JANUARY/FEBRUARY 2024IN THIS ISSUE... The Role of Financial Litigation Consultants in Class Certification By Michael D. Pakter, CPA, CFF, CGMA, CFE, CVA, MAFF, CA, CIRA, CDBV, and Miranda Kishel, MBA, CVA, CBEC This article explores the role of financial litigation consultants in class certification. From analyses to large data management, the authors aim to add to the reader’s body of knowledge as to how litigation consultants participate in the early stages of class action lawsuits. COLUMNS & DEPARTMENTS Academic Review Academic Research Briefs By Peter L. Lohrey, PhD, CVA, CDBV This column provides readers with summaries of contemporary research in valuation and forensic accounting. In this issue, the author reviews “Private Equity Net Asset Values and Future Cash Flows,” by Tim Jenkinson, Wayne R. Landsman, Brian R. Rountree, and Kazbi Soonawalla. In this paper, the authors evaluate whether fair value estimates of net asset values made by private equity managers are exact and impartial prognosticators of future discounted cash flows. ON THE COVER The Valuation Prophecy: Consideration of Post-Valuation- Date Information By Alan B. Clements, PhD, Esq., CPA Valuations are conducted as of a specific date, and appraisers determine business value on that date based on all available evidence. The use of post-valuation-date information to determine the value of a business interest is controversial, with no clear standards. Thus, the process of determining value becomes a nuanced exercise, specific to each case and court, and involves interpretation of the somewhat elusive concept of foreseeability on the date of valuation. ON THE COVER 26 18 4 The Value Examiner 2SUBMISSION DATES Issue Submission Date Publish Date May/Jun. Feb. 16 Jun. 3, 2024 Jul./Aug. Apr. 18 Aug. 1, 2024 Sep./Oct. Jun. 18 Oct. 1, 2024 SUBMISSION STANDARDS The Value Examiner is devoted to current, articulate, concise, and practical articles on business valuation, litigation consulting, fraud deterrence, matrimonial litigation support, mergers and acquisitions, practice management, exit planning, and building enterprise value. Articles submitted for publication should range from 1,500 to 6,000 words. Manuscripts should be submitted via the Scholastica professional journal management platform. For more information, or to submit an article, please visit: https:// www.nacva.com/tveauthors. By clicking on the “Submit via Scholastica” button, you can view detailed editorial and submission guidelines. If you have questions, please contact Dan Shiffrin, Editor, at DanS1@NACVA.com, or Lynne Johnson, Associate Editor, at LynneJ1@NACVA.com. REPRINTS Material in The Value Examiner may not be reproduced without express written permission. Article reprints are available; call NACVA at (800) 677-2009 and/or visit the website: www.NACVA.com. © 2024 NACVA. All rights reserved. NACVA members (except Affiliate members) are automatically provided a subscription to The Value Examiner with membership. If you do not want to receive this publication, upon request, we will reduce your annual dues by $25. EDITORIAL STAFF CEO & Publisher: Parnell Black, MBA, CPA, CVA Editor: Daniel Shiffrin, JD Associate Editor: Lynne Johnson EDITORIAL BOARD Chair: Lari B. Masten, MSA, CPA, ABV, CFF, CVA, ABAR, MAFF Past Chair: Michael Goldman, MBA, CPA, CVA, CFE, CFF Ashok Abbott, MBA, PhD John E. Barrett Jr., MBA, CPA, ABV, CVA, CBA Gary W. Baum, MBA, CPA, CVA Neil J. Beaton, CPA, ABV, CFF, CFA, ASA Rod P. Burkert Lorenzo Carver, MS, MBA Wolfgang Essler (Germany) Dorothy Haraminac, MBA, CFE, MAFF, PI Hubert Klein, CPA, ABV, CVA, CFE, CFF Andrew M. Malec, PhD Z. Christopher Mercer, FASA, CFA, ABAR Michael J. Molder, JD, CPA, CFE, CVA, MAFF Judith H. O’Dell, CPA, CVA Michael D. Pakter, CPA, CFF, CGMA, CFE, CVA, MAFF, CA, CIRA, CDBV Danny A. Pannese, MST, CPA, ABV, CVA, CSEP Kevin A. Papa, CPA, CVA, ABV, CVGA Donald Price, CVA, ASA Angela Sadang, MBA, CFA, ASA, ABV Keith Sellers, DBA, CPA, ABV Todd Zigrang, MBA, MHA, FACHE, CVA, ASA, ABV The Value Examiner ® is a publication of: National Association of Certified Valuators and Analysts ® (NACVA ® ) 1218 East 7800 South, Suite 301 | Sandy, UT 84094 Tel: (801) 486-0600, Fax: (801) 486-7500 E-mail: NACVA1@NACVA.com Production and Design: Chris Peterson, Creative Director, Digital Paint Booth, DigitalPaintBooth.com Inquiries concerning advertising should be directed to NACVA1@NACVA.com Financial Forensics Cryptocurrency in Litigation Practice: Tips and Pitfalls for the Financial Forensics Practitioner By Dorothy Haraminac, MBA, CFE, MAFF, PI This column discusses blockchain forensics, cryptocurrency valuation, and other cryptocurrency issues in litigation. The author provides financial forensics practitioners with tips and practice tools, and alerts them to the many potential pitfalls in these cases. The subject of this installment is “Enabling the Court to Act.” Legal Insights Courtside View: Valuation and Financial Forensics Perspectives from the Bench By Michael J. Molder, JD, CPA, CFE, CVA, MAFF Courtside View highlights recent decisions by federal and state courts addressing significant valuation, financial forensics, and expert witnessing issues. In this issue, the author reviews two cases involving owners of privately held businesses who attempted to break up with their co-owners and move on: Herremans v. Fedo (W.D. Mich.) and Owen v. Hurlbut (Sup. Ct. N.Y.). 30 36 January | February 2024 3The Valuation Prophecy: Consideration of Post-Valuation- Date Information By Alan B. Clements, PhD, Esq., CPA 4 The Value Examiner Valuation“Valuation of securities is, in essence, a prophecy as to the future and must be based on facts available at the required date of appraisal.” 