Impact of Inadequate Discovery

in a Divorce Proceeding

Not all is fair in love and war when it comes to the fight for business records within a matrimonial action. When one spouse is denied adequate discovery, his or her case can quickly begin to unravel. Usually, some records are available either because the spouse had some previous access or there was a partial document production. Business appraisers should consider all appropriate means to obtain needed discovery. Failing to obtain sufficient, reliable discovery can ultimately result in the production of a report that is incorrect and/or rejected by the courts.

Accurately determining the value of a business ownership interest at the usual points in time (date of marriage/date of commencement) is dependent on several factors, one of which is the quality and completeness of the data from which the valuation is derived.  Such data is obtained by the valuator or forensic accountant in several ways:

[su_pullquote align=”right”]Resources:

Working With Counsel Through The Discovery Process: Identifying and Obtaining the Pertinent Information

The Discovery Process: Deadlines and Other Limitations

Valuation Issues in Matrimonial Engagements

Forensic Accounting in Matrimonial Cases

Matrimonial Expert Witness Bootcamp

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• Through submission of documents and information submitted through counsel
• Provided by the engaging spouse
• The product of subpoena
• Depositions
• Interrogatories
• Court order resulting from motion practice

Not all is fair in love and war when it comes to the fight for business records within a matrimonial action.  When one spouse is denied adequate discovery, his or her case can quickly begin to unravel.  Usually, some records are available either because the spouse had some previous access or there was a partial document production.  “For many dependent spouses it is an uphill battle to force the other spouse to divulge much-needed information, yet full financial disclosure is critical for an informed settlement in equitable distribution proceedings” (National Legal Research Group, Inc., 1998, p.1).

Sometimes the business records provided by the custodial spouse indicate clear manipulation of transactions, leading to situations where one spouse reported substantially lower income to the taxing authorities and the court than that determined by the other spouse’s financial expert.  Examples of such manipulations include unreported business revenues, understatement of accounts receivable, under reporting of inventory, and improper recording of owner’s compensation (including perquisites), dividends, and loans.  In cases where there is a depletion of working capital by the custodial spouse, valuation can be permanently or temporarily reduced.  Moreover, if the withdrawn funds are hidden, there are additional adverse financial consequences to the non-moneyed spouse.  Thus, understanding the true nature of cash outflows caused by the custodial spouse will influence equitable distribution and alimony, as well as child support obligations.[1]

Discovery

Discovery is intended to “make a trial less a game of blind man’s bluff and more a fair contest with the basic issues and facts disclosed to the fullest practicable.”[2]  However, the court has discretion in determining what discovery is necessary, and if the analysis used by an expert to reach conclusions is reliable and admissible.

The Federal Rule of Evidence 702: Testimony by Experts states:

“If scientific, technical, or other specialized knowledge assist the trier of fact in issue, a witness qualified as an expert by knowledge, skill, experience, training or education, may testify thereto in the form of an opinion or otherwise if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.”

In Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 589 (1993), “the trial judge’s responsibility with regard to expert opinions is to ensure that any and all scientific testimony or evidence admitted (at trial) is not only relevant, but reliable.”  Accordingly, a court can reject a business appraiser’s findings if it is based on incomplete or erroneous data.  There are many published cases where the testimony of financial experts have been excluded due to inadequate factual data.

The message from the courts is clear—use all appropriate means to obtain the evidence needed to render a reliable conclusion.

Summary

It is critically important for a business appraiser to obtain adequate discovery in connection with the development of a reliable valuation conclusion.  Failing to obtain and critically examine necessary documents can result in failing to identify owner manipulations such as understatements of revenues, overstatements of expenses, and improper and/or nonrecurring transactions.  Business appraisers should consider all appropriate means to obtain needed discovery.  Failing to obtain sufficient, reliable discovery can ultimately result in the production of a report that is incorrect and/or rejected by the courts.

References

National Legal Research Group, Inc. (1998). Sanctions for discovery violations. Retrieved   November 6, 2015:             http://www.divorcesource.com/research/ed;/discovery/98nov21.shtml

[1] Describing the specific forensic accounting procedures in a divorce proceeding to be performed by the appraiser is beyond the scope of this article.  For guidance with respect to such procedures, see Forensic Accounting for Divorce Engagements, a Practical Guide, third edition, published by the American Institute of Certified Public Accountants, 2009.

[2] United States v. Proctor & Gamble, 356 U.S. 677, 682 (1958).

Eric J. Barr is the Partner-in-Charge of Valuation Services at Marks Paneth LLP, in the Financial Advisory Services group. He was Partner-in-Charge of Accounting and Assurance Services and a founder and co-managing member of Fischer Barr & Wissinger, LLC, a New Jersey-based accounting firm that was acquired by Marks Paneth in 2015. Previously, he was a litigation and accounting partner in a national CPA firm. He has also held Quality Control positions at several accounting firms and was a Director of Accounting and Assurance Services of a mid-sized New Jersey CPA firm.
Mr. Barr can be reached at (973) 630-5031 or by e-mail to ebarr@fbwcpas.com.

Eric Kreuter, PhD, CPA, CGMA, CFE, CBA is a Partner in the Financial Advisory Services group at Marks Paneth LLP. He specializes in litigation and forensic services including commercial damages and fraud investigations. His background also includes management, human resources and other consulting services. He is also a specialist in all facets of the construction industry.
Dr. Kreuter can be reached at (212) 201-3117 or by e-mail to ekreuter@markspaneth.com.