SOURCE: Marks Paneth & Shron LLP

Marks Paneth & Shron LLP

November 03, 2011 09:00 ET

The Biggest Mistake by Expert Witnesses: They Use the Wrong Benchmarks to Calculate Damages, and Put Cases at Risk

To Estimate Losses and Lost Enterprise Value, They Make Unjustified Assumptions and Often Rely on Financial Valuation Metrics That Don't Reflect Business Reality. The Result: Cases Are Lost and Experts Are Excluded on Daubert Challenges

NEW YORK, NY--(Marketwire - Nov 3, 2011) - Expert witnesses often make critical mistakes that put litigation at risk: they use the wrong benchmarks to calculate damages, making assumptions that don't stand up to scrutiny, and causing their testimony to be excluded on a Daubert challenge, says Marks Paneth & Shron litigation advisor.

In particular, they rely on metrics used for valuation analysis. These metrics rely on assumptions that fail to reflect a business' operational reality, or what happened to the economy as a whole, according to a valuation authority.

"Benchmarking is critical in the analysis of damages from lost profits, lost enterprise value, and business valuation," says Donald M. May, Ph.D., a former professor at MIT's Sloan School of Management and current director in the Litigation and Corporate Financial Advisory Services Group at New York accounting firm Marks Paneth & Shron LLP. "Using inappropriate benchmarks or methodologies can lead to the wrong conclusions -- and that, in turn, can put the case at risk."

Dr. May is available for interviews and can author a bylined article on which benchmarking methods to use, and which to avoid. He can discuss:

  • Why one benchmarking "size" doesn't fit all. "Both litigators and expert witnesses often fail to understand which benchmarking methodology is the right one for a particular situation," Dr. May says. "They use the same approach across a range of scenarios. That leads to erroneous conclusions."

  • Why benchmarking for valuation purposes does not make sense for benchmarking for lost profits. "Valuation experts and investment bankers use metrics that are designed to forecast future performance. They measure past performance, then look ahead in order to create a prediction, using data that might include the company's own forecasts. In estimating damages, the task is different -- you start from a given date in the past, the date when the alleged harmful event took place, and then try to calculate two different scenarios. One scenario reflects what actually happened, and the other reflects what might have happened if the event had not occurred. There is more and different data available -- including information about how the company, the industry and economy actually performed. None of that would apply in projecting a valuation, but it's essential for calculating lost profits or lost enterprise value. Many experts have had their testimony excluded because they used valuation type metrics in cases involving damages from harmful acts."

  • Why bad benchmarking puts expert testimony -- and cases -- at risk. "Expert testimony is aggressively challenged. According to an annual study by PricewaterhouseCoopers, in 2010 over 50 percent of financial expert witnesses were excluded in whole or in part on Daubert challenges. Bad benchmarking is often the basis for successful Daubert challenges. In a recent case involving Celebrity Cruises [Celebrity Cruises, Inc. v. Essef Corp., 434 F. Supp. 2d 169 - Dist. Court, SD New York 2006 No. 96 CIV. 3135(JCF)], five of seven experts testifying on behalf of Celebrity and one of three experts testifying on behalf of the defendants were excluded on Daubert, all because of their benchmarking assumptions. And the case as a whole shows that wrong assumptions, such as using valuation benchmarks for damages related to lost profits or lost enterprise value, can greatly weaken the case."

  • How benchmarks should be set. "To be defensible, benchmarks for lost profits and or lost enterprise value need to conform as closely as possible to business and economic reality and control for all factors other than the alleged act of harm. In practice that means applying 'ex post' benchmarks -- measurements applied after the period under scrutiny that factor in such details as operating costs, fluctuations in business demand and changes in the economy. 'Ex ante' benchmarks -- the kind of forward-looking assumptions used by valuation experts and investment bankers - are not appropriate for estimating damages."

"A financial economist who understands the operating realities of a business is an essential partner in arriving at an accurate benchmark," Dr. May says. "Litigators need to make sure that they bring industry and institutional, as well as operating experience to the table -- either with the financial economist serving as an expert witness, or guiding the benchmarking work of other experts. The result will be expert witnesses and cases that have a much better chance of standing up in court."

For more information, or to schedule an interview or arrange a bylined article, contact Katarina Wenk-Bodenmiller of Sommerfield Communications at (212) 255-8386 or katarina@sommerfield.com.

About Marks Paneth & Shron LLP
Marks Paneth & Shron LLP is an accounting firm with nearly 475 people, of whom approximately 60 are partners and principals. The firm provides businesses with a full range of auditing, accounting, tax, consulting, bankruptcy and restructuring services as well as litigation and corporate financial advisory services to domestic and international clients. The firm also specializes in providing tax advisory and consulting for high-net-worth individuals and their families, as well as a wide range of services for international, real estate, media, entertainment, nonprofit, professional and financial services and energy clients. The firm has a strong track record supporting emerging growth companies, entrepreneurs, business owners and investors as they navigate the business life cycle.

The firm's subsidiary, Tailored Technologies, LLC, provides information technology consulting services. In addition, its membership in Morison International, a leading international association for independent business advisers, financial consulting and accounting firms, facilitates service delivery to clients throughout the United States and around the world. Marks Paneth & Shron LLP, whose origins date back to 1907, is the 30th largest firm in the nation and the 13th largest in the New York area. In addition, readers of the New York Law Journal rank MP&S as one of the area's top forensic accounting firms.

Its headquarters are in Manhattan. Additional offices are in Westchester, Long Island and the Cayman Islands. For more information, please visit www.markspaneth.com.

About Don May, Ph.D.
Donald M. May, Ph.D., is a Director in the Litigation and Corporate Financial Advisory Services Group at Marks Paneth & Shron LLP and a former professor at MIT's Sloan School of Management. Dr. May has prepared expert reports and expert witness testimony related to business valuation, hedge fund valuation, lost profits, lost enterprise value, time-series forecast models, asset and investment portfolio valuation and statistical forecasting models and methodologies. Marks Paneth & Shron's litigation support practice is consistently ranked among the top-three practices by readers of the New York Law Journal.

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