|EXECUTIVE SUMMARY |
| THE CPA EXPERT WITNESS MUST CHOOSE an approach in the pretrial planning phase that will develop and integrate facts and legal theories presented later in trial testimony. CPAs may find using a visual framework works best both in the preparation stage and as a tool on the witness stand.
VISUAL GRAPHICS PREPARED BY THE EXPERT witness can outline logical sequences and relationships in the case and can help to structure a trial plan. At trial the graphics can become exhibits to explain salient points and to educate the trier of facts.
ONE ADVANTAGE TO A VISUAL PRESENTATION is that the CPA can display the entire case on a single page. The graphic analysis flows logically, provides facts, theories and claims and highlights what information is missing.
WITH A DETAILED GRAPHIC AS A COMMON POINT of reference, the experts and counsel can then develop a list of exhibits the client must ultimately produce and decide whether additional expert witnesses are needed for trial.
CREATE A CUMULATIVE ANALYSIS, displaying both sides of the case, including claims, counterclaims and factual interpretations. Identify strengths and weaknesses. Focus on discussing the points that will help prove your case or disprove the opponent’s. The completed visual establishes a simple path for the trier of fact during trial testimony.
|GEORGE L. JOHNSON, CPA, CFA, is president of Brueggeman and Johnson, P.C., in Seattle. His accounting firm is a member of the Financial Consulting Group and specializes in business valuation and litigation support services. His e-mail address is firstname.lastname@example.org . CYNTHIA WALLER VALLARIO, JD, is a senior editor with the Journal of Accountancy. Ms. Vallario is an employee of the American Institute of CPAs. Her views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation. |
ecause most commercial disputes involve an accounting issue—such as valuation of a business for a change in ownership, amortization of intangible assets, calculating earnings to define a business’s net profits—CPAs often are hired by plaintiff and defense lawyers to provide expert testimony as litigation support consultants. The CPA expert witness can play a variety of roles in business valuation cases—from performing simple damage calculations to orchestrating complex research and analysis and creating case strategies. To do this, the CPA expert witness must choose an approach in the pretrial planning phase that will help him or her develop and integrate facts and legal theories presented later in the trial testimony. CPAs may find using a visual framework helps them in the preparation stage and as a tool on the witness stand.
Litigation Support as a Consulting Niche
Approximately 12% of all AICPA members in public practice either serve as expert witnesses or have expressed an interest in this consulting area. Litigation support services were among the top ten CPA growth niches in the 1990s.
Source: AICPA membership data.
Visual graphics prepared by the expert witness can outline logical sequences and relationships in the case and can help to structure a trial plan. At trial the graphics can become exhibits to explain salient points and to educate the trier of facts. Most CPAs and attorneys make checklists or chronologies to depict events, but lists alone will not meet the demands of complex litigation since experts and counsel cannot determine the course of events, what is important or what is missing without something tangible pulling all the pieces together. A visual approach makes it possible for the CPA expert witness to completely integrate the case on one document by:
Showing what happened.
Identifying both the expert’s and opponent’s claims.
Highlighting relevant data.
Identifying missing data.
Identifying key areas and responsibilities of the client, counsel and experts.
Creating a damages model.
Providing a way to challenge and test the other expert’s case to achieve optimal results.
One advantage to a visual approach is that the CPA can display the entire case on a single page. The graphic analysis flows logically, provides facts, theories and claims and highlights what information is missing. With a detailed graphic as a common point of reference, the experts and counsel can then develop a list of exhibits the client must ultimately produce and decide whether additional expert witnesses are needed for trial.
The completed visual, while initially used in preparation and planning, also serves as an outline for the expert’s later, more complicated, technical testimony in court. It establishes a simple and understandable path for the jury, arbitrator or trier of fact to follow and then provides the basis for the details. This approach allows the expert witness to use a broad range of presentation formats to accompany his or her testimony, from the structured “drill-down” approach of computer-supported Powerpoint presentations to the use of audiovisuals or simple flip charts.
