources.com.  I also own a phone and know how to use it:  610-312-4754.

 

James Dugan on Testifying & Consulting Experts

 

By Tom Hagy

 

An important decision in selecting a financial expert in complex commercial litigation is whether you pick a “testifying” expert or a “consulting” expert. 

 

Speaking on a teleconference for Mealey Litigation Conferences, James C. Dugan of Willkie Farr & Gallagher cited Federal Rule of Civil Procedure 26(a)(2)(B), which, he explained, offers very broad discovery parameters for testifying experts and materials exchanged in preparing for trial. 

 

In the case of a testifying expert, “assume everything you send to your expert will end up in the hands of the jury,” he said.  While most lawyers want to see drafts of expert reports, like everything else, “those drafts will probably have to be disclosed and may create issues for you and your expert.”  The other side will pore over these materials methodically in an effort to call your witness’ credibility into question. 

 

In some cases you will want to work with a consulting expert, someone who will not testify and never get before a jury, Dugan explained.     In this arrangement the materials exchanged between you and your expert are protected as attorney work product, he said.  That’s not to say the other side may not challenge you, he said, but typically they won’t be successful in breaking through the work product shield.  When you are going through rounds of drafts, you will want a consulting expert, not a testifying expert, to work with you to best position your analysis. 

 

Dugan said this is especially true where different damages theories are at issue.  You will want to investigate those thoroughly and fully prepare with your consulting expert before you work with your testifying expert.  “You don’t want to put your testifying expert in that position,” Dugan said, since this could throw their conclusions into question.

 

This is from audio recordings and materials available on CD from Mealey’s Litigation Conferences and BVR.  These packages — “Effective Timing & Use of Financial Experts” and “Compelling Statistical Evidence: Mining, Modeling, & Presenting Quantitative Financial Evidence to Juries” – contain audio, presentations and transcripts. For more information, write to me directly: tom.hagy@bvresources.com.

 

 

Michele Miles: When Picking a Financial Expert, Beware of Hormonal Imbalances

By Tom Hagy

 

 

Battle metaphors are frequent when talking about litigation and trials.  Verbs like kill, shoot, crush, and destroy are not uncommon.  Michele G. Miles, both a J.D. and accredited business appraiser, sees a danger in taking the macho metaphors too far, especially when they affect the conduct of a financial expert. 

 

Miles said you need to avoid what she calls “testosterone poisoning,” and urges you to learn the signs.

 

First, she said during the recording of a Mealey’s Litigation Conference / BVR audio, that you do not want a witness who is going to pick a fight.  Instead, she said, you want one who is proud of their process – “so proud that he will be glad to go through it again and again.”  This will give counsel an indicator that the expert will exude credibility.

 

But what are the signs of a testosterone-poisoned witness?  Miles said such a character may refer to a place in their office as a “war room” where they store and summarize documents.  They may be inclined to place a photo of themselves in their expert report.  They tend to come to you with checklists, suggesting rigidity in their process.  They may have trademarked some of their terms or processes.

 

If you want someone to pass Daubert review, she said, you do not want to show “personally developed methods” were used in place of “real world” methods.  

 

Testosterone-engorged experts may also have a tendency to read or interpret case law for the attorney.  If case law makes its way into the expert’s report “something is badly broken,” Miles warns.  If an expert must discuss a case in his report, he should refer to a treatise written by an authority on the subject, something everyone agrees is authoritative. 

 

A testosterone imbalance also can lead to a decision to have one expert to attack another, something Miles cautions against.  “Don’t use your expert as a paid assassin,” she said.  “Your witness can’t testify on his own opinion while throwing rocks as someone else’s.”   She said to stick to the process and avoid getting into past conflicts. 

 

Not only should an expert not be an assassin, they should not be a “crutch” for an attorney making his way through new subject matter.   “Do your learning behind the scenes,” she advises.  “Ask dumb questions behind the scenes.”

 

Miles warned against appearing to be too close to your witnesses.  Never take your expert out for “show and tell,” she said.  Do not pass notes during hearings, do not take him to depositions, and do not hang out during trial.  “Don’t treat them as part of the team,” she said.   

 

“What you want is an expert that, when he leaves, prompts everyone to say ‘and we never even got a chance to thank him,’” she said, recalling romanticized heroes from the Old West. 

 

You can hear more from Michele Miles, who also is former executive director of the Institute for Business Appraisal, plus commercial litigator James Dugan of Willkie Farr & Gallagher and financial expert Steven Schroeder of Schwartz & Associates LLC,  on the CD package entitled “Effective Timing & Use of Financial Experts.”   For more information, write to me directly at tom.hagy@bvresources.com.

