Financial experts/Rule 702

Financial experts/Rule 702

Introduction: Financial experts/Rule 702

Financial experts play a vital role in financial restructurings, delivering important insights in many contexts, including plan confirmation, analysis of sales of a debtor’s property, preferential and fraudulent transfer litigation, and many other areas. They also are pivotal in commercial disputes and transactions, opining on business and asset valuation, damages (including lost profits), liquidity requirements, whether a transaction is fair, whether a company is solvent, and other relevant topics.

A variety of rules apply to expert testimony and understanding them could be the difference between an expert’s opinions being extremely valuable—indeed, even dispositive—or inadmissible in their entirety. In this article, we describe at a high level the rules governing admissibility of expert testimony, discuss common pitfalls, and provide some tips for avoiding these pitfalls so that expert opinions can be admitted into evidence with maximum effect.

Rule 26

In federal court, Federal Rule of Civil Procedure 26(a)(2)(B) governs the requirements for expert reports. Rule 26(a)(2)(B) provides that an expert report must contain: “(i) a complete statement of all opinions the witness will express and the basis for them; (ii) the facts or data considered by the witness in forming them; (iii) any exhibits used to summarize or support them; (iv) the witness’s qualifications, including a list of publications authored in the previous 10 years; (v) a list of other cases in which, during the last four years, the witness testified as an expert at trial or by deposition; and (vi) a statement of compensation to be paid for the study and testimony in the case.”

Most states have adopted similar standards, but there can be meaningful differences. Experts should consult with retaining lawyers to ensure understanding of what is required under the rules of the court in which the report will be used.

Rule 702

Federal Rule of Evidence 702 governs admissibility of testimony, rather than requirements for reports; and it is important to keep in mind that the reports themselves often are treated as hearsay so they may not be admissible, at least not in that form. Rule 702 provides that “[a] witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if the proponent demonstrates to the court that it is more likely than not that (a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert’s opinion reflects a reliable application of the principles and methods to the facts of the case.”

In summary, a qualified expert, who offers a relevant opinion based on sufficient facts or data, using reliable methods reliably applied, may provide admissible evidence in court.

The admissibility of expert testimony is governed by a “preponderance of the evidence” standard, which essentially means the testimony is “more likely than not” to satisfy the requirements in Rule 702. The proponent of the testimony bears the burden to show it is admissible.

The first element of the Rule 702 standard deals with a witness’s qualifications. Courts have interpreted this standard liberally, such that a broad range of knowledge, skills, or training can qualify an expert. In assessing a witness’s qualifications, courts examine a witness’s educational background, licensure or certifications, history of practical application in the field, peer recognition, and contributions to the discipline. However, there is no requirement that a witness have been previously “admitted” or “qualified” to serve as an expert.

Moreover, courts recognize that, in certain fields, experience is the primary basis for opinion testimony, rather than scientific methods. For experts testifying from their own experience, courts generally require that the expert explain how his or her experience leads to the conclusion reached. Also important is why that experience is a sufficient basis for the opinion, and how that experience was reliably applied to the facts.

Another important element of the Rule 702 standard is reliability. For many years, the lead case on this issue has been Daubert vs. Merrill Dow. In that case, the U.S. Supreme Court found that, in determining reliability, courts should weigh (a) whether the expert’s technique or theory can be tested, (b) whether the technique or theory has been subject to peer review or publication, (c) the known or potential rate of error of the technique or theory, (d) the existence of standards and controls, and (e) whether the theory has been generally accepted in the scientific community.

In the valuation context, however, these elements, while sometimes helpful, often are inapplicable at least in part because valuation opinions are often based on the expert’s experience. As noted above, experts testifying based on their own experience must explain why that experience supports their opinions and cannot rely on mere “say-so.”

Rule 702 also requires that the evidence or testimony help the trier of fact. Especially when expert opinions rely on what appears to be simple arithmetic, opposing parties may seek to challenge an opinion on the basis that the expert is not helpful because the valuation expert’s opinion is based upon basic math that the court could or jury do itself.

In response to these arguments, experts should be prepared to explain how the testimony is based on their expertise and relies upon skills not common to an ordinary juror (or judge). In other words, the addition and subtraction are not the expertise; the expertise is in knowing what to add and subtract.

Another component related to the helpfulness analysis is that the proposed opinions be relevant to, or “fit”, the facts at hand. This issue arises frequently in the valuation context. For instance, courts use a balance-sheet test in calculating solvency for purposes of avoidance actions under Section 547 or 548 of the Bankruptcy Code, so using a different test may result in an absence of “fit”, meaning the expert’s analysis can be deemed irrelevant and inadmissible.