A court case in which an emerging technology company filed suit against its auditor illustrates the application of the visual approach and some “land mines” facing a CPA expert witness. The technology company claimed it would have successfully gone public and raised a significant amount of funds if its auditor had returned audited financial statements on time. The company hired a business valuation expert to determine damages based on the allegations, but this particular expert did not look at the big picture and focused solely on lost business value. Plaintiff’s counsel ultimately declined to call the business valuation expert at trial. A second expert witness who testified for the plaintiff on lost profit calculations likewise responded unsuccessfully to the scope of the issues.
Because the plaintiff company could not prove the sequence of alleged events and assumptions relating to its claim, the plaintiff, in fact, had no financial damages and its case failed.
On the other hand, the defense expert used a visual approach to plan and present his testimony, highlighting the other party’s mistakes and illustrating that the plaintiff’s lost business value claim was an inappropriate theory of damages. Using the defense expert’s strategy in this actual case, an expert witness can start preparation for trial testimony in this manner:
Decide what data you need to prove your case. Collect historical and prospective company data, other potential experts’ testimony, industry, market and regulatory information and data regarding causation and potential or actual mitigation of damages.
Establish priorities of the claims and responsibilities of key parties on both sides of the case, as well as how factual events and theories of damages are related.
Define any alternative theories of damages that may exist and how to measure them. Decide who the damaged party really is; how and when the damages occurred; what the damages consist of and when and how alternative damages should be measured.
Then, the expert witness can create a visual graphic for use at trial:
Choose the key elements which are the building blocks for the case. List important points of the plaintiff’s allegations under each key element (as shown in exhibit 1 ).
Display your case. Identify the weaknesses in the plaintiff’s strategy and valuation of the claims (see exhibit 2 ).
Create a cumulative analysis, displaying both sides of the case, including claims, counterclaims and factual interpretations (as shown in exhibit 3 ). Identify strengths and weaknesses. Focus on discussing the points that will help prove your case or disprove the opponent’s.
In this case, the CPA expert for the defense, instead of testifying about an alternative business valuation, created the visual graphic to accompany his courtroom testimony which identified several weaknesses he had seen in the plaintiff’s strategy and valuation of the claims. The graphic showed that lost business value was not a valid theory to support a claim for damages because the lost value primarily affected the shareholders, not the plaintiff company. The plaintiff’s expert had measured damages for the wrong party. The theory on which a claim for damages is based must fit the facts of the case.
Contrary to the plaintiff’s allegations, the defense’s expert said other reasons that had nothing to do with the auditor prevented the IPO from going forward. The product was not ready for the marketplace or investors and the company didn’t have a qualified underwriter. In addition, the defense’s analysis demonstrated the IPO would have encountered significant regulatory obstacles. The net result showed the plaintiff’s theories and assumptions were weak, unsupported by the facts or inappropriate.
W hether the CPA expert witness uses a visual approach to prepare for trial or relies on more traditional methods, his or her experience and expertise are an advantage in the lawsuit’s planning phase.
The first step for a CPA expert using either approach is to find out what happened by interviewing counsel and reading the complaint, motions and related documents and reviewing a chronology if the attorney has prepared one. Then, the expert witness identifies elements of damages as outlined in the complaint and requests relevant data in order to conduct research and perform an analysis for the case. Because of the nature of litigation, counsel may not receive important data needed for pretrial discovery on time, new facts may arise and the focus of the case may change, thus revising the expert’s preparation for the execution and presentation stages of the trial.
One of the biggest hurdles the expert witness faces is collecting and organizing the thousands of pages of documents produced or created in pre-trial preparation and discovery. The CPA expert witness, on both sides of the lawsuit, must literally sift through the data and material to determine what is specifically relevant to his or her testimony. Also, the trial team always finds there seems to be either too much, too little or missing data. Without proper communication expert witnesses may initially fall into the trap of “chasing” elusive data that ultimately are never produced or turn out to be immaterial. “The expert witness can shorten the chase by focusing on evidence that is really primary and accessible and making counsel aware of this,” says Sandra K. Johnigan, CPA, of Johnigan, P.C. in Dallas, and a member of the AICPA litigation and dispute resolution services sucommittee. “If a piece of evidence does not exist and cannot be produced, discuss it with counsel.”