 

Willkie’s James Dugan on Professional Experts & Expert Professionals

By Tom Hagy

 

When selecting a financial expert, you first want to make sure you need one and, if so, why type.  Speaking for Mealey Conferences, James C. Dugan, partner with Willkie Farr & Gallagher LLP, said not all cases require a financial expert.  The attorney needs to ask:  will an expert genuinely help inform the judge or jury?   “In some cases an expert will be cumulative and not additive,” he said – you don’t want an expert when the other side’s case is clearly weak otherwise you risk dignifying your adversary’s position. 

 

Once you’ve made the decision that a financial expert is what you need, another question is whether you want a “professional expert” or an “expert professional.”  Professional experts, whose primary source of income is testifying, and professionals who rarely if ever testify, both have advantages and disadvantages for different situations.  “It’s important to get this [choice] right early on,” Dugan said.  The advantages of a professional expert are his ability to testify across disciplines and their experience in the courtroom.  They are less likely to become flustered and are used to analyzing large amounts of data.  “However, professional experts have a huge public record that can be used by an adversary in cross-examination,” Dugan cautioned.  “It’s very hard to be completely consistent on every issue you are tapped to opine on.  The larger the record, the more likely your adversary will find something.”

 

Another downside to the professional expert is that the jury or judge may infer a lack of credibility to someone who testifies for a living, Dugan said, especially if they have only taken one side of an issue in their testifying career.  Counsel must scrutinize the expert’s record thoroughly during the vetting process, Dugan said, just as their adversary will do later on.

 

In practice attorneys do not always get the choice between types of experts, he said, and sometimes a subject is so esoteric that it simply cannot be addressed by an “arm-chair practitioner.”   Sometimes you need someone who acted in the relevant role, such as an investment advisor, to have more credibility with a jury.   The disadvantages in this situation are that the witness will not be familiar with the litigation process.  “It’s pretty hard to withstand cross examinations if you haven’t done it before,” Dugan said.  Or, the expert professional may not be a good communicator to a jury.  The advantage of a professional expert is that they will have been in front of juries before and the attorney will have some idea of how the witness will come across.   Dugan added that some professional experts – despite deep technical knowledge – also know how to come off folksy, which is a winning combination.

 

This is adapted from audio recordings and materials available on CD by Mealey’s Litigation Conferences and Business Valuation Resources.  These audio packages — “Effective Timing & Use of Financial Experts” and “Compelling Statistical Evidence: Mining, Modeling, and Presenting Quantitative Financial Evidence to Juries” –contain presentation materials and full transcripts.  For more info, write to me directly at tom.hagy@bvresources.com.  

 

Statistical models can make all the difference

Just how important are statistical models?   Just take a look at some recent cases where effective statistical analysis, including market event studies, became the “make or break” evidence, especially in cases concerning securities litigation and lost profit/economic damages:

• Expert’s market event study helps support loss causation claims and class action certification in large securities litigation; In re Flag Telecom Holdings, Ltd. Securities Litigation, (U.S. District Court, S.D.N.Y., 2007)
• Sophisticated event study shows efficient market and convinces court to certify class of litigants in a “fraud on the market” theory; In re Xcelera.com Securities Litigation (1st Cir., 2005)
• Delaware Chancery Court rejects lost profits computation based on an event study analysis that failed to consider all possible events that may have contributed to the loss; In Penn Mart Supermarkets, Inc. v. New Castle Shopping, LLC, (2005)
• Delaware Chancery Court favors “shared synergies” and actuarial analysis in the fair value appraisal of an insurance conglomerate’s merger; Highfields Capital, Ltd. v. AXA Financial, Inc. (2007)
• Federal court defines market efficiency, the five factors that prove it—and the statistical financial analysis that does (and does not) meet the burden of proof; In re Polymedica Corporation Securities Litigation (U.S. District Court, Mass., 2006)
• In context of shareholder seeking access to company books, Delaware Chancery Court approves unique statistical methodology for testing whether stock option backdating has occurred; Louisiana Municipal Police Employees’ Retirement System v. Countrywide Financial Corp. (2007)
• Court reverses $1.45 billion jury verdict based on lack of “fraud-free” valuation of securities; Morgan Stanley & Co. Inc. v. Coleman Holdings Inc.(Fla. App., 2007)

The last case was—until its reversal for lack of reliable statistical evidence, the largest jury award for economic damages ever.  All of these case—especially in light of the securities and loss litigation that is certain to come out of the current economic spiral—demonstrate just how important it is for valuation analysts to present compelling and understandable statistical models to a judge or jury (and assist their attorneys in preparing the evidence for deposition and trial). Reminder: Copies of all cases are available at BVLaw™, and the case abstracts are available by subscription at BVLibrary™.)

