001

Table of Contents
 
Title Page
Copyright Page
Dedication
Preface
 
CHAPTER 1 - Introduction
 
Development of the Field of Litigation Economics
Development of the Field of Forensic Accounting
Qualifications of an Economic Expert
Qualifications of an Accounting Expert on Damages
Interdisciplinary Nature of Commercial Damages Analysis
Difference between Disciplines of Economics and Finance
Finding a Damages Expert
Critically Reviewing a Potential Expert’s Curriculum Vitae
Getting the Damages Expert on Board Early Enough
Courts’ Position on Experts on Economic Damages
Standards for Admissibility of Expert Testimony
Expert Reports
Defense Expert as a Testifying Expert, Not Just a Consultant
Quantitative Research Evidence on the Benefits of Calling a Defense Expert
Treatment of the Relevant Case Law
Legal Damage Principles
Other Types of Damages Cases
Summary
References
 
CHAPTER 2 - Economic Framework for the Lost Profits Estimation Process
 
Foundation for Damages Testimony
Role of Assumptions in Damages Analysis
Hearsay
Approaches to Proving Damages
Causality and Damages
Using Demonstrative Evidence to Help the Client Understand Its Losses or Lack ...
Causality and Loss of Customers
Graphical Sales Analysis and Causality
Causality and the Special Case of Damages Resulting from Adverse Publicity
Length of Loss Period: Business Interruption Case
Length of Loss Period: Plaintiff Goes Out of Business
Length of Loss Period: Breach of Contract
Methodological Framework
Summary
References
 
CHAPTER 3 - Economic Analysis in Business Interruption Loss Analysis
 
Economic Fluctuations and the Volume of Litigation
Macroeconomic Analysis
Definition of a Recession
Measuring Economic Growth and Performance
Business Cycles and Economic Damages
Using More Narrowly Defined Economic Aggregates
Overstatement of Inflation Statistics
Regional Economic Trends
International Economic Analysis
Macroeconomic and Regional Economic Analysis and the Before and After Method
Summary
References
 
CHAPTER 4 - Industry Analysis
 
Sources of Industry Data
New North American Industry Classification System
Retaining an Industry Expert
Conducting an Industry Analysis
Relating Industry Growth to the Plaintiff’s Growth
Other Industry Factors
Yardstick Approach and Industry Analysis
Summary
References
 
CHAPTER 5 - Projecting Lost Revenues
 
Projections versus Forecasts: Economic versus Accounting Terminology
Using Graphical Analysis as an Aid in the Forecasting Process
Methods of Projecting Lost Revenues
Curve-Fitting Methods and Econometric Models
Understanding Regression Output and Diagnostics
Common Problems Affecting Regression Models
Confidence in Forecasted Values
Frequency of the Use of Econometric Techniques in Commercial Litigation
Seasonality and the Forecasting Process
Capacity Constraints and Forecasts
Sensibility Check for the Forecasted Values
Projecting Lost Sales for a New Business
Projecting Losses for an Unestablished Business
Summary
Appendix
References
 
CHAPTER 6 - Cost Analysis and Profitability
 
Presentation of Costs on the Company’s Financial Statements
Measures of Costs
Profit Margins and Profitability
Appropriate Measure of Profitability for a Lost Profits Analysis
Burden of Proof for Demonstrating Costs
Fixed versus Variable Costs
Using Regression Analysis to Estimate Costs as Opposed to More Basic Methods
Pitfalls of Using Regression Analysis to Measure Incremental Costs
Possible Nonlinear Nature of Total Costs
Limitations of Using Unadjusted Accounting Data for Measuring Incremental Costs
Treatment of Overhead Costs
Must a Plaintiff Be a Profitable Business to Recover Damages?
Mitigation of Damages
Cash Flows versus Net Income: Effects on the Discounting Process
Recasted Profits
Firm-Specific Financial Analysis
Cross-Sectional versus Time Series Analysis
Summary
References
 
CHAPTER 7 - Time Value of Money Considerations
 
Determination of Interest Rates
Types of Interest Rates
Financial Markets: Money Market versus Capital Market
Money Market Securities and Interest Rates
Capital Market
Real versus Nominal Interest Rates
Determinants of Interest Rates
Prejudgment Losses
Components of the Cost of Capital
Discounting Projected Future Profits
Common Errors Made in Discounting by Damages “Experts”
Summary
References
 
CHAPTER 8 - Business Valuations
 
Legal Standard for Business Valuations in Business Interruption and Business ...
Lost Profits versus Lost Business Value
Business Valuation Framework
Theoretical Value of a Business
Public versus Private Companies
Business Valuation Parameters
Revenue Ruling 59-60 and Factors to Consider in Valuation
Valuation Concepts
Most Commonly Used Valuation Methods
Capitalization of Earnings
Comparable Multiples
Adjustments and Discounts
Summary
References
 