1 This simple but illustrative statement underlies a complex subject in valuation: the use of hindsight evidence and other post-valuation-date information in the valuation of a business interest. Valuations are conducted as of a specific date, such as the date of gift, the date of death, or a contractual date, such as the date a merger agreement is signed or closed. Appraisers determine business value at that date based on all available evidence. The difficulty lies in determining what evidence is both “available” and relevant to the property or business being valued. The use of post-valuation-date information to determine the value of a business interest is controversial, with no clear standards. Thus, the process of determining value becomes a nuanced exercise, specific to each case and court, and involves interpretation of the somewhat elusive concept of foreseeability at the date of valuation. 1 Rev. Rul. 59-60, 1959-1 C.B. 237. The case law is filled with disputes involving the use of post-valuation-date information, both in federal and state courts. These cases include valuations in gift and estate tax matters, income-tax-related valuations (e.g., valuations under Internal Revenue Code Section 409A), bankruptcy valuations, shareholder appraisals, and contract disputes. In addition, issues in using subsequent event information arise in fair value determinations under U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), along with related audit standards. This article discusses the application of hindsight evidence and subsequent events, and seeks to clarify if and when post-valuation-date information can be considered in estimating value, with a focus on gift and estate tax matters. A future article will discuss the application of these principles in other valuation contexts, including fair value determinations under income tax law, state law, and financial accounting applications. To illustrate the principal issue in this discussion, assume that Donor is a cofounder and chairman of the board of Corporation A, a publicly traded corporation. On January 1, Donor transferred 10,000 shares of Corporation A stock to a newly formed grantor retained annuity trust (GRAT) with a 10-year term, with a remainder to Donor’s children. A month later, after the market closed, Corporation A announced a merger with Corporation B. The merger was the culmination of negotiations with multiple parties, and then, before the January 1 transfer, exclusive negotiations with Corporation B. On the day of trading after the merger was announced, the value of Corporation A’s stock increased substantially, though it was less than the agreed merger price. The merger was consummated more than 90 days after January 1. The IRS contested the value of the transfer to the GRAT, arguing that the stock’s fair market value on the transfer date should incorporate the price from the merger, even though it was still pending on that date. Donor contends that the merger price was not reasonably foreseeable on the date of transfer and should not be included in the value determination. The issue in this case is whether a hypothetical willing buyer of the stock could have reasonably foreseen the merger and anticipated that Corporation A’s stock would trade at a premium. Hindsight Evidence and Subsequent Events In the valuation of property (including businesses), two types of post-valuation-date information may be relevant: hindsight evidence and subsequent events. Hindsight evidence refers to information affecting value that was not known but existed during the valuation and becomes available after the valuation date. Subsequent events are events that occur after the valuation date. These events are either foreseeable (known or knowable) on the valuation date (such as a pending merger) or unforeseeable at the time of the valuation (such as an unexpected natural disaster). The distinction is important. In determining value, a court might admit hindsight evidence but disallow consideration of a subsequent event, depending on its foreseeability. These concepts are discussed further below. Hindsight evidence clarifies or reveals the conditions that were actually present on the valuation date. For example, assume that a valuation of a company was conducted as of February 28. In early March, a report was published 5 January | February 2024 A Professional Development Journal for the Consulting Disciplinesrevealing the company’s significant gain in market share. This report would be considered hindsight evidence because it is information that provides insight into the company’s financial condition that was not explicitly known on the valuation date but existed at that time. Another example would be the discovery of a contract negotiation that was confidential and not public knowledge on the valuation date, but later revealed, which significantly impacted the value of a business. Courts tend to be cautious with hindsight evidence as it can lead to “outcome bias,” where the outcome of an event is used to judge the quality of the decision made before the event occurred. The Estate of Newberger v. Commissioner case (discussed below) provides a good example of the use of hindsight evidence (later sale) to determine the value of artwork on the date of death. In contrast to hindsight evidence, which clarifies or confirms value on the valuation date, subsequent events are events that occur after the valuation date. For instance, if the same company entered into a major merger transaction in April, this event, occurring after the February 28 valuation date, could significantly influence the company’s future earnings potential and market position. The merger transaction is a subsequent event that could alter the business’s valuation if it were to be reassessed. Thus, the key distinction between hindsight evidence and subsequent events is whether the information or event was existent (but unknown) on the valuation date (hindsight) or was a development that occurred after the valuation date (subsequent event). 