valuation services bulletin

Fall 2014  |  Table of Contents
 

U.S. Tax Court Judge Laro Discusses Valuation and Expert Testimony Issues

It is not every day that one has an opportunity to hear the insights of a U.S. Tax Court judge on issues of interest to valuation analysts. At a recent luncheon sponsored by the Business Valuation Association, Judge David Laro spoke on a number of interesting topics. Judge Laro is the author of the seminal Mandelbaum decision. Valuation professionals Robert Reilly and Dan Van Vleet moderated the luncheon.

Tax Court facts: Reilly and Van Vleet asked Judge Laro to situate the Tax Court in the U.S. legal system. The judge obliged and pointed out that there is one Tax Court, in Washington, D.C., that is composed of 19 federal judges, all of whom have their own jurisdiction. Most tax-related cases settle rather than proceed to the U.S. Tax Court. In cases where the parties do not come to a resolution, they can litigate in federal district court, the U.S. Court of Federal Claims or the U.S. Tax Court. Consequently, financial experts cannot assume that every tax decision is a Tax Court decision. Litigants may appeal a U.S. Tax Court decision at the U.S. Court of Appeals of the appropriate regional circuit; but the appeals court decision only serves as precedent in that circuit—it does not bind Tax Court judges in other circuits. Also, the appeals court affirms 94 percent of the time. Judge Laro’s affirmation rate is even higher—97 percent.

Tax Court memos are fact-intensive and do not serve as precedent, but they can serve as persuasive authority. Reilly pointed out that some opinions can assume landmark status. Judge Laro’s Mandelbaum decision is a case in point. By now, it has become the quintessential job aid for the Internal Revenue Service (IRS) and valuation analysts when it comes to conceptualizing and computing a discount for lack of marketability (DLOM).

More on Mandelbaum: Reilly wants to know: Why don’t all judges do what Judge Laro did in Mandelbaum? That is, provide a thorough description of how they arrived at their valuation conclusions. Different judges prefer different approaches, Judge Laro explained. It is a matter of transparency, and not every judge wants to set out his or her thought process. The judge’s approach to Mandelbaum was to research the DLOM legal landscape and provide a methodology that valuators and future litigants could use to create their valuations. When he discovered that many of the earlier memo cases broaching the subject lacked explanations as to how the court arrived at its decision, he made a deliberate effort to develop a decision that could guide the appraisal industry.

Tailor approach to presiding judge? Should knowledge about the presiding judge influence the way an expert performs a valuation, Reilly and Van Vleet wanted to know. No, said Judge Laro. He allowed that he would question the thoroughness of a report in which an expert appearing in front of him failed to discuss the Mandelbaum factors.

He also thought it was good practice for an expert to read the cases in which a presiding judge discussed valuation issues to get a picture of where the judge is coming from, but it would be a mistake to tailor a valuation to the judge. What matters is the expert’s independent, unbiased opinion. How did he or she arrive at it? Can he or she back it up?

There are so many variables, Judge Laro said, that go into a judge’s decision-making: the facts specific to a case, the experts, the witnesses, documentary evidence, and the judge’s own views and preferences. For an expert to assume he or she can influence the outcome of a case by studying the judge’s prior decisions would be a big mistake.

Tax affecting: Judge Laro was hesitant to answer technical questions. When Van Vleet and Reilly tried to ask about specific issues, he reminded them that the judges look to the experts for the right answer to those questions, but he did allow that the issue of tax affecting was not a closed matter in his court. The Delaware Court of Chancery allows it, he noted. “The door is wide open,” he said. He was waiting for the right set of facts to walk through it.

‘Hot tubbing’: What’s the future of expert testimony? “Hot tubbing,” responded Judge Laro to chuckles in the audience. Hot tubbing is an alternate way to handle cross-examination of expert witnesses. In our system, he explained, the parties retain experts to teach the fact-finder and the court (sometimes the same) about valuation and other issues that require specialized knowledge; but, the judge points out, think of what the expert’s testimony looks like to a judge after the opposing counsel has put the expert through cross-examination, as our adversarial model requires. The testimony is fragmented because of the sustained attack on the expert’s credibility.

The solution to a more equitable outcome, he said, is a technique practiced in a number of other countries known as hot tubbing or, more formally, “concurrent witness testimony.” Judge Laro, who has used it in a few cases, says he usually sits at a table with the two experts flanking him and the attorneys relegated to the periphery. The judge opens a conversation, asks questions of the experts, and invites them to pursue their own dialogue. Without having to worry about attacks on their credibility, the experts are able to have a collegial discussion about their work on the case.

Reilly, who had experience with this approach involving cases in Australia, Ireland and England (countries that trace their legal system to England), says it is “radically different” from the U.S. approach. In many ways, it is better for fact-finding. When you sit next to someone you know or whose work you know, he says, you do not attack the person just because you feel on the defensive. You talk about the case and air honest disagreements.

All three speakers agreed it requires a certain sophistication by the presiding judge because the judge has to get the conversation started. Reilly wanted to know what the reception of this approach has been in the legal community. When he proposed adopting it in a case, Judge Laro said, the parties at first were reticent, but ultimately the IRS and the petitioning taxpayer agreed and seemed satisfied. In a second case, the taxpayer asked for it. Judge Laro thinks this approach is the way forward: It provides the judge with coherent expert testimony and as such aids the decision-making.