Other issues include ensuring the expert uses the correct date when performing the valuation analysis, and equally importantly, the correct premise of value (e.g., liquidation value vs. going concern) and standard of value (e.g., book value, fair value, fair market value, etc.).

Experts should carefully consider the underlying facts at issue in the case, work with counsel to understand the relevant legal “targets”, and tailor their analysis accordingly to ensure that their opinions “fit” the case.

Ways to be excluded

In view of the above, below are some common grounds for exclusion of valuation experts:

• • Applying a standard or premise of value not appropriate to the situation. By way of example, courts have excluded experts who applied synergistic value where fair value was required and where they valued a company as a going concern when a liquidation value was more appropriate because the company could not be rehabilitated.

• • Offering a valuation based on information that would not have been known or knowable as of the effective date of the valuation. An expert must utilize data that would have been available as of the valuation date. In the valuation context, this issue sometimes arises when an expert opines that a company was insolvent on a particular date because it later filed for bankruptcy. This issue can also arise when an expert uses financial statements or data from later years when opining on value in prior years.

• • Speculative testimony. Experts generally should not testify about what a party would or would not have done given different facts and also should not testify about what parties intended.

• • Relying on techniques that are not accepted by experts in the field. Experts should be careful when relying on methodology that is not typically used in the field, as this can present persuasive grounds for exclusion of an opinion as unreliable.

• • Double-counting damages. In certain circumstances, certain types of damages can be duplicative, such as lost profits and lost business value for the same period of time.

• • Testifying about damages that are contractually barred. If a contract at issue provides that a certain kind of damages are not compensable, experts should be mindful of the risk that an opinion about those kinds of damages will be excluded as irrelevant.

• • Failing to use data reasonably related to the business being evaluated. Generally, experts should carefully consider whether the data they are using comports with the facts of the case. Common examples of this include uncritically using valuation data for public companies where the company being evaluated is private, using information about a company’s revenue that is out of date, and not taking into account current events (e.g., failure to consider the effects of COVID-19 on a gym operator when valuing that operator as of a date where COVID-19 was relevant).

• • Veering into the lane of a fact witness. Expert witnesses should be careful not to testify to the truth or falsity of facts in a case unless based on the expert’s personal knowledge. Background sections of expert reports should make clear that they are a disclosure of the facts or data on which an opinion is rendered, not a stance as to the truth or falsity of those facts.

• • Relying on materials not available to the opposing party, such as privileged materials. Experts must base their opinions on facts and data available (and disclosed) to the opposing party. Reliance on undisclosed privileged material can force a party to choose between the expert’s testimony and maintenance of the privilege.

• • Failing to timely disclose an expert opinion to the opposing party. As discussed below, always ask retaining counsel for a scheduling order and for any rules-driven deadlines for various disclosures.

• Valuing the company or its assets as-of the incorrect or irrelevant date. Always ensure that the date upon which a valuation is based fits the issue(s) for which the opinions are being provided. For instance, if value is to be determined on a bankruptcy petition date, a valuation expert should ensure that his or her valuation actually speaks of that date.

How to avoid pitfalls

So, what practices can help avoid these pitfalls and ensure an expert is not struck? First and foremost, experts should ask retaining counsel some key questions. Examples of particularly helpful questions include: Do the relevant contracts bar certain types of damages? What evidence will the other side use to undermine me and my assumptions? Am I valuing the company/assets on the correct date? How were the company’s projections generated, and is an opposing party likely to criticize them? Have all the documents I am receiving been produced to the opposing party? Are all the documents I am reviewing being tracked? Is my opinion tailored to the specific facts of the case? What facts will the other side rely on to undermine my opinions?

Remember that the legal team retaining you has a vested interest in your expert testimony being admitted into evidence, so they will appreciate your questions; when in doubt, ask!

Valuation experts should also think of their expert engagement as requiring the same degree of rigor as any analysis outside of court. Experts should think about the types of things they (or others in their field) would rely upon in coming to an opinion regarding a set of facts. Experts should consider both favorable and unfavorable evidence or theories, and they should resist any temptation to become hired advocates for one side. And, as stated above, the rigor, and usually the methodology, used in court should be the same as the expert would use outside of court.

Conclusion

More fundamentally, experts should always tell the truth. Courts see testimony every day and are adept at detecting when a witness is insincere. 

By keeping all these principles in mind, experts can maximize the likelihood that their opinions will be admissible (and avoid being struck).

For further information about HP’s expert witness, please look here.