2 279 U.S. 151 (1929). General Rule Generally, events occurring after the valuation date, and hindsight evidence, are not considered in valuing property. This principle is grounded in the notion that the valuation should be based on the facts, circumstances, and market conditions that were known or knowable as of the valuation date. This approach helps ensure that the valuation is fair and accurate, reflecting the value of the property at a specific point in time without being influenced by hindsight or subsequent developments. This principle is particularly important in legal and financial contexts, such as estate and gift tax valuations, mergers and acquisitions, and other appraisal engagements where an objective valuation as of a certain date is crucial. The idea is to provide a snapshot of the property’s value based on the information available at that specific time, ensuring that the valuation is not skewed by events or data that were not known or foreseeable at that point. In the landmark estate tax case, Ithaca Trust Co. v. United States , 2 the U.S. Supreme Court held that the value of a bequest made in trust, where the income is paid to a person for life with the remainder going to another person, should be determined based on the value at the time of the decedent’s death. The court ruled that it was inappropriate to consider subsequent events that might affect the valuation of the remainder interest. This decision established the principle that valuations for estate tax purposes should be based on the circumstances and values as of the date of death, not on later developments. 6 The Value Examiner ValuationExceptions There are exceptions to the general rule that subsequent events or hindsight evidence are not considered in property valuation. These exceptions typically depend on the nature of the information and whether it was reasonably foreseeable on the valuation date. Since the Supreme Court’s decision in Ithaca Trust , courts, regulatory agencies, and standard setting groups have been more flexible regarding the use of subsequent events and hindsight evidence in valuations. The standard set in Ithaca Trust focused on using information available on the valuation date for estate valuations. However, in later cases, courts have recognized that subsequent events may sometimes provide relevant insights into value, especially when they were foreseeable or reflect the conditions that were present on the valuation date. In James Couzens , a 1928 case, the Board of Tax Appeals, in evaluating the consideration of subsequent stock sales to determine a value on March 1, 1913, held that the evidence from the sales was admissible to confirm “reasonable expectations” on the valuation date. 3 As noted by the court: Serious objection was urged by respondent to the admission in evidence of data as to events which occurred after March 1, 1913. It was urged that such facts were necessarily unknown on that date and hence could not be considered. It was apparent that there was a fear that the Board would in reaching its judgment be influenced toward a higher value if it were permitted to see the evidence of increasing value after the date in question. The evidence was nevertheless admitted. It is true that value on March 1, 1913, is not to be judged by subsequent events. There is, however, substantial importance in the reasonable expectations entertained on that date. Subsequent events may serve to establish 3 James Couzens, 11 BTA 1040 (1928). 4 Ibid. 5 Estate of Michael J. Jackson v. Commissioner, T.C. Memo 2021-48. both that the expectations were entertained and also that such expectations were reasonable and intelligent. Our consideration of them has been confined to this purpose. Such subsequent events as have no reasonable relation to the considerations of the date in question have been disregarded. We have not, by looking at the subsequent events now known, found what the value would have been had they been definitely known on March 1, 1913. The only facts upon which our judgment of value has been predicated are those reasonably known on that date. These included not only those which had completely occurred, but also those which were in process and those which were reasonably in contemplation. 4 In general, post-valuation-date information might be considered in determining value when the following criteria are satisfied: 1. Foreseeability Subsequent events can be considered in a valuation if they were reasonably foreseeable to a prudent person on the valuation date or if they provide evidence confirming or illustrating the conditions that existed at that time. Foreseeability means that a prudent person could have reasonably predicted the event based on the information available at the time. The issue of foreseeability is well illustrated in the valuation of the estate of Michael Jackson, 5 in which the U.S. Tax Court evaluated the fair market value of Jackson’s name and likeness at the time of his death. This case presented several difficult valuation issues, including the valuation of name and likeness, the foreseeability of future revenue streams, and the impact of synergy when combining estate assets. The valuation of projected post-death revenue streams was a contentious issue. There are exceptions to the general rule that subsequent events or hindsight evidence are not considered in property valuation. These exceptions typically depend