Legal Update

FRE 702—Challenging the Expert Witness: White Buffalo Environmental, Inc. v. Hungry Horse, LLC

In modern litigation, expert witnesses have become nearly indispensable. As a result, motions to preclude those experts from testifying are almost inevitable. With the forthcoming amendment to Federal Rule of Evidence 702 clarifying both which party bears the burden of proof on challenging expert testimony and the court’s obligations as gatekeeper, White Buffalo Environmental, Inc. v. Hungry Horse, LLC is a worthwhile reminder of what constitutes a valid basis to move to exclude a damages expert and, perhaps more to the point, what does not. This article discusses the case.

In modern litigation, expert witnesses have become nearly indispensable. As a result, motions to preclude those experts from testifying are almost inevitable. With the forthcoming amendment to Federal Rule of Evidence (FRE) 702 clarifying both which party bears the burden of proof on challenging expert testimony and the court’s obligations as gatekeeper, White Buffalo Environmental, Inc. v. Hungry Horse, LLC, 2023 U.S. District LEXIS 48355 (D.N.M. March 22, 2023) is a worthwhile reminder of what constitutes a valid basis to move to exclude a damages expert and, perhaps more to the point, what does not.

Background[1]

White Buffalo Environmental, Inc. (“Plaintiff”) is an environmental consulting firm for the petroleum industry. In April 2018, Plaintiff hired Defendant Gladden as an Environmental Director in its Hobbs, New Mexico office. At some point, Gladden and Defendant Hungry Horse, LLC, Plaintiff’s direct competitor, agreed that she would “move all or substantially all of the files, customers, and property of White Buffalo to Hungry Horse, and close down the operations of White Buffalo’s Hobbs office.”

Just over a year after Gladden started working for Plaintiff, the crew supervisor in Hobbs and his team left to begin working at Hungry Horse. Gladden withheld this information from Plaintiff for several weeks when, over a 10-day period, she and the rest of the Hobbs office staff also left to take positions at Hungry Horse. At the same time, Gladden presented Plaintiff with e-mails from several customers authorizing her to take their files to Hungry Horse.

In response, Plaintiff conducted an audit of the Hobbs office timesheets, payroll records, and customer invoices, allegedly uncovering evidence of fraud, embezzlement, theft of equipment and files, and a conspiracy to divert business to White Horse. Plaintiff sued the Defendants for breach of fiduciary duty, breach of the duty of loyalty, unjust enrichment, tortious interference with business relations, and conspiracy. In support of its claim for damages, Plaintiff proffered the report of Jeremy Jennings, CPA, ABV, showing a lost business value of $2,035,000. In response, the Defendants served the report of Mike Miller, CPA, CrFA.

Certain of the Defendants moved to strike Mr. Jennings report and proposed testimony based, in large measure, on Mr. Miller’s report. These Defendants asserted that “(i) Jennings had not done independent factual research; (ii) Jennings relies on unaudited financial statements that are marked for management purposes only; (iii) [Plaintiff’s] operation from April, 2018 to June, 2019 is not enough time to reliably predict [its] future success, and, similarly, Jennings considers only December, 2018 through May, 2019 in his report; (iv) fluctuations in the oil and gas market make a reliable valuation of future profits impossible or improbable; (v) [Plaintiff’s] reduction in value is the result of bad management, inadequate capitalization, cash flow shortages, bounced checks, late payroll, dishonored company credit cards, repossessed equipment, and unstable operating environment; and (vi) Jennings’ calculations are flawed.”[2] After taking Mr. Jennings deposition, the Defendants filed a second motion to strike because the financial statements on which he based his analysis were not prepared in accordance with generally accepted accounting principles (GAAP).

Court Findings

After an extensive discussion of both FRE 702 and the Daubert line of cases on which that rule is based,[3] the court addressed each of the Defendants’ arguments.

Sufficiency of Facts or Data

FRE 702 allows an expert witness to testify if the proposed testimony is “based on sufficient facts or data.” The rule does not establish what constitutes sufficient facts or data, instead leaving that essentially to the discretion of the trial judge.

The moving Defendants’ first motion challenged the sufficiency of Mr. Jennings analysis because:

• He had not conducted independent factual research;
• He relied on unaudited financial statements;
• He relied on six months of financial data;
• The oil and gas market’s volatility render any valuation of future profits impossible or improbable;
• Plaintiff’s reduction in value resulted from its poor financial management; and
• His arithmetic was flawed.

The court found these arguments wanting. “First, the Federal Rules of Evidence do not require an expert witness to conduct an independent factual investigation.”[4] The plain language of FRE 703 makes that clear (“An expert may base an opinion on facts or data in the case that the expert has been made aware of or personally observed…” emphasis added.) Mr. Jennings was “made aware of” Plaintiff’s financial situation by reviewing the company’s monthly balance sheets, monthly income statements, annual income statements, invoice register reports, and purchases documentation.

