Data Reliability Issues

When is there a Duty to Corroborate Data?

NACVA’s Standards Board (SDB) was formed in 2016 with the purpose to promulgate NACVA’s Standards, including the development of interpretations, amendments, restatements, and new releases of NACVA’s Standards as deemed necessary and prudent. While being able to influence the very rule governing one’s profession is an astute honor, the most rewarding role performed by the SDB is that of responding to questions that a member has asked or issues they are dealing with. This article addresses data reliability questions and issues, and how it relates to the NACVA standards.

NACVA’s Standards Board (SDB) was formed in 2016 with the purpose to promulgate NACVA’s Standards, including the development of interpretations, amendments, restatements, and new releases of NACVA’s Standards as deemed necessary and prudent. While being able to influence the very rule governing one’s profession is an astute honor, the most rewarding role performed by the SDB is that of responding to questions that a member has asked or issues they are dealing with. This article addresses data reliability questions and issues and how it relates to the NACVA standards.

General and Ethical Standards

Did you have sufficient data? Was the data you relied on relevant? Can you demonstrate that your conclusions, recommendations, or positions were reasonable? Members may find these questions tough to answer in a litigation setting where one finds themselves in a deposition or on cross-examination. These complications can be compounded by the fact that members may rely upon information provided by any source without corroboration, so long as it was disclosed. These three questions and issues are encompassed in Section II.F and Section IV.C of the NACVA Standards.

Members should stay vigilant and be aware that they are still held to the General and Ethical Standards, which include remaining objective, not knowingly misrepresent facts, or act in a manner that is misleading or fraudulent (Section II.A). Members must use due professional care (Section II.C) and complete the engagement with a high degree of professional competence (Section II.B).

Reporting Standards

Members may find, especially in a litigation setting, that certain data or information is being withheld. A good recommendation in these instances is to speak with the client about any scope or data limitations and how it may affect the conclusions reached. Detailed reports should include any scope limitations (Section C.1.c.9) or denial of access to essential data (Section C.1.c.14). A discussion of any scope limitations or denial of access to essential data can also be discussed in the assumptions and limiting conditions (Section C.1.f). Although there are reporting exemptions for litigation engagements, members should be aware that the General and Ethical Standards and Development Standards still apply. This includes topics previously addressed.

Resources

Before we get into the specifics of data reliability issues, I believe it is important to be aware of the NACVA’s Business Valuation/Appraisal Standards Comparison Chart (Chart) available on the NACVA.com website[i]. The intent of the Chart is to provide a general reference tool for the valuation analyst involved in business appraisals; it is not intended to suggest precision in the classification of professional standards. The Chart provides a comparison of the respective business valuation standards promulgated by the NACVA, the Uniform Standards of Professional Appraisal Practice (USPAP), to the American Society of Appraisers (ASA), and to the American Institute of Certified Public Accountants—Statement on Standards for Valuation Services (AICPA—SSVS).

Although not directly related to the NACVA, The International Valuation Standards Council (IVSC) is an independent, not-for-profit, private sector standards organization incorporated in the United States and with its operational headquarters in London, UK. IVSC develops international technical and ethical standards for valuations on which investors and others rely. The IVSC issued a letter from its technical boards titled: Dealing with valuation uncertainty at times of market unrest (the Letter)[ii]. Members may find this Letter helpful, especially during the current COVID-19 pandemic.

The Letter divides valuation uncertainty and their root causes into three sections: market disruption, input availability, and choice of valuation method or model. The Letter states, “In some cases, valuation uncertainty is a result of inconsistent or conflicting data that can be estimated by the effect on the valuation of using possible alternative inputs.” Valuation uncertainty revolves around the data valuation practitioners rely on when estimating value. The Letter also states, “The principle of quantifying uncertainty by the use of a sensitivity analysis can be applied to assets where there are a sufficient number of reasonably possible alternative numeric inputs that could have been selected on the valuation date.”