CHAPTER 9 - Intellectual Property
 
Patents
Computation of Damages for Patent Infringement
Legal Requirements Necessary to Prove Lost Profits
Lost Profits Due to Price Erosion
Lost Profits Due to Changing Cost Conditions
Royalty Arrangements
Copyrights
Measurement of Damages for Copyright Infringement
Trademarks
Trade Secrets
Summary
References
 
CHAPTER 10 - Securities-Related Damages
 
Key Securities Laws
Damages in Securities Litigation
Fraud-on-the-Market
Comparable Index Approach
Event Study Approach
Broker Raiding Cases
Merger-Related Damages
History of Mergers in the United States
Client-Broker Claims
Churning
Appendix 10A: Case Study: In Re Computer Associates International, Inc.
References
 
CHAPTER 11 - Antitrust
 
Antitrust Laws
Antitrust Enforcement
Economics of Monopoly
Changing Pattern of Antitrust Enforcement
Antitrust and the New Economy
Monopolization and Attempts at Monopolization
Market Definition and Microeconomic Analysis
Market Power
Measures of Market Concentration
Common Types of Antitrust Cases
Summary
References
 
CHAPTER 12 - Economics of Punitive Damages
 
Evolving Position of the U.S. Supreme Court on Punitive Damages
Frequency of Punitive Damages
Frequency of Punitive Damages and the Shadow Effect of Punitive Damages
Purposes of Punitive Damages
Punishment of Corporations and Corporate Governance
Spillover Effects and Punishment of Corporations
Deterrence Theory and the Changing Litigation Environment
Deterrence and Regulatory Processes
Typical Financial Measures Used in the Determination of Punitive Damages
Net Worth
Market Capitalization
Uncertain Litigation Environment
Summary
References
 
Index

001

To Kerry with love
 
In memory of John Gaughan, Jr.

Preface
Over the past few decades the fields of forensic accounting and forensic economics, the latter sometimes referred to as litigation economics, have grown dramatically. Part of the work that practitioners in these fields engage in involves measuring various types of economic damages. One of the more prominent areas of economic damages is commercial damages. This involves estimating the economic losses of corporations who are alleging that other entities have caused them to incur losses. A common cause of such damages is the interruption of a business’s operations. The first half of this book is devoted to this very common type of commercial damages. In doing so, the book sets forth a methodological framework for the measurement of such losses. The second half of the book then focuses on other related types of commercial damages.
The anticipated audience is a combination of accountants, attorneys, and economists. For economists and accountants, the book is designed to give them assistance in their role as experts in litigation. For attorneys, it should aid them in working with and challenging such experts. Given the breadth of the audience, a detailed analysis of particular specialties is not attempted. Rather, an overview of these special topics is provided. The reason for this is that the goal of each subsection is to provide the reader with an introduction to these areas. It is assumed that the reader does not have an in-depth familiarity with many of the issues in these areas.
As mentioned numerous times throughout this book, the knowledge and skills required to work as an expert measuring commercial damages are quite broad. Few experts will possess strengths in all related areas. For this reason, experts who are strong in one area, say, accounting, may find the introduction to the relevant economic topics useful, whether they are attempting to do some of this analysis on their own or are working with economists in a team paradigm. Conversely, readers who are economists will repeatedly find that the strengths of accountants are touted throughout the book (and vice versa). Readers who are attorneys working with experts will gain a better understanding of how these different experts can interact and what each can and cannot do. Attorneys will also learn how damages should be measured so as to arrive at a nonspeculative opinion. Armed with such knowledge, they will be better able to challenge the work of experts who have not measured losses properly or who have done so in a speculative manner.
This book is organized so that readers who seek to efficiently learn more about a particular topic do not have to read the entire book or preceding chapters to gain an understanding from the selected reading. This is particularly true for topics in the second half of the book. However, the cost of presenting more self-contained chapters is some repetition. Readers of the entire book may note that some topics that have already been covered are briefly discussed a second time. While this is done to a limited extent, it is done by design, allowing readers of selected chapters to gain the most they can from the time they invest in the book. Clearly, the professional audience has very high time costs, and this format may be helpful.
It is hoped that the second edition of Measuring Business Interruption Losses and Other Commercial Damages will add to the limited literature that exists in the field of commercial damages and will spur further developments as others build on what has been done in this book. This second edition features completely updated data throughout the book. In addition, advances in the case law as they are related to specific topics are incorporated into this edition. New applications also are added. As an example, the discussion of the derivation of a risk-adjusted discount rate has been expanded in Chapter 7 to include recent advances in the field. An analysis of damages in broker raiding cases is added to Chapter 10 on securities litigation. In addition, an expanded treatment on the economic analysis that occurs in antitrust litigation has been added to Chapter 11.