If other professionals on the trial team do an incomplete or disorganized job, the opponent will find it easier to attack the CPA expert witness during his or her cross-examination. Also, before trial the expert should caution counsel not to ask him or her questions which belong to other witnesses. “One way to protect yourself is to agree to testify only in your area of expertise, and not get involved in commenting on others’ testimony over which you have no control,” says Johnigan. “It’s also important expert witnesses remember they are there to testify on technical matters, not facts.”
NO CONFLICTS, PLEASE
At the beginning of the engagement when the attorney contacts the CPA expert witness, the CPA needs to examine his/her records to look for possible conflicts of interest with the parties in the lawsuit. An expert witness does not want to appear on a case where he or she (or the firm) has present or past professional relationships with individuals on either side of the suit which prevent or interfere with the witness’s objective testimony. This also applies as the investigation of facts proceeds and the attorney provides lists of potential witnesses and third parties. “It is imperative that the expert check the firm’s files and records for professional conflicts immediately. This check should include not only the named parties, but also potential third party defendants who could be named in the suit later. The bigger the case the longer the list of potential conflicts that may arise,” says Johnigan.
And the expert witness must avoid appearing as too much of an advocate for the client’s position. One way to do this is to testify on both direct and cross-examination in the same manner and avoid sounding as if reading from a script. “Be careful about perceptions of being part of the team. This can impair the appearance of the CPA’s independence,” cautions A. Marvin Strait, CPA, of Colorado Springs, Colorado.
Commercial lawsuits requiring CPA testimony generally do not follow a simple model of calculating lost profits or valuing a business. These cases may require the expert witness to integrate different aspects of finance, accounting, economics and statistics and be conversant with relevant businesses and industries.
At the outset of an assignment, the CPA expert witness will receive an engagement letter from the lawyer stating the scope of the engagement and for whom the expert is working. The CPA should establish the client’s expectations towards possible outcomes along with the budget to prepare the case for trial. To handle the variety of challenges and the high level of performance required from an expert witness at trial, the CPA needs a pretrial planning system to apply to all cases. At the same time, however, since each case is unique, the expert’s creativity in approaching an engagement can be critical in the planning stages.
The CPA expert witness should prepare a first draft of the damages analysis as soon as he or she understands the facts of the case, and should review the draft with counsel to ensure it is accurate and complete. Sometimes legal and damages theories and the facts of the case don’t mesh perfectly, and the expert must anticipate the actions of any opponents who will attempt to exploit those weaknesses. It’s much better for the trial team to address these issues early in the planning phase.
In many situations, the expert witness can also use the visual analysis to assist counsel in discovery and preparation for settlement and as the basis for outlining the case in opening arguments. Success in providing litigation advisory services depends on the practitioner’s experience and his or her ability to apply it to the facts and circumstances of the case. But no model approach, no matter how well designed, will guarantee success. The same holds true for the amount of preparation; CPA expert witnesses can still be anxious about their work because the other side will challenge their testimony and credibility (see “Never Underestimate the Opposition,” below).
CPA expert witnesses are retained based on their reputations and technical expertise. “When companies hire a CPA expert in a valuation matter, they want an objective, competent and supportable valuation performed by an independent expert,” says A. Marvin Strait, CPA, of Colorado Springs, Colorado, a former AICPA board chairman who has worked as an expert witness for more than ten years. The depth of the CPA’s expertise ultimately determines how frequently he or she is retained, the breadth of the engagements and the fees he or she earns. “Do not testify beyond your area of competence and do not appear in the courtroom without adequate preparation,” advises Strait. When CPA expert witnesses think broadly and use techniques which help them see all of the strengths, weaknesses, opportunities and threats inherent in a lawsuit, they take a long step in having their testimony achieve the desired outcome.