Another great resource is PricewaterhouseCoopers’ (PwC) study: Daubert Challenges to Financial Experts, a yearly study of trends and outcomes (2000–2019).[iii] This study analyzes post-Kumho Tire challenges to financial expert witnesses under the Daubert standard. According to the study, “When excluding testimony due to a lack of reliability, courts most frequently cite a lack of sufficient data or the use of methods that are not generally accepted as reasons for exclusion.”

NACVA Frequently Asked Questions (FAQs)

The NACVA’s FAQs address a variety of questions, answers, and interpretations related to the NACVA Professional Standards. This resource is intended to provide NACVA members with an acute understanding of interpreting frequently asked questions by its members. The FAQs are written by the SDB and approved by the Executive Advisory Board (EAB). Unfortunately, the FAQs in their entirety are not generally available. However, I am fortunate to share one FAQ as it pertains to the reliability of data, which has been approved by the EAB.

Question: Per the NACVA Professional Standards, a member may rely upon information provided by any source without corroboration if disclosed in their report. Does this safeguard an expert’s testimony or the underlying data for which it is based upon from being ruled unreliable by a trier of fact?

Answer: No. While “a member may rely upon information provided by any source without corroboration if disclosed in the report,” this disclosure does not safeguard an expert’s testimony or the underlying data for which it is based upon from being ruled unreliable by a trier or arbiter of fact.

Interpretation: The fact that a member may rely upon information provided by any source without corroboration if disclosed in the report has no bearing upon how a trier or arbiter of fact may rule regarding the reliability of an expert’s testimony. A trier or arbiter of fact may rule/find a member’s testimony or the underlying data (basis) of said testimony unreliable, less reliable, or lacking foundational reliability whether the member discloses their uncorroborated reliance upon data or not. If the underlying data of a member’s expert opinion is deemed unreliable, the expert opinion or conclusion drawn from said data may, by default, also be ruled, deemed, or found unreliable.

Litigation

Data reliability affects virtually all types of engagements. Litigation engagements, more often than not, gets its fair share of the attention pertaining to data reliability and sufficiency issues. Members should be aware of the following:

• Credibility of the valuation hinges on the data and information used; and
• Almost any engagement can become a litigation engagement.

Point number one above seems obvious. However, point number two may need more explanation. Let us look at a recent example of Remy v. Lubbock National Bank, 2019 U.S. Dist. LEXIS 133421 (Aug. 8, 2019).[iv]

Facts: Lubbock National Bank (Lubbock) engaged Stout Risius Ross (SRR), an experienced ESOP appraiser, to prepare an independent valuation of TBM and a fairness opinion concerning the proper consideration to be paid by the ESOP for the shares owned by Anand Sharma (President and CEO of TBM). SRR holds itself out to the public and its clients as a professional and experienced financial advisor, including as an expert in valuation advisory services. SRR relied on projections provided by Anand Sharma, the seller and primary shareholder. The plaintiffs in the main case sued the defendant, Lubbock, claiming Lubbock breached its fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA) when it caused the ESOP to overpay for company stock. In turn, Lubbock sued SRR claiming the projections have been manipulated to maximize the sale price.

Issues: Could Lubbock seek contribution and/or apportionment from SRR as a nonfiduciary?

Held: It was found that SRR was not a fiduciary under ERISA, and ERISA did not provide a right to contribution against a nonfiduciary. The Court granted SRR’s motion to dismiss Lubbock’s claim for contribution against SRR with prejudice. Effectively, SRR was not held liable for the notion of providing an unsupportable sales price, “given the unreliability of the financial projections.”

Was the underlying data utilized reliable? According to the complaint against SRR, Lubbock stated, “These forecast increases over this period [2011–2015] were inconsistent with the trajectory of TBM’s actual financial performance, as audited, for the years 2006–2010, and with the internally prepared financial statements of TBM for the first seven months of 2011.”

