Reasonable Certainty and the AICPA

Practice Aid

Background

August 5th 2015 – AICPA Forensics & Litigation Services

Task Force releases 107 page “Practice Aid”

Task Force is composed of 7 CPAs and 3 Attorneys.

The stated intent of the Practice Aid is to “help

practitioners understand the expectations courts impose

upon experts as a result of, for example, Rule 702 of the

Federal Rules of Evidence or comparable tests applied at

the state level.”

The Task Force studied numerous cases, judicial opinions

and various scholarly writings and relied heavily on federal

cases.

Not announcement of any new legal or accounting standard.

AICPA Code of Professional Conduct

Rule 102—Integrity and objectivity In the

performance of any professional service, a

member shall maintain objectivity and

integrity, shall be free of conflicts of interest,

and shall not knowingly misrepresent facts

or subordinate his or her judgment to

others.

AICPA Code of Professional Conduct

Rule 201 - A member shall comply with the following

standards and with any interpretations thereof by

bodies designated by Council.

* * *

Sufficient Relevant Data. Obtain sufficient

relevant data to afford a reasonable basis

for conclusions or recommendations in

relation to any professional services

performed.

Certainty/Speculation Spectrum

Speculative

Lottery ticket

($1 to win $1.5 billion)

Hopes and dreams

The Middle

Lost profits

Valuations

Royalties

Property damage

Certain

100 shares of Apple stock on February 9, 2016 at 12:30 pm CST

What is Reasonable Certainty?

*Reasonable certainty is simply code for - Does the court think that,

given all of the circumstances, this plaintiff has presented sufficient

evidence to make it fair to award it the damages in question?

*Richard Posner U.S. Court of Appeals 7th Circuit (Chicago) – quoted from his book How Judges Think

2008

“A venture that has a 40-percent chance of earning

$1,000, with an expected value of $400, is not

worthless even though the probability of achieving

the earnings in question is less than 50 percent.”

Why Should You Care?

Resource/Primer

Designed for use by CPA/damages expert

Roadmap

Expert reports

Expert challenges

Cross-examination of experts

Cross-examination of fact witnesses

Claim assessment (pre- and post-filing)

Topics Addressed

Introduction/General Principles

Reliance on Client-Supplied

Information

Causation Considerations

New Business Rule

Take Away

Backstop With Other Testimony/Experts

Consider Alternative Causes

Anchor With Real World

Test the Damages Model

Client Supplied Information

An expert’s use of client supplied data has

historically been at issue:

Projections of financial performance—including lost revenues,

associated costs, loss of value, out-of-pocket costs, and so on;

Assumptions regarding growth rates, pricing, financing

opportunities, and cost structure;

Business information—such as markets served, competitors,

market share, and industry trends; or

Technical information—such as product features and

specifications, and how those features and specifications

contribute to the operation of a product.

Client Supplied Information

Court’s acceptance of the use of client supplied information by the

expert relies heavily on FRE 702 but there is no set formula for

what constitutes sufficient relevant data.

In using client supplied data, the courts have focused on:

Whether the data was prepared in the normal course of

business;

Who at the client prepared the data – management vs. those

who are qualified w/ day-to-day responsibilities;

Extent of evidence that corroborates the data;

Realistic assumptions;

Whether the opposing side previously saw the projections;

Whether the expert tested the data, assumptions and

linkage to the business.

Causation Considerations

Damages experts who testify as to causation will

generally face vigorous challenges including:

Extent of industry experience;

Lack of evidence that business lost because of

misconduct;

Identifying specific customers or transactions lost

as a result of misconduct;

Alternative reasons for the plaintiff’s loss.

Causation Considerations

Damages experts must consider alternative factors such as:

Generally prevailing economic conditions;

Product quality issues unrelated to the defendant’s alleged conduct;

Technology changes such as the loss of intellectual property;

Market changes such as the development or acquisition of IP by a

competitor;

Reputational harm for any reason other than the conduct of the

defendant;

Loss of key personnel;

Environmental issues such as hurricanes, earthquakes, freezes, and

the like.

