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.

 

‘Lost Sales’ Damages Valuation Based on Independent Data Verification Prevails

Lyman v. St. Jude Medical S.C., Inc.; 2008 WL 2224352 (U.S. Dist.) or 2008 U.S. Dist. LEXIS 42015

A case from federal court in Wisconsin, involving starkly different approaches to valuing damages in a contract dispute, stresses the importance of independent verification and objective data.

Plaintiff Lyman entered into a 10-year deal with St. Jude Medical to sell pacemakers and defibrillators (CRM products). The agreement contained a four-year guarantee period for which Lyman was to receive $3 million. After that, compensation was commission-only. St. Jude terminated the agreement after two years. Lyman sued. Daniel Gotter with Winter, Kloman, Moter & Repp, the plaintiff’s expert, used raw data to prepare five different models of damages projections based on sales quotas; projections calculated by the CFO for St. Jude’s parent company; regression analysis of the plaintiff’s company’s past sales at St. Jude; projected future sales; and projected net sales of the plaintiff’s company. The court allowed testimony on all five calculations, saying they would assist the jury in assessing damages.

Winter, Kloman, Moter & Repp, the plaintiff’s expert, used raw data to prepare five different models of damages projections based on sales quotas; projections calculated by the CFO for St. Jude’s parent company; regression analysis of the plaintiff’s company’s past sales at St. Jude; projected future sales; and projected net sales of the plaintiff’s company. The court allowed testimony on all five calculations, saying they would assist the jury in assessing damages.

The defendant’s expert, Randall D. Wilson with RGL Forensic Accountants & Consultants prepared two sets of projections: one weighted and one unweighted. Both sets were derived from the plaintiff’s “alleged sales” during the approximately two years it sold CRM products to St. Jude, the numbers were obtained from one document provided to the expert by St. Jude’s counsel. Taking into account the plaintiff’s decreased sales performance between 2003 and 2004, St. Jude’s expert’s original regression resulted in a “negative sloping trendline.” Because the plaintiff’s sales varied widely from month-to-month, the expert weighted the data to obtain a positive trendline for years five through 10 of the agreement.

The court focused not only on the source of the defendant’s expert’s data, but what he failed to do with it. Contrasted with Gotter’s independent valuation of raw data, the court said “the bottom line is that [the defense expert] never talked to anyone at St. Jude to verify the accuracy of the information in any of the documents he reviewed.” Finding the basis for his projections unreliable, the court excluded Wilson’s projection testimony. The case settled on the eve of trial.

Plaintiff attorneys: Todd R. Seelman and Leslie E. Miller of Grimshaw & Harring PC, Denver, CO; Michael J. Cohen and Thomas M. Hruz, Meissner Tierney Fisher & Nichols SC, Milwaukee, WI. Defense counsel: Brian G. Cahill, David J. Turek and Paul F. Heaton, Gass Weber Mullins LLC, Milwaukee, WI.

 

Legionnaires Cruise Case Settles

The highly publicized Celebrity Cruise, Inc. case over lost profits caused by a 1984 Legionnaires’ disease outbreak aboard the Celebrity ship “Horizon” has settled.  The maker of the swimming pool water filters (Essef Corporation, now called Pentair Water Treatment Co.)—which allegedly triggered the disease—agreed to pay the cruise company $35 million this month.  Subscribers to the Business Valuation Litigation Database™ can read the January 2007 District Court abstract of the case here and the January 2008 District Court abstract here.

The event sparked a number of individual claims and a class action.  In the original bellwether trial a jury found that Celebrity shared 30% of the responsibility for the outbreak, assigning 70% of the liability to Essef Corp. now called Pentair Water Treatment Co.  In 2006 a jury awarded $190 million to Celebrity, based largely on the “yardstick analysis” conducted by business valuation expert Robert Schweihs of Willamette Management Associates.  The verdicts for lost profits and loss of enterprise value were reversed in 2007.  At a second trial, this time seeking damages of roughly $60 million, Celebrity and Schweihs presented the yardstick analysis with two comparables criticized by the court, plus a third that was considered more reliable yet reached a similar valuation as the first two.  This time the jury returned $15M in damages to Celebrity.  On appeal, the court found the evidence sufficient to support the award, but applied a 30% reduction for comparative fault.  Celebrity Cruises, Inc. v. Essef Corp., 2008 U.S. Dist. LEXIS 568 (January 4, 2008).

In February 2008 the District Court entered a $30.4 million judgment against Pentair for out-of-pocket costs, expenses and lost profits, including interest.  Celebrity and Pentair both appealed. 

According to a 10Q filing by Pentair on July 22, 2008, the parties agreed to a $35 million settlement. Pentair agreed to pay $28 million this month, with its first layer excess carrier covering the $7 million remainder of its policy limits.  According to a July 25 10-Q filing by Royal Caribbean Cruises Ltd., Celebrity’s parent, the cruise company will receive “net of costs and payment to insurers, approximately $18.0 million.”  Pentair says it has sued an insurance carrier for coverage under another policy.

Celebrity Cruises was represented by Gregory W. O’Neill, Mark M. Jaffe, and Mary Teresa Reilly of Hill, Betts & Nash LLP of New York and Miami. The defendant manufacturer was represented by Jeffrey C. Crawford and Renee M. Plessner of Mound Cotton Wollan & Greengrass in New York.