CHAPTER 1
Introduction
This book is designed to provide a methodological framework for how lost profits should be measured in business interruption litigation. Such a framework is provided so that a standard approach can be followed in the measurement of such damages.
In following the discussion, readers will notice the interdisciplinary nature of commercial damages analysis. Depending on the type of case, the expert who seeks to measure a plaintiff’s lost profits needs to possess a well-rounded knowledge of the research and practices in various different areas of expertise. In some cases the issues are more limited and defined. Other cases are complex and require broad areas of expertise. These may include certain major subfields of economics (macroeconomics, microeconomics, econometrics, and forensic economics), several subfields of finance (investment analysis, capital market theory, and corporate finance), and accounting. Given the broad range of expertise that ultimately may be needed and that few individuals would be experts in all of these fields, a team of experts, such as economists working with accountants, is often the optimal solution for complex cases.
This book is not meant to present an exhaustive review of all the issues relevant to commercial damages analysis. Rather, it is meant to discuss those issues that are the most important and fundamental. It is necessary to bear in mind, however, that each case brings with it a unique set of factors that need to be considered on an individual basis. No broad-based book, such as this one, can anticipate all of the unique circumstances that may be encountered. For this reason, this book focuses on those circumstances that are most commonly encountered and attempts to present a general damages evaluation framework capable of handling most of them.

Development of the Field of Litigation Economics

The field of litigation economics, which is sometimes referred to as forensic economics, has developed significantly over the past two decades. During this time period, the National Association of Forensic Economics (NAFE) was formed. It is a national body of economists who work in the field of litigation economics and who may provide expert testimony in court proceedings. The organization is composed primarily of Ph.D. economists, many of whom have academic affiliations. In addition to the advent of NAFE, two well-received, refereed, academic journals devoted to the field of litigation economics have been created. They are the Journal of Forensic Economics and the Journal of Legal Economics. These journals have given litigation economics an academic stature similar to other subdisciplines in the field of economics. In addition to this forum for respected scholarly work in the area, most of the major meetings and the leading professional conferences of economists in the United States, including the annual meetings of the American Economics Association and the Western Economics Association, now have several sessions, sponsored by NAFE, devoted exclusively to litigation economics. Such conferences have allowed an exchange of ideas that has further developed the methodologies in the field.
At present, the leading use of damages experts, often economists, is in personal injury and wrongful death litigation. This is not surprising, since this type of litigation is the most common.1 While there are some similarities between lost profits analysis and the estimation of damages in personal injury and wrongful death litigation, there are major differences that cause them to be two separate fields, often including different groups of practitioners. Most economists who do personal injury damages analysis have a background in labor economics but may not have a background in finance. Many of these experts are sole practitioners who often have a full-time academic position. Experts in business interruption matters, however, tend to be a more diverse group. Some of them work for large firms, including some public companies. They come from a variety of backgrounds, the most common of which are accounting, economics, and finance.