I have no insight into the facts regarding who decided to use Anand Sharma’s projections without independently corroborating them. Nor could I tell you whether or not SRR applied professional judgment, or if they truly believed the projections relied on were reasonable. However, this is a prime example where a nonlitigation case can become a litigation matter.

Furthermore, while there are differences in development and reporting standards among the professional valuation organizations, these differences are minimal and are generally consistent between the various professional organizations, including the NACVA, ASA, and AICPA. This matter was dismissed due to the procedural nature with respect to this case. However, I could envision a different outcome if this were not an ESOP case, and experts were hired on behalf of a plaintiff and defendant simulating a traditional litigation case.

For instance, I was recently engaged to provide a business valuation and review report for a shareholder dispute case. The parties who engaged me were the defendants, and the plaintiffs engaged their own valuation expert. The plaintiff’s expert relied on four years of historical cash-based financial statements to develop an income approach and damages model. The expert also conducted a management interview with key employees. In my valuation, I analyzed both the cash-based and accrual-based financials, and also conducted a management interview. My analysis indicated the subject company’s days sales outstanding was over 1,000 days as of the valuation date. The management interview I conducted revealed the company had not made a sale within the past year, and the company had a 10-year closure plan (due to known environmental issues) in place with a regulatory body. These facts proved to be undeniably problematic for the plaintiff, as the foundation for the income approach prepared by the plaintiff’s expert was flawed due to the unreliability of the underlying data. Fortunately, this case settled quickly and the damages claims disappeared.

Case Law

The following cases provide insight into the topic of data reliability across various topics surrounding the business valuation profession. These topics incorporate a range of categories, including reporting, compensation, discounts, and persuasiveness. This is not intended to be a complete discussion of each case, or an accumulation of all cases pertaining to these issues, but rather a quick reference. Each case must be referenced for a complete understanding.

• Estate of Kaufman—A proper valuation report must contain enough data on each similar corporation to allow the Court to make an informed, independent decision as to whether the corporations are sufficiently similar to the subject corporation to perform a proper valuation analysis.
• Donald J. Janda v. Commissioner—Appraisers usually rely on generalized studies for DLOMs and would prefer to have more specific data.
• Estate of James J. Reiner v. Commissioner—Unsupported compensation adjustment due to unsupported objective criteria.
• Ina F. Knight v. Commissioner—Did not show a relationship to the supporting data and the company.
• Robertson v. U.S.—Discounts must be justified by solid data.
• Okerlund v. United States—The Court found that the taxpayers expert’s analysis was far more detailed and persuasive than the IRS’s expert, and commended the taxpayer’s expert for emphasizing the pre-IPO studies, which, the Court determined were more comparable to the subject company.

In all cases, we must stay vigilant and be aware that they are still held to the General and Ethical Standards. Members should familiarize themselves with the NACVA’s FAQs when they become available, and be aware that relying upon information provided by any source without corroboration if disclosed in the report has no bearing upon how a trier or arbiter of fact may rule regarding the reliability of an expert’s testimony.

[i] http://web.nacva.com/TL-Website/PDF/DomesticStandardsChart.pdf

[ii] https://wwwlivsc.org/files/file/view/id/1719

[iii] https://www.pwc.com/us/en/services/forensics/pdf/pwc-daubert-study-2020.pdf

[iv] A summary of this case can be found in BVWire’s Issue #206-1 “Novel issue of law raised in ESOP case that pits trustee against appraiser.”

 

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Nick Mears, MBA, CVA, MAFF, is the founder and managing member of Caprock Business Consulting, LLC, a business valuation, litigation support, and consulting firm based in Lubbock, Texas. He is a Standards Board (SDB) member with the National Association of Certified Valuators and Analysts (NACVA) and focuses his expertise on valuing privately-held business interests for litigation support, acquisitions, SBA and commercial lending, and gift and estate tax purposes.

Mr. Mears can be contacted at (806) 853-7832 or by e-mail to admin@caprockbusinessconsulting.com.