on the nature of the information and whether it was reasonably foreseeable on the valuation date. 7 January | February 2024 A Professional Development Journal for the Consulting DisciplinesThe IRS expert included several revenue streams in his valuation considered as “foreseeable opportunities.” These included themed attractions and products, a Cirque du Soleil show, a film, and a Broadway musical. The Tax Court rejected this analysis, labeling it as fantasy and finding that four of the five revenue streams proposed by the IRS were unforeseeable at the time of Jackson’s death. The court emphasized the importance of relying on information that was known or knowable as of the valuation date and found that the IRS expert’s projections did not meet this standard. The court emphasized that the valuation must be based on the circumstances at the time of Jackson’s death rather than hindsight. “We also find that [the IRS expert] included revenue streams that were unforeseeable at the time of Jackson’s death. Even if these potential revenue streams were traceable to Jackson’s image and likeness, they were not foreseeable when Jackson died, which means we should not include them in the Estate’s gross value.” 6 Examples of foreseeable subsequent events include the following: • Announced merger or acquisition. A merger or acquisition publicly announced before the valuation date but completed afterward would be included in determining value as it was a foreseeable event. • Zoning changes. Announced or proposed changes in zoning laws or land use that are in the public domain and expected to be implemented could affect property values. For example, a change from residential to commercial zoning could significantly increase property value. • Planned development projects. If there are known plans for major infrastructure projects—such as new highways, public transportation lines, or commercial developments— they can impact property values. For instance, a new shopping center approved before the valuation date would likely affect nearby property values. • Market trends. Observable market trends leading up to the valuation date, like a steady increase in property prices in the area due to demand outpacing supply, can be considered foreseeable. • Economic indicators. Known economic policies or indicators that are expected to impact the property market, such as changes in interest rates announced by the central bank. 6 Ibid. at 137. 7 Ibid. 8 Ibid., citing Estate of Gallagher, 101 T.C.M. (CCH) at 1706 (2011). • Environmental reports. Existing environmental reports indicating potential for future remediation or changes in land use could impact property valuation. Unforeseeable subsequent events are those that could not have been reasonably predicted based on the information available on or before the valuation date. These are typically extraordinary or unforeseen occurrences, such as: • Natural disasters. Events like earthquakes, hurricanes, fires, or floods that occur unexpectedly after the valuation date and significantly impact property values. • Sudden economic crises. Unforeseen economic events, such as an unexpected major recession or sudden market crash, which were not indicated by prior economic data. • Legislative changes. Sudden and unexpected changes in laws or regulations that impact property use or value, which were not under consideration or known before the valuation date. For example, if the county zoning commission unexpectedly voted to rezone a large block of property from residential to commercial, that would be an unforeseeable event. • Unpredictable market changes. Sudden shifts in the real estate market due to factors such as unexpected demographic changes or unforeseen shifts in consumer preferences. • Major unforeseen events. Events—such as the COVID-19 pandemic, political upheaval, or other significant incidents—that could not have been predicted and have a broad impact on the economy and property values. In Estate of Michael J. Jackson , 7 the U.S. Tax Court refused to consider the enhancement of value from future revenue streams that could not have been reasonably foreseen on the date of Mr. Jackson’s death. “Foreseeability,” the court stated, “can't be subject to hindsight.” 8 Unlike subsequent events, for hindsight evidence, foreseeability is not typically required because this type of evidence clarifies conditions that existed on the valuation date but were unknown then. For example, a previously unknown environmental liability discovered after the valuation date represents hindsight evidence that existed but was undisclosed during the valuation. This information was not foreseeable but could be considered in determining value at the earlier date. 8 The Value Examiner ValuationI Need Estate Planning I'm Getting a Divorce Certified Valuation Analyst I'm Missing Out My Partnership is Dissolving Visit www.theCTI.com/BVTC or Call (800) 677-2009 Early registration discounts available. Dates and locations subject to change. Consultants' Training Institute ® Business Valuation Certification and Training Virtual Training Schedule February 26–March 1, 2024 March 18–22, 2024 April 22–26, 2024 June 10–14, 2024 NACVA’s Certified Valuation Analyst® (CVA®) designation is the only valuation credential accredited by the National Commission for Certifying Agencies® (NCCA®), the accreditation body of the Institute for Credentialing Excellence™ (ICE™), and the ANSI National Accreditation Board® (ANAB®). In-Person Training Schedule January 22–26, 2024 Salt Lake City, UT May 13–17, 2024 Salt Lake City, UT July 15–19, 2024 Salt Lake City, UT Co-Sponsored by the National Association of Certified Valuators and Analysts® (NACVA®) I Want to Sell My BusinessNext >