The Legal Intelligencer Blog

Purchasing Department Fraud – A Major Threat and Hard to Detect

By B.J. Hoffman
Special to the Legal

In my last post, I highlighted that most organizations lose 5 percent of annual revenues to fraud, waste and abuse – a staggering figure that can mean the difference between a firm’s survival and its demise, especially in challenging economic climates.

One of the greatest fraud risks that you and your clients face is within the purchasing function, as a tremendous amount of funds flow through most companies’ cash disbursement and purchasing departments. Unfortunately, purchasing frauds can be among the most difficult to detect, owing to the fact that they are often conducted “off the books” by way of vendor kickbacks to employees.

Kickbacks to employees represent one common purchasing fraud, but other schemes include payments to fake vendors, bid-rigging and false invoicing for services not performed or goods not received. Typically, these frauds involve a company purchasing agent who has been “compromised” by a vendor who seeks to do more business with the company. The scheme may begin with small tokens of appreciation given to the employee responsible for purchasing, including tickets to sporting events, meals and gift certificates. While not all gifts from vendors to company employees indicate the presence of fraud, the presence of vendor gifts should pique management’s interest and lead to greater scrutiny over vendor/employee relationships.

Employees experiencing financial difficulties are particularly susceptible to such schemes, as they tend to be more able to rationalize the acceptance of kickbacks, so as to alleviate their financial or lifestyle pressures.

Indicators of possible kickback schemes include:

• Unexplained increases in operating expenses, measured as a percentage of company revenues.
• Poor purchasing department documentation regarding vendor selection and bidding processes.
• Excessive entertaining of purchasing staff by vendors.
• Poor cash management practices (the payment of certain “preferred” vendors immediately, instead of the standard payment timetable).
• Receipt of substandard goods/services from certain vendors (possibly an indicator that the vendor is recouping its kickback costs by substituting inferior products at delivery).
• Unexplained lifestyle changes among purchasing department staff (increased spending without a known sources of funds).

Among the ways management can prevent kickback schemes are:

• Get control over company expenses by adopting budgets and by measuring actual performance against those budgets.
• Adopt vendor selection policies, so that management (outside of the purchasing department) has discretion over the approved vendor list. Changes to the approved list would require management approval.
• Secure competitive bids for major expenses and strictly control the bidding process, so that management is closely involved in the receipt of sealed bids. Regularly check competing prices in the marketplace.
• Adopt strict gift acceptance policies and procedures for employees and compel the employees to annually acknowledge the policy. Similarly, many companies require outside vendors to agree to not offer gifts to purchasing department personnel.
• Monitor the quality of goods and services received from vendors.
• Segregate duties within purchasing to separate purchase authorization from the receipt of goods, and from the disbursement of funds to vendors.

Kickback schemes within purchasing departments are difficult to detect, since accounting records will continue to reflect cash disbursements to legitimate vendors for actual goods and services received. However, the prices paid for such goods and services will be higher than normal, and the quality of the goods received will often be below standard.

The adoption of effective policies, procedures and controls within your purchasing department can go a long way in the effort to minimize the losses every organization incurs from fraud, waste and abuse.

B.J. Hoffman is a certified public accountant and certified fraud examiner for Citrin Cooperman, an accounting, tax and business consulting firm. He is a partner in the Philadelphia office. Hoffman provides clients with a mix of audit, tax and litigation support services. He often works with closely held entities in a variety of industries including professional service firms and real estate enterprises. He can be reached at bjhoffman@citrincooperman.com or 215-545-4800.

Inventory – An Often Abused Asset

By Terry Silver
Special to the Legal

Tax reduction through inventory manipulation is not an uncommon practice. A company desiring to reduce income tax liability can achieve this result through inventory manipulation. Because this illegal tax-reducing technique does occur, the forensic accountant, business valuator, litigator, etc., must be aware of how it works.

To illustrate how this may happen, I have included the following scenario: a company realizes an annual profit of $250,000, which produces $75,000 (estimated at 30 percent) income tax liability. The firm management decides this is more than the tax budget will bear, and so reduces ending inventory from $1.25 million to $1.1 million. The resulting impact is:

• Costs of goods sold increases by $150,000
• Net income reduces by $150,000
• Income tax reduces by (30 percent) $45,000

Additionally, the inventory asset is now understated on the company balance sheet by $150,000