Reasonable Certainty and the AICPA Practice Aid

Reasonable Certainty and the AICPA Practice Aid

Background August 5 th 2015 AICPA Forensics & Litigation Services Task Force releases 107 page Practice Aid Task Force is composed of 7 CPAs and 3 Attorneys. The stated intent of the Practice Aid is to help practitioners understand the expectations courts impose upon experts as a result of, for example, Rule 702 of the Federal Rules of Evidence or comparable tests applied at the state level. The Task Force studied numerous cases, judicial opinions and various scholarly writings and relied heavily on federal cases. Not announcement of any new legal or accounting standard.

AICPA Code of Professional Conduct Rule 102 Integrity and objectivity In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

AICPA Code of Professional Conduct Rule 201 - A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council. * * * Sufficient Relevant Data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.

Certainty/Speculation Spectrum Speculative Lottery ticket ($1 to win $1.5 billion) Hopes and dreams The Middle Lost profits Valuations Royalties Property damage Certain 100 shares of Apple stock on February 9, 2016 at 12:30 pm CST

What is Reasonable Certainty? *Reasonable certainty is simply code for - Does the court think that, given all of the circumstances, this plaintiff has presented sufficient evidence to make it fair to award it the damages in question? *Richard Posner U.S. Court of Appeals 7 th Circuit (Chicago) quoted from his book How Judges Think 2008 A venture that has a 40-percent chance of earning $1,000, with an expected value of $400, is not worthless even though the probability of achieving the earnings in question is less than 50 percent.

Why Should You Care? Resource/Primer Designed for use by CPA/damages expert Roadmap Expert reports Expert challenges Cross-examination of experts Cross-examination of fact witnesses Claim assessment (pre- and post-filing)

Topics Addressed Introduction/General Principles Reliance on Client-Supplied Information Causation Considerations New Business Rule

Take Away Backstop With Other Testimony/Experts Anchor With Real World Consider Alternative Causes Test the Damages Model

Client Supplied Information An expert s use of client supplied data has historically been at issue: Projections of financial performance including lost revenues, associated costs, loss of value, out-of-pocket costs, and so on; Assumptions regarding growth rates, pricing, financing opportunities, and cost structure; Business information such as markets served, competitors, market share, and industry trends; or Technical information such as product features and specifications, and how those features and specifications contribute to the operation of a product.

Client Supplied Information Court s acceptance of the use of client supplied information by the expert relies heavily on FRE 702 but there is no set formula for what constitutes sufficient relevant data. In using client supplied data, the courts have focused on: Whether the data was prepared in the normal course of business; Who at the client prepared the data management vs. those who are qualified w/ day-to-day responsibilities; Extent of evidence that corroborates the data; Realistic assumptions; Whether the opposing side previously saw the projections; Whether the expert tested the data, assumptions and linkage to the business.

Causation Considerations Damages experts who testify as to causation will generally face vigorous challenges including: Extent of industry experience; Lack of evidence that business lost because of misconduct; Identifying specific customers or transactions lost as a result of misconduct; Alternative reasons for the plaintiff s loss.

Causation Considerations Damages experts must consider alternative factors such as: Generally prevailing economic conditions; Product quality issues unrelated to the defendant s alleged conduct; Technology changes such as the loss of intellectual property; Market changes such as the development or acquisition of IP by a competitor; Reputational harm for any reason other than the conduct of the defendant; Loss of key personnel; Environmental issues such as hurricanes, earthquakes, freezes, and the like.

New Business Rule? Historically, many jurisdictions have had various versions of the new business rule limiting recovery for lost profits. Mullen and Kinesoft Development Corp. decisions illustrate what is often referred to as a per se version of the new business rule, with the award of lost profits hinging on whether or not the business in question is "new" or "unestablished. In MindGames, Inc. v. W Publ g Co., Judge Posner, applying Arkansas law distinguishes between a rule and a standard: States that have rejected the new business rule are content to control the award of damages for lost profits by means of a standard damages may not be awarded on the basis of wild conjecture, they must be proved to a reasonable certainty... The "new business" rule is an attempt now widely regarded as failed to control the award of such damages by means of a rule. The new business rule is no longer a Rule in all jurisdictions.

Newly Established Businesses The Practice Aid cites the following cases for guidance in what is a New v. an Established Business : Delahanty v. First Pa. Bank, N.A. 318 Pa. Super. 90 (Pa. Super. Ct. 1983). Clark v. Scott, 520 S.E.2d 366 (Va. 1999). Gorjuice Wrap, Inc. v. Okin, Hollander & De Luca, LLP, 2011 N.J. Super. Unpub. LEXIS 93, *3 4 (App. Div. Jan. 12, 2011). The trend toward allowing recovery of lost profits for a new business is to focus on "evidentiary sufficiency" to calculate damages.

Newly Established Businesses In allowing new businesses to recover future lost profits, courts focus on whether or not the expert has provided the necessary evidence, with the quantum of evidence required different than that required of an established business seeking recovery of lost profits. In MindGames, Inc. v. Western Publishing Co., Judge Posner called for consideration of all information available that is relevant in evaluating whether the expert has met the threshold to prove the lost profits of a new business a rule of evidence. In Kids' Universe v. In2Labs, the Court of Appeals of California (Second Appellate District) relied in part on the Restatement (Second) of Torts as support for its finding that recovery for future lost profits of a new business was an evidentiary inquiry.

Newly Established Businesses Success in recovering lost profits for newly established businesses can be achieved through: Using multiple sources of evidence to establish sufficiency of analysis; Using multiple experts such as a CPA and an Economist or a CPA and an industry Expert, etc.; Using other similar businesses as a yardstick ; The expert should demonstrate "a substantial similarity between the facts forming the basis of the profit projections and the business opportunity that was destroyed;" There should be evidence of objectively verifiable dimensions of similarity including size, profits, investors, management, cost structures, etc.; Expert should consider and adjust for slight differences in clientele and geographic location.

Newly Established Businesses Pre-litigation projections have been successfully used. As previously discussed, courts have been more accepting of projections when: The projections were made in the normal course of business; The expert knew who constructed the projections; The person constructing the projections had the requisite experience; The expert had the background and expertise (was properly qualified) to make appropriate adjustments to the projections.

Newly Established Businesses The chances of recovering lost profits for newly established businesses has been improved when the expert has considered: The nature of the market for the business in question; The existence of management s expertise in the business in question; and/or The damages expert has relied on the opinions of other qualified experts. Even in states with per se new business rules, the Practice Aid cites examples of achieving successful recovery of lost profits.

Summary Courts articulation of what reasonable certainty means appears to recognize that the profits that form the basis for an economic damages calculation need not be certain in order to adduce a calculation of damages that has a reasonable basis. Courts generally seem to focus on: Whether the damages calculation has been made such that there is reasonable certainty that the damages amount has been properly calculated; The amount has been proven with a reasonable basis and sound methodology; Having multiple sources of evidence (and experts) supporting the calculation; Whether the expert has tested and adjusted the calculation to consider other causes.

Larry Kanter CPA, CFF, CFE 3102 Maple Ave, Suite 400 Dallas, Texas 75201 214 207-5238