The Defendants’ remaining assertions (that unaudited financial information is unreliable, that the industry is highly volatile, and that Plaintiff’s losses were due to its own mismanagement) were equally lacking. The court highlighted that the Defendants had produced (a) no evidence that the internal, unaudited financial data was actually inaccurate or (b) any case law to support its position that a damages expert could only rely on audited financial information. Also, the Defendants based their arguments about market volatility, Plaintiff’s alleged financial mismanagement, and Mr. Jennings’ arithmetic errors solely on their own expert’s proposed testimony. These, according to the court, were classic issues of weight and credibility, and squarely in the realm of the jury.

The moving Defendants’ second motion to strike was because the underlying data was not prepared in accordance with GAAP. They pointed to Mr. Jennings’ deposition testimony that acknowledged that the accounting profession uses GAAP to help promote reliability of financial statements. The moving Defendants “cite no evidence, however, that requires business valuation experts to use only financial data prepared in accordance with GAAP. Instead, [the court concluded] that the underlying data may not have been prepared in accordance with GAAP is another issue which the Defendants may attack on cross-examination.”[5] The GAAP vs. non-GAAP distinction, while perhaps meaningful to a fact finder, could not be a basis to preclude Mr. Jennings’ testimony as a matter of law.

Reliability

FRE 702 also requires that to be admissible, the proffered expert’s testimony must be the product of reliable principles and methods that have been reliably applied to the facts of the case. During his deposition, Mr. Jennings testified that his valuation was prepared under the professional standards of the AICPA, that he had valued several businesses in litigation engagements (including one in the oil and gas industry) and that he had testified in several of those cases. The moving Defendants provided no evidence contradicting Mr. Jennings’ testimony regarding his experience.

Instead, the moving Defendants relied solely on the report of their own expert, Mr. Miller. “Nowhere does [Mr.] Miller state that [Mr.] Jennings’ methodologies are contrary to the industry standard. Thus, Miller’s assessment is simply one expert criticizing another expert’s opinion.”[6] The situation, according to the court, was the quintessential “battle of the experts,” where both are appropriately qualified, and it is the jury’s responsibility to determine which is more credible.

Conclusion

Judge Browning devoted a significant portion of his ruling decrying the general proliferation of unwarranted motion practice, particularly motions to strike expert witnesses, in modern litigation. He clearly thought this was a prime example and ruled, essentially, that because a party disagrees with the analysis and conclusions of an opposing expert is not sufficient to exclude the expert’s testimony. Absent evidence that the proffered expert’s methodology was contrary to the standards of the profession, the moving party’s expert opinion that the analysis should be done differently, alone, is insufficient, and the court should not strike the expert witness. More particularly to issues for valuation and financial forensics experts, it is not inappropriate to rely on the financial data provided by the litigants, and experts are not required to conduct independent verification of that data.

[1] The opinion’s factual recitation was drawn from the Plaintiff’s complaint. Judge Browning included it purely for background purposes. Whether or not the underlying facts are provable or even true was not relevant to the court’s ruling on the motions.

[2] 2023 U.S. Dist. LEXIS 48355 at *7–8.

[3] Daubert v. Merrell Dow Pharm., 509 U.S. 579 (1993), General Elec. Co. v. Joiner, 522 U.S. 136 (1997) and Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999).

[4] 2023 U.S. Dist. LEXIS 48355 at *32.

[5] Ibid. at *36.

[6] Ibid. at *39–40, emphasis added.

---

Michael J. Molder, JD, CPA, CFE, CVA, MAFF, applies 30 years of experience as a Certified Public Accountant and litigator to help investigate and analyze cases with complex financial and economic implications. He has acted as both counsel and accounting expert in pending and threatened litigation as well as participating in internal investigations of financial misconduct. As a litigator, Mr. Molder helped co-counsel understand complex financial and accounting issues in dozens of cases. In 2006, Mr. Molder returned to public accounting applying his unique skills to forensic engagements. He has also performed valuations of business interests in a wide variety of industries.

Mr. Molder has served as valuation expert for both plaintiffs and defendants in commercial litigation matters and owner and non-owner spouses in matrimonial dissolutions. He has participated in the valuations of businesses in a wide variety of industries, including: food service, wholesale and retail distribution, literary development and production, healthcare, manufacturing, and real estate development.

Mr. Molder has also investigated and valued damages in a wide variety of litigation contexts ranging from breach of contract claims to personal injury cases, and from employment disputes to civil fraud. He has consulted on many matters which have not involved the issuance of a report for litigation or resulted in deposition or trial testimony. Accordingly, the identity of these matters is protected by attorney client privilege.

Mr. Molder has also lectured widely on a variety of accounting and litigation related topics including business valuation, financial investigations in divorce proceedings, accountant ethics, financial statement manipulation and “earnings management.”

Mr. Molder can be contacted at (610) 208-3169 or by e-mail to Molder@lawandaccounting.com.