Never Underestimate the Opposition
B eing part of a trial team can require more from CPA experts than creating a visual approach to integrate facts and theories for trial. When a CPA expert witness prepares testimony for the courtroom, he or she must take the time to educate counsel on any contingencies that may arise. In other words, assume if something can go wrong, it probably will.
Our firm was engaged to serve as a rebuttal expert witness on a valuation report of an S corporation. In our examination we found one fundamental flaw that overstated the value of the company. Of course, the opposing party’s counsel had used that flaw to support the cause of his client, the spouse of the company owner.
The opposing CPA expert witness had calculated the S corporation’s pretax earnings and applied a capitalization rate to it, using the capitalized earnings method. This witness derived the capitalization rate from the Ibbotson build-up method, which uses publicly traded company returns, adds company-specific risk factors and subtracts an estimate of the company’s long-term growth rate. Calculated earnings or cash flows are then divided by the capitalization rate in order to determine value of the subject company.
In our opinion, to apply the capitalized earnings method correctly, the opposing expert had either to apply appropriate income tax rates to the S corporation earnings or to convert the aftertax capitalization rate to a pretax capitalization rate. Since the opposing expert had done neither, I was called to testify as a rebuttal witness. Our contention was that their capitalization rate was an aftertax rate since the Ibbotson build-up method uses returns of publicly traded companies after they have paid corporate income taxes. In preparing for trial, we had documented the flaw in the opposing expert’s reasoning and report. We introduced into evidence documents from well-respected valuation sources that supported our position. As part of my testimony, I summarized my findings, reviewed the contents of the documents and tendered a value of the company applying hypothetical C corporation rates to the company’s pretax earnings.
During cross-examination, the opposing attorney had only a few questions for me, none of which related to the capitalized earnings method or the technical error itself. He did call his CPA expert witness who, in essence, testified that he had taken into consideration income tax issues within the capitalization rate. Based on the details of the report and the methodology he employed, the other witness’s testimony could only be described as false, since his report had not considered income taxes, either directly or indirectly.
It was apparent that the judge was not convinced by my rebuttal testimony since in the divorce decree he decided to use the opposing expert’s value.
We learned three important lessons from this engagement. First, the expert witness cannot rely on the judge to understand technical issues. Consequently, an expert witness must take time to educate the trier of facts. (Editor’s note: A visual approach might be very useful in achieving this.) Many times an expert witness feels rushed, fearful of losing the judge’s attention if testimony runs too long on technical issues. Therefore, it is essential the expert witness be a master communicator on the witness stand, explaining technical concepts in easily understood ways. One way the expert does this, while on the stand, is to address issues in contention that anticipate the opposing expert’s testimony, preventing the opposing expert from sidestepping technical errors. Airtight testimony goes a long way in countering an opposing expert who counts on the judge’s ignorance of valuation issues.
Second, an expert witness must never underestimate a clever opposing expert who is a fast thinker and may have no problem with not telling the truth on the stand. As frustrating as it is, even when an expert witness knows his or her analysis is correct, the verdict may not always acknowledge that. One of the reasons the opposing expert’s value determination prevailed was because our attorney’s cross-examination did not uncover the opposing expert’s unsupportable testimony.
Last, the expert witness must educate his or her attorney on the testimony the opposing expert may offer at trial. It is not enough to present great direct examination if the testimony by the opposing expert negates it and the attorney cannot discredit that testimony. In the pretrial preparations, it’s the expert witness’s job to assist the attorney not only with his or her direct examination but also with the cross-examination of the opposing expert. It is best to educate the attorney as much as possible before the trial date. It is too late to provide questions for cross-examination to counsel when the opposing expert is under direct examination.
—Robert T.P. Metcalf, Jr.
Robert T.P. Metcalf, Jr., CPA/ABV, CVA, thanks Linda A. Campbell for her help with this case study. Both are members of Marks, Nelson, Vohland & Campbell, LLC, a CPA firm in Leawood, Kansas, that specializes in litigation support and business consulting.