Development of the Field of Forensic Accounting

Forensic accounting has undergone great development and has become a well-defined specialization in the accounting profession. Part of this development was due to the competitive pressures that were placed on traditional accounting work such as auditing and taxation. However, the most fundamental reason has been the growth in demand for this very specialized expertise. Some of this development has been focused on the detection of fraud. Other work has been directed toward the development of standard methodologies for the valuation of businesses. Various organizations have sought to market training in these areas and offer certification programs in these areas. Less focus has been placed of the valuation of damages in commercial litigation. For this reason we tend to see greater variability in the techniques and methods used to value lost profits.
As noted, economists are often called on to provide testimony on damages in personal injury and wrongful death litigation. These cases utilize a methodology that does not vary significantly among cases. This methodology has been well developed in the forensic economics literature. In addition, a concise statement of many of the generally accepted steps in the damages measurement process for personal injury cases has been set forth in Economic Expert Testimony: A Guide for Judges and Attorneys.2 The methodology usually involves projecting lost earnings and fringe benefits (net of mitigation in personal injury cases) over the work-life expectancy of the plaintiff, as well as valuing lost services over a time period that may approach the life expectancy (or, more accurately, the healthy life expectancy) of the plaintiff/decedent. The work-life is the generally accepted standard for the terminal date of lost earnings estimates, while the life expectancy is often used as a guide to establish the length of the loss period for the valuation of lost services. (The life expectancy may be reduced to reflect the diminished ability to provide services due to the aging process, and this may be reflected in the healthy life expectancy.)3 Both the life expectancy and the work-life expectancy are based on statistical data that establish averages from demographic and labor market characteristics. This contrasts with lost profits analysis in which the loss period is usually determined by a different set of circumstances, such as a time period set forth in a contract. Naturally, there may be differing interpretations of this contract and what it means about the length of the loss period.
In personal injury litigation, the monetary amount that is presented is usually derived from the historical earnings of the plaintiff or decedent. For those who have not yet had much of an earnings history, lost earnings may be derived from government statistics, which list earnings as a function of age, sex, and education. Where appropriate, historical compensation data may allow the expert to measure the value of fringe benefits. Once the total compensation base has been established, the expert constructs a projection by selecting a proper growth rate. The projected values are then brought to present-day value terms through the application of an appropriate discount rate.
In employment litigation, the expert may project damages using similar methods as those employed in personal injury cases. However, the role of the economist can be expanded when there are claims of bias or other discriminatory practices. Here, in addition to possibly measuring the damages of the plaintiff, the economist may be called on to utilize his or her econometrics background to render an opinion on the liability part of the case.4
Business interruption lawsuits, however, tend to vary considerably. Although some of the evaluation techniques used may be similar, the circumstances often vary more widely from case to case. In addition, the industries involved can be very different and may each present unique issues. Given this wide variability, business interruption cases present a greater degree of complexity than the two types of litigation mentioned previously. They typically involve significant time demands for the expert who must conduct a thorough analysis. These time demands often are greater than those associated with a typical personal injury or wrongful death loss analysis, thereby making an expert business interruption analysis a more expensive proposition for clients.
Another important difference between business interruption analysis and personal injury or wrongful death loss analysis is the role of cost analysis. The losses of a worker are typically wages and benefits; job-related expenses usually are not a significant factor. In business interruption analysis, however, costs related to lost revenues are generally quite important. It is here that the skills of an accountant may be most useful in measuring the appropriate costs that would have been incurred in order to realize certain lost revenues. This is why we have devoted an entire chapter to cost analysis.

Qualifications of an Economic Expert

It is important that the business interruption expert possess a well-rounded background in order to measure the damages reliably and withstand the criticisms that will come during cross-examination. While courts are generally somewhat lenient in whom they accept as an expert, the expert must possess requisite skill, training, education, knowledge, or experience from which it can be assumed that the opinion is reliable.”5 Given that these are generic attributes, it is important to evaluate the expert’s specific credentials relevant to measuring economic damages.
The desirable qualifications of an economic expert witness are given in various publications in the field of litigation economics. Examples can be found in Stuart Speiser’s Recovery for Wrongful Death and Injury, Michael Brookshire and Stan Smith’s Economic/Hedonic Damages, Gerald Martin’s Determining Economic Damages, and Baker and Seck’s Determining Economic Loss in Injury and Death Cases.6 The qualifications listed in these publications focus on applications in personal injury and wrongful death litigation. The requisite qualifications for competently estimating business interruption lost profits and rendering an expert opinion are similar. However, the expert qualifications in business interruption matters are normally broader. These have also been set forth in the forensic economics literature.7
A list of the desirable qualifications of an economist who could provide expert witness testimony on business interruption losses includes:
• Ph.D. in economics, finance, or accounting
• Background in finance or financial economics
• University teaching position, preferably at the graduate level
• Scholarly publications in economics, finance, or accounting
• Professional presentations in economics, finance, or accounting
• Experience in industry analysis and forecasting
• Experience in commercial damages analysis
The qualified witness may not possess all of the above but may have strengths in one area that outweigh deficiencies in other areas. Courts and juries should consider such factors when weighing the testimony of individuals who have been presented as experts but who may lack many of these attributes or who only possess minimal levels of the listed qualifications. Other individuals who are strong in most or even all of the areas may “bring a greater level of expertise to the table.”

Example of How Courts Weigh and Compare Credentials of Experts

When hearing the opinions of two opposing damages experts, courts will naturally consider the credentials of the experts when deciding how much weight to give their opinions. This was very clear in United Phosphorous, Ltd. v. Midland Fumigant, Inc. In discussing the respective credentials of two economists put forward as damages experts, the courts summarized their backgrounds in this way:
Hoyt received a B.S. degree in Milling Technology from Kansas State University in 1962, and a Ph.D. in Agriculture and Applied Economics from the University of Minnesota in 1972. Hoyt previously held a teaching position at the William Mitchell College of Law in St. Paul, Minnesota and served as a guest lecturer at the University of Minnesota and at St. Olaf College. Hoyt has published a total of seven articles in his entire career, two of which appear in agricultural economics journals, and two of which were published in law reviews, and were therefore not subject to peer review by economists.
In contrast, Dr. John Siegfried is a professor of economics at Vanderbilt University and has served as a professor there for 24 years. Siegfried earned a bachelor’s degree in economics from Rensselear Polytechnic Institute in 1967, a Master of Arts degree in economics from Penn State University in 1968, and a Ph.D. in economics in 1972. At Vanderbilt, Dr. Siegfried served as chair of the department of economics from 1980 to 1986. He taught numerous courses at Vanderbilt, including undergraduate and graduate courses on industrial organization and antitrust economics.
The court continued with a discussion of Dr. Siegfried’s credentials and then addressed his publication record:
Siegfried has authored over 100 articles, which have been published in economics journals or as chapters in various books on economics. Siegfried currently serves on the editorial board of three economics journals, and frequently “referees” articles submitted for publication as a contribution to scientific knowledge in the field of economics.8
It is interesting to note that the court put particular emphasis on the relative publication and scholarship records of the two experts. One had a more limited publication record, a record that was not focused on the areas on which he was testifying. The other had an extensive publication record and was also a referee for such publications. The court seemed impressed with these credentials, and it is not surprising that it put more weight on that expert’s opinions.