New Business Rule? Historically, many jurisdictions have had various versions of the “new

business rule” limiting recovery for lost profits.

Mullen and Kinesoft Development Corp. decisions illustrate what

is often referred to as a per se version of the new business rule, with

the award of lost profits hinging on whether or not the business in

question is "new" or "unestablished”.

In MindGames, Inc. v. W Publ’g Co., Judge Posner, applying

Arkansas law distinguishes between a rule and a standard:

“ … States that have rejected the ‘new business’ rule are content to control the

award of damages for lost profits by means of a standard—damages may not

be awarded on the basis of wild conjecture, they must be proved to a

reasonable certainty ... The "new business" rule is an attempt now widely

regarded as failed to control the award of such damages by means of a rule.”

The “new business rule” is no longer a Rule in all jurisdictions.

Newly Established Businesses

The Practice Aid cites the following cases for guidance in what

is a “New” v. an “Established Business”:

Delahanty v. First Pa. Bank, N.A. 318 Pa. Super. 90 (Pa. Super.

Ct. 1983).

Clark v. Scott, 520 S.E.2d 366 (Va. 1999).

Gorjuice Wrap, Inc. v. Okin, Hollander & De Luca, LLP, 2011 N.J.

Super. Unpub. LEXIS 93, *3–4 (App. Div. Jan. 12, 2011).

The trend toward allowing recovery of lost profits for a new

business is to focus on "evidentiary sufficiency" to calculate

damages.

Newly Established Businesses

In allowing new businesses to recover future lost profits, courts

focus on whether or not the expert has provided the necessary

evidence, with the quantum of evidence required different than

that required of an established business seeking recovery of

lost profits.

In MindGames, Inc. v. Western Publishing Co., Judge Posner

called for consideration of all information available that is

relevant in evaluating whether the expert has met the threshold

to prove the lost profits of a new business—a rule of evidence.

In Kids' Universe v. In2Labs, the Court of Appeals of California

(Second Appellate District) relied in part on the Restatement

(Second) of Torts as support for its finding that recovery for future

lost profits of a new business was an evidentiary inquiry.

Newly Established Businesses

Success in recovering lost profits for newly established businesses

can be achieved through:

Using multiple sources of evidence to establish sufficiency of

analysis;

Using multiple experts such as a CPA and an Economist or a CPA

and an industry Expert, etc.;

Using other similar businesses as a “yardstick”;

The expert should demonstrate "a substantial similarity

between the facts forming the basis of the profit projections

and the business opportunity that was destroyed;"

There should be evidence of objectively verifiable dimensions

of similarity including size, profits, investors, management,

cost structures, etc.;

Expert should consider and adjust for slight differences in

clientele and geographic location.

Newly Established Businesses

Pre-litigation projections have been successfully used.

As previously discussed, courts have been more accepting of

projections when:

The projections were made in the normal course of business;

The expert knew who constructed the projections;

The person constructing the projections had the requisite

experience;

The expert had the background and expertise (was properly

qualified) to make appropriate adjustments to the projections.

Newly Established Businesses

The chances of recovering lost profits for newly established businesses

has been improved when the expert has considered:

The nature of the market for the business in question;

The existence of management’s expertise in the business in

question;

and/or

The damages expert has relied on the opinions of other qualified

experts.

Even in states with per se new business rules, the Practice Aid cites

examples of achieving successful recovery of lost profits.

Summary

Courts’ articulation of what reasonable certainty means appears to

recognize that the profits that form the basis for an economic

damages calculation need not be certain in order to adduce a

calculation of damages that has a reasonable basis.

Courts generally seem to focus on:

Whether the damages calculation has been made such that there

is reasonable certainty that the damages amount has been

properly calculated;

The amount has been proven with a reasonable basis and sound

methodology;

Having multiple sources of evidence (and experts) supporting the

calculation;

Whether the expert has tested and adjusted the calculation to

consider other causes.

Larry Kanter CPA, CFF, CFE 3102 Maple Ave, Suite 400

Dallas, Texas 75201 214 207-5238