LEARN MORE.   To refresh and refine your use of statistical models, regression analysis, and market event studies, be sure to tune into BVR’s next teleconference, “Compelling Statistical Evidence: Mining, Modeling, and Presenting Quantitative Financial Evidence to Juries,” featuring William Kennedy, Ph.D, CPA/ABV of St. Louis’ Anders Minkler & Diehl, LLP, and Jeffrey Dorman, Esq. with the Chicago office of law firm Freeborn & Peters, LLP.  The teleconference takes place Wednesday October 22, 2008; to register, click here. 

Compiled and written by the fine staff at Business Valuation Resources in the latest issue of their free eZine, the BV Wire.

Court Approves Valuation Expert’s $18.6M Diminished Value Tag in S&L Case

WASHINGTON, D.C. – In a case that begins at the dawn of the 1980s S&L crisis, the U.S. Court of Federal Claims has found “fair and reasonable” the opinion of an expert witness for S&L owners that the Government’s breach of their assistance agreements caused by the enactment of FIRREA cost them $18.6 million in economic value.  Claims for future lost profits did not survive, however.

 

Publisher’s Note:  You can comment on this story and see the complete case summary where the Court addresses a number of valuation methods and the defense expert’s testimony elsewhere on this blog.  

 

Plaintiffs Holland and Ross purchased all of the shares in Rock Falls Savings & Loan Association in 1986, about the time that S&Ls were collapsing across the country.  The FSLIC, which insured the thrift deposits, tried to get healthy thrifts to acquire insolvent ones.  The plaintiffs entered into an assistance agreement with the FSLIC to purchase some S&Ls.  The agreement included language that cash contribution from the FSLIC, the subordinated debenture and preferred stock purchased by the FSLIC could all be counted as regulatory capital on River Valley’s books – a provision that was wiped out with the enactment of FIRREA in1989.   To purchase another thrift called San Antonio Federal Savings Bank, the pair had to find other investors and form a new entity.  They acquired the bank.  Its assets were sold at a significantly gain for the investors.  First Bank acquired River Valley in 1995. 

 

Holland, Ross and First Bank sued the Government for breach of contract.  The court ruled in an earlier decision that the Government’s enactment of FIRREA did breach the contracts. 

 

Losing on Future Lost Profits

 

In calculating damages, the Court reviewed the plaintiffs’ theories, starting with the claim that they suffered lost opportunity to purchase SAFSB; therefore losing  potential profits or dividends.  Rejecting this claim, the Court said that when seeking damages from future income generating property, the market value of the asset at the time of the breach must be considered, not lost actual profits that could have been produced in the future had a different set of circumstances occurred.  Lost potential future income and dividends are not recoverable for the loss of the acquisition opportunity, the Court determined.

 

Daubert Attacks Go Beyond Experts to the Supporting Data

OCALA, FLA. – In an interesting twist to what’s becoming the standard Daubert challenge, the party opposing the financial expert in this case not only attacked the reliability of his opinions but also moved to exclude the mortgage pricing data on which he based his calculations, claiming that the provider should have been disclosed as a separate expert under the federal rules. 

 

The case raises an important distinction: the fine line between an expert offering a qualified opinion and his impermissible conclusion of law or fact.

 

In this suit between two mortgage companies, the plaintiff challenged the defendant’s financial expert in a pre-trial, Daubert-based motion.  To determine this preliminary matter, the court did not recite the facts of the case but it did summarize the expert’s findings in his report, including 1) that the defendant overpaid the plaintiff for certain mortgage servicing rights (MSRs); and 2) that the overpayment totaled $20 million.  To calculate the $20 million damages, the expert relied on data provided by the Mortgage Industry Advisory Corporation (MIAC)—in particular, its price indices for mortgage servicing rights.

 

The plaintiff argued that the MIAC data constituted such an “essential” aspect of the expert’s opinion that the provider qualified as an additional expert, requiring disclosure under Rules 26 of the Federal Rules of Civil Procedure (FRCP).  Because the defendant had failed to disclose MIAC, the plaintiff argued, its “opinions” should be excluded from the expert’s report pursuant to Rule 37 FRCP.

 

The court found the defendant had disclosed its expert’s use of the MIAC data.  “Moreover, there is no suggestion that MIAC created its indices or generated any other data based upon the specific details of this case,” it said.  Rather, the expert relied on the compilation of data that MIAC routinely provides the public.  An MIAC representative did give the expert “general guidance” on using the data, the court said, but that “does not, in and of itself, make MIAC an expert in this case.”   Instead, MIAC was a source of data, comparable to the federal Bureau of Labor Statistics, and the defendant’s expert did not rely on anyone else’s analysis or calculations but his own.

 

Further, the court found that even though the expert did not “understand every detail” of how MIAC calculated its data, the pricing indices were the type on which experts in the mortgage servicing industry reasonably relied.  The expert’s timely disclosures permitted the plaintiff sufficient opportunity to conduct its own research and analysis regarding the reliability of the MIAC data, the court held, and denied the motion based on any failure to disclose.

 

For the rest of this article and the opinion, go to BVRLegal.com.

 

Taylor, Bean & Whitaker Mortg,. Corp. v. GMAC Mortg. Corp., 2008 WL 3819752 (M.D. Fla.)(Aug. 12, 2008) or  Taylor, Bean & Whitaker Mortg. Corp. v. GMAC Mortg. Corp., 2008 U.S. Dist. LEXIS 59900 (M.D. Fla. Aug. 6, 2008)

 

Defendant’s CEO a Valuation ‘Expert,’ Not Fact Witness

Compania v. Titan International, 2008 U.S. App. LEXIS 14571

CHICAGO – The Seventh Circuit has affirmed the exclusion of testimony from an officer of the defendant in the case, because the defendant attempted to offer his opinion as a fact witness.  The court said his valuation was not based on “particularized knowledge” gained by working at the company, but on his “extensive experience purchasing and selling the type of goods at issue.”  Since the court said the CEO was truly presenting an expert opinion, and he wasn’t disclosed by the deadline, the trial court was correct in excluding him.

“[Former Titan CEO] Taylor purported to value the collateral by applying his generalized knowledge of the worldwide tire market, gained through his experience in the worldwide tire business, to a proffered list of specific items owned by a third party.”  Noting that Taylor had no personal knowledge of the items, his position was “not akin to the owner of a small business testifying to the value of that business.”  The court said that since his testimony was based on his “special training or experience,” his testimony was that of an expert.

Compania’s law firm is Sonnenschein, Nath & Rosenthal in Chicago and Brown, Hay & Stevens in Springfield, Illinois.  Titan’s firm is Pepper Hamilton in Washington, D.C.  

Lack of Very Specific Experience Beats Expert’s Knowledge, Diligence in Painstaking Daubert Review

Baldwin v. Bader, 2008 U.S. Dist. LEXIS 56236 or 2008 WL 2875351

PORTLAND, Me.—This is the Maine federal court’s second look at what it called a close and difficult question—the valuation of personal guaranties given by company insiders to secure financing.  The first review came on a motion to exclude expert testimony that valued personal guaranties by comparing them to the risks borne by equity investors.   After the previous judge retired and other issues were raised, the court reconsidered Daubert matters, with added references to the just-released Cost of Capital: Application and Examples (3d ed. 2008) by Shannon P. Pratt and Roger Grabowski.  The opinion makes for provocative reading for appraisers and attorneys alike, especially on the novel and “hard-fought” issue how to value guaranties separate from valuing the business.

One issue was whether an excerpt from Cost of Capital was admissible at a Daubert hearing if the expert didn’t rely on it.  U.S. Magistrate Judge John H. Rich III saw no such requirement.  “[N]one of the authorities that the plaintiff cites . . . can be read to stand for the proposition that a proponent of expert testimony is confined to defending against a Daubert challenge solely on the basis of the authorities the expert used to formulate his or her opinion . . . .By contrast,” the judge added, “my own research indicates that . . .  it is permissible for proponents of expert testimony to rely on authorities other than those explicitly relied on by the expert to establish the reliability of the expert’s methodology.”  He added that the exhibit is probative at least relating to whether Pratt “subscribed to the view that there was no published study quantifying the risk premium added by provision to a personal guaranty.”

Novel Methodologies, ‘Tried & True,’ and Ipse Dixit

Whether defense expert John T. Gurley’s  testimony passed Daubert muster was a “close question,” the court commented.  Despite a “combined depth of accounting experience of some 70 years,” it said, neither Gurley nor the plaintiff expert had ever valued a personal guaranty.  The plaintiff attacked Gurley’s testimony as based solely on his ipse dixit.  Daubert says novel methodologies can be reliable and old ones can be applied in new ways, the judge observed, “yet novelty does not relieve the burden of proving reliability” and the defendants did not carry that burden.  While acknowledging all the ardent study, analysis and independent research Gurley undertook, the magistrate judge said he could not conduct his gate keeping from “too generalized a perspective.”  Did Gurley arrive at the “particular conclusion” that the risk of personal guaranties was comparable to the risk of equity investment?   In the end, despite his efforts and experience—perhaps, even, following “tried-and-true” BV practices—the court excluded Gurley’s testimony on personal guaranties because he never valued one before and because of questions raised by the competing expert about Gurley’s methodology.  

The decision was handed down on July 23.  It is available in BVR’s Business Valuation Litigation Database.   Portland law firms were Marcus, Clegg & Mistretta for Baldwin and Bernstein Shur for Bader.

(Editor’s Disclosure: Shannon Pratt is the founder and former owner of Business Valuation Resources, publisher of BV LEGALWire.)