Qualifications of an Accounting Expert on Damages

In lost profits litigation, the courts have consistently ruled that both economists and accountants are appropriate expert witnesses to testify on damages. Like economists, the background of accountants can vary considerably. Sometimes we find that attorneys sometimes hire accountants to do lost profits analysis assuming that by virtue of the training and experience in accounting they have the requisite expertise to conduct such an analysis. As with economists, such general assumptions often are wrong. Lost profits analysis is a unique area requiring specialized expertise and experience.
The typical accountant possesses a bachelor’s degree in accounting and often is a certified public accountant (CPA). Some accountants may not have passed the CPA exam and lack this certification, but it is unusual to see such individuals presented as litigation experts—especially when there is such an abundance of accountants who are CPAs. Many CPAs also possess a higher degree—usually a Master’s in Business Administration. This degree may feature a specialization in certain relevant areas such as accounting or finance. The characteristics of an MBA degree and what it implies about an expert’s credentials will be discussed later in this chapter.
As the practice of accounting has gotten increasingly competitive, accountants have branched out into more lucrative areas of consulting. Litigation expert consulting is an area that has recently seen an influx of accountants. In order to enhance accountants’ expertise, and in recognition that the typical training of an accountant does not address many of the issues that arise in expert work, the accounting profession has developed certifications that address specific aspects of a forensic accountant’s work. Perhaps the most common is the certified fraud examiner (CFE). However, fraud analysis may not be relevant to business interruption cases. Other certifications in business valuation also may have little relevance to lost profits analysis. It is ironic that while there is a relatively large volume of commercial lawsuits, the development of training for lost profits analysis lags well behind other forensic work such as business valuation.

Interdisciplinary Nature of Commercial Damages Analysis

Most commercial damages analysis is performed by an expert from one discipline—economics, finance, or accounting—who does not draw on the acumen of those outside his or her field. This is unfortunate because in many business interruption cases, the necessary skills and expertise transcend traditional discipline boundaries. The skills of an economist may be invaluable in analyzing the relevant economic environment, doing an industry analysis, and constructing reliable projections. A finance expert may be necessary for analyzing relevant variables from financial markets, such as rates of return. An accountant may be useful for conducting a costs analysis or performing other work, such as the reconstruction of financial statements (including cash flow statements). The needs just described are not generally part of the training that one acquires in these disciplines. However, it is common to see an expert from one field try to conduct the entire damages analysis for a given case. In such instances, the expert may do a competent job on the part of the analysis that is within the individual’s expertise yet be inadequate elsewhere. In more complex cases, a preferable approach may be to use a team of experts, with one leading expert providing the methodological structure for the analysis and performing the part that is within his expertise. Other experts will then provide their own input on which the leading expert will rely to put forward the loss measure.
While it is acceptable for one expert to rely on the opinions of other team members when putting forward an opinion, it may be useful to have more than one expert on the team testify. In this manner, each expert stays within his own knowledge base and is capable of handling the cross-examination on the relevant issues that arise.

Relative Strengths of Economists versus Accountants

Economists have training in various forms of macroeconomic and microeconomic analysis. Often economists have extensive training and expertise in statistical analysis and econometrics, skill areas that may be invaluable in forecasting. However, unless they have separately acquired a background in finance, many economists have limited familiarity with financial statements and are not involved in the preparation of such statements. Rather, this is the domain of accountants who have specialized training in areas such as cost accounting, which is most useful when determining profit ratios to apply to forecasted revenue levels. As noted earlier, some accountants have a master’s degree in Business Administration; others have an undergraduate degree in accounting with a CPA. It is important to note that even though an MBA is a graduate degree, most MBA programs provide only general business training. The economics and forecasting courses in MBA programs are often elementary and provide the student with only limited training in these areas, training that would not be considered expertise by economists. These courses are not comparable to the training that a Ph.D. economist normally receives. Experts who possess only an MBA have been rejected by courts when they seek to offer expert opinions requiring specialized and advanced knowledge. For example, in Thomas J. Kline, Inc. v. Lorrilard, the court concluded that a witness with only an MBA was merely a professional witness and did not possess the requisite expertise, such as a background and training in antitrust economics, to testify whether a company’s credit practices constituted a violation of the Robinson Patman Act.9 One should also bear in mind that a doctorate in Business Administration is offered, which offers significantly greater training than an MBA. Some accountants have Ph.D. degrees and also possess such training. However, one of the strengths of accountants is their field experience: It is particularly useful if it is in the industry that is being considered in the lawsuit. Accountants with Ph.D. degrees may be pure academics and may not have the experience of a practicing accountant.
An example of the court’s reaction to opposing experts who possessed some of the strengths and shortcomings discussed above can be found in Digital Analog Design Corporation v. North Supply Company. The plaintiff introduced an expert who had a Ph.D. and who presented himself as an expert in economics and business finance. While the court appeared confused by the forecasting methods the economist employed, it was notably impressed.
In this regard DAD’s economic expert in the field of economic analysis, with a large number of publications and professional activities to his credit. The evidence would reasonably support his technique of cost-profit analysis, the so-called “time series analysis and projection.”
NSC, by comparison did not produce a comparable expert. Instead, NSC relied upon the testimony of a certified public accountant, an employee controller of NSC, a Mr. Simon, neither of whom it appears had as extensive training or expertise in the time series analysis method as had Dr. Zinser, and neither of whom utilized a competing method of analysis to calculate a lesser amount of profits.10
Although impressed by the economist’s forecasting abilities, the court found his cost analysis lacking. The economist applied the gross margin to projected lost sales without more carefully measuring incremental costs along the lines of what is discussed in Chapter 6. A solution that neither side attempted would have been to have an economist do the lost revenue projection and an accountant conduct the analysis of the costs associated with the forecasted lost revenues. Such an approach is advocated throughout this book.

Difference between Disciplines of Economics and Finance

Attorneys are more aware of the relative skills of economists versus accountants than they are when comparing specialists in economics versus finance. This is partly due to the fact that the fields are interrelated. Many economists consider finance to be a subfield of economics. Indeed, there is a field called financial economics, which applies economic analysis to financial markets. However, there are several differences between a Ph.D. in finance and a Ph.D. in economics. For one, finance degrees are often conferred by a college of business within a university; economics degrees, however, may be offered by the university outside of the college of business. This difference is not important. What is more relevant is the different training of the individuals.
A finance Ph.D. and an economics Ph.D. provide different training. A Ph.D. in finance may have some training in accounting and may have taken certain courses taught in business school that economists are not required to take. Many economists lack any knowledge of finance and financial statements. It is possible, for example, to get a Ph.D. in economics without ever having even seen a financial statement (as shocking as this sounds). Indeed, many economists do their work in complicated and esoteric areas and consider topics such as the analysis of financial statements simplistic. Nonetheless, it is important that the economists in commercial damages analysis have a broad knowledge base that goes beyond the training received in graduate school. Those, for example, who write their dissertation on a financially related topic may get this background as part of their thesis research. Each expert has a unique combination of credentials, training, and experience. The court and jury will have to consider this set of credentials and then determine the weight to apply to the testimony.

Finding a Damages Expert

There are many ways for an attorney to find a damages expert. One of the most often used is word-of-mouth referrals, whereby an attorney consults with colleagues he or she respects and gets the names of experts who have successfully performed for them. If this process is not productive, other methods must be employed.
There are certain media that advertise the services of experts. They include regional legal publications as well as legal reference diaries. It is important that references be gathered and checked, particularly in cases where the attorney does not have any information on the expert other than what the advertisement lists. This review process can be enhanced by a verdict search, which may reveal the names of cases in which the expert has testified.11 The attorneys who retained the expert in the past and the attorneys who cross-examined the expert in prior matters can be consulted for feedback. However, an adversarial attorney may fail to give an objective review, particularly an attorney who did not do as well as he would have liked in the case in question. Other sources where one can obtain information on experts are the expert referral companies. These are firms that maintain names and curriculum vitae (CVs) of experts with many different specialties whom they refer to attorneys for a fee.12 A CV is a document that lists an expert’s credentials. The fee that these companies charge may include an initial charge as well as a built-in hourly charge incorporated into the expert’s fee. This causes the expert’s fee to be different from what it otherwise would be if he were he contacted directly without a referral intermediary. However, referral agencies can greatly speed up the process of finding an expert—particularly if one is looking for unique expertise from a specialist in a narrowly defined industry.
Another source of experts is local universities. A professor at a nearby university may have a certain appeal to a jury from the same community. In addition, professors may possess the ability to explain complicated concepts clearly. However, attorneys have to be very careful if they hire an academic who lacks litigation and testimony expertise. It takes a certain personality to withstand the rigors of the adversarial litigation process in the United States. Furthermore, the way one voices arguments and positions in an academic environment is very different from how one expresses those same arguments and positions in an adversarial litigation environment. As obvious as this sounds, many would-be litigation experts who are pure academics may find this difficult to comprehend. Therefore, attorneys need to exercise caution in using untested experts—their testimony may be somewhat unpredictable. The role of experience will be discussed later in this chapter.
There are several economic consulting firms that offer litigation-related services. Some specialize in commercial matters while others offer a variety of damages-related services. These economic consulting firms range from small “boutiques” to large national firms. Many possess well-qualified individuals, but attorneys still need to carefully evaluate the experts working on their case.
Still another source of experts is the major consulting arms of accounting firms and other larger litigation companies. In recent years, accounting firms have aggressively expanded their consulting operations after they discovered that the profit margins on traditional accounting work, such as auditing, were shrinking from competitive pressure and corporate cost-cutting. These firms can bring larger quantities of manpower to a project. However, though it may seem comforting that such firms can apply many professionals to a given project, usually only one expert ends up taking the stand and testifying. An army of accountants may be of limited benefit when that expert testifies on his personal credentials, the analysis that was performed, and the opinions that were developed. The specific credentials and track record of the expert are more important than the quantity of staff that a firm employs. It should not be inferred, however, that larger firms are inferior to small ones. Rather, the expert selection process is individualistic and should focus on the expert or team of experts who will ultimately testify.
In the wake of the accounting scandals of the past few years, the issue of accountants’ independence has been called into question. Accountants who are not independent may be more of a liability than an asset. This should give attorneys pause when they consider retaining the consulting division of an accounting firm that does other work for their client.

Critically Reviewing a Potential Expert’s Curriculum Vitae

Many attorneys take at face value the content of a potential or opposing expert’s curriculum vitae. They merely give the CV a cursory scan and conclude from the length of the CV that the expert possesses impressive credentials. A closer review of the listings included on the CV, however, may possibly expose the misleading nature of the items. For example, in lieu of quality publications, an expert may list presentations made before attorneys, which are nothing more than marketing appeals and sales pitches. A CV may list very general articles published in legal newspapers and magazines. These articles, though, do not enjoy the scrutiny that a peer-reviewed or refereed journal article or book would. Sometimes what is listed as a publication is a paper or article that has not even been published.

Degrees

Some basic comments on degrees are mandatory. The most fundamental characteristic of a degree as it relates to litigation is the relevance of the degree. It is very common for experts to want to testify in an area that is outside their expertise. Courts, though, have been supportive of objections to experts who testify outside their expertise.13 In the area of commercial damages, one sees a variety of individuals present themselves as experts. Courts are often liberal in accepting such individuals and rely on the voir dire process and cross-examination to expose any deficiencies. However, attorneys should be aware that Ph.D.’s in some fields provide little or no training in the areas that are relevant to most types of commercial damages analysis. For example, fields like engineering or operations research may provide little training relevant to measuring damages in litigation.
Attorneys should be very wary of the “mail-away Ph.D.” These are Ph.D. degrees that one can earn at home. Several institutions offering such Ph.D.’s have sprung up, and some even advertise their degrees in major publications. This issue has become more convoluted as online higher education has grown considerably; now even major academic institutions are offering online courses. In fact, online education has become one of the faster-growing areas of academia. If the degree-granting institution is unknown, the attorney should read its catalog course descriptions and degree standards to review the criteria employed for issuing degrees. When encountering experts with questionable degrees, this can be a very fertile area of inquiry.

Published Books

Published books are impressive credentials for an expert to have. These books are even more noteworthy if they are published by major publishers who can afford to be more selective. Books that have received acclaim or won awards for their quality are even better. In addition, books that have been used as textbooks may also provide the author with credentials that other experts who have not published any books may lack. Books in the area in which the expert is testifying can be invaluable. It is ideal to use as an expert the person “who wrote the book” in the area.
Beware of books published by vanity publishers. These publishers “publish” a book for an author—for a fee. They are not unlike photocopy houses as opposed to the more traditional publisher. Having a book published in such a way implies that none of the reputable publishing houses considered the work worthy of publication. It also implies that the book in question has a very limited readership and may not be regarded as authoritative by anyone in the field.

Refereed or Peer-Reviewed Journal Articles

In addition to published books, another important standard used for evaluating scholarship in academia is refereed, or peer-reviewed, journal articles.
A refereed journal is one that utilizes a group of experts to blindly review articles submitted to the journal in their specialty. A journal’s editors will allocate the articles to the referees and ensure that the process is completed without revealing the names of the authors or the referees. These referees judge the quality of the article and decide if it is worthy of publication. Peer-reviewed articles are very different from articles that undergo editorial review; in the latter case, an editor simply decides whether a piece is of interest to the readers.
As noted earlier, there are two refereed journals in the field of litigation economics. They are the Journal of Forensic Economics and the Journal of Legal Economics. At one time there were three journals in the field. However, another journal, Litigation Economics Review, has been merged into the Journal of Forensic Economics. While many of their articles focus on areas other than commercial damages, a certain quantity of articles on business interruption losses have been published in each of these refereed journals. Other refereed journals, which feature articles in the area of commercial damages, can be found in the closely related field of law and economics. This is a subfield of economics in which someone getting a Ph.D. in economics can specialize. The five leading journals in the field are the Journal of Law and Economics; Journal of Legal Studies; International Review of Law and Economics; Journal of Law, Economics and Organization; and Journal of Empirical Legal Studies. In finance, there are many refereed journals. These include the Journal of Finance, Journal of Financial Economics, Journal of Applied Corporate Finance, Financial Management, Financial Analysts Journal, and Journal of Accounting and Economics. In econometrics, there are several quality journals, such as Econometrica, the Journal of Econometrics, and the Journal of the American Statistical Association.
In the field of accounting, Accounting Review and Accounting Horizons are two leading refereed journals. Accounting Horizons is published by the American Accounting Association. While not a refereed journal, the Journal of Accountancy is published by the American Institute of CPAs and is widely distributed to all members of the Institute. In addition, the Journal of Corporate Accounting and Finance is known as a source of quality articles in accounting and finance.

Presentations

An expert’s CV often contains lists of presentations. In the academic world, the publication process often begins with a refereed presentation to one’s peers in the specific area of the article. Refereed presentations are those that are accepted after a “call for papers” has been announced and submitted articles are reviewed by the organizers of paper sessions at academic conferences. The standards for acceptance vary widely but are usually higher than those for nonrefereed presentations. Attorneys should be wary of listings that are merely sales presentations made before potential clients. For example, a talk before a group of attorneys or at a law firm may be nothing more than a marketing session. This should not be considered a “credential.”

Concluding Comments on CVs Content

The expert witness arena has become quite crowded—professionals from many fields have discovered that they can charge substantial fees by serving as experts in litigated matters. They have learned that they may be better able to get the assignment if they have a long CV filled with impressive-sounding contents. Therefore, it is incumbent on the attorneys to carefully review the listed items and ascertain their quality. When reviewing the contents of an opposing expert’s CV, one’s own expert can be invaluable. For example, it has been observed on many occasions that experts who lack publications may try to compile a list of alternative credentials that may take up several pages. As noted above, one tactic employed by such witnesses is to list testimonies. It is important to note that prior testimony experience is not a credential. Some attorneys may be reluctant to challenge an expert’s background if the expert has been accepted as an expert a number of times by other courts. This may be a mistake. It simply could be the case that attorneys in those other cases made the same mistake. This was the court’s position in Kline v. Lorrilard: “Although it would be incorrect to conclude that Gordon’s occupation as a professional expert alone requires exclusion of her testimony, it would be absurd to conclude that one can become an expert simply by accumulating experience in testifying.”14 It is not unusual to have an expert with marginal credentials present a CV that is six or even ten pages in length. This may include several pages of testimony lists and marketing presentations but little scholarly, peer-reviewed work. The retaining attorney must then decide if a list of court appearances as an expert witness is truly a credential, particularly if there is little else on the CV. Another example of misrepresentation is what may be listed under the heading of publications. Experts who lack legitimate publication credits often list items that range from papers that were not even published to speaking appearances. A cross-examining attorney may expose such misrepresentations. Therefore, it is the retaining attorney’s responsibility to review the contents of an expert’s CV carefully.
One additional comment on expert credentials is necessary. As noted earlier, it is common that attorneys merely give a CV a cursory scan prior to retaining or cross-examining an expert. They often conclude that if the CV is several pages in length, then the individual must possess sufficient expertise. Often attorneys who know that the expert has testified several times assume that there is no point in challenging the individual’s expertise. This is sometimes an error. It could be that many of these other testimonies were made possible by other attorneys neglecting to made similar challenges. Moreover, prior courts could have concluded that the expert was allowed to testify but that the jury could hear the challenges and accord the testimony whatever weight it wanted to. The fact that an expert has testified does not indicate anything about what weight the jury ultimately gave the testimony. If there is a legitimate concern about the strength of an individual’s expertise, the opposing attorney should not hesitate to pursue this.

Credentials versus Experience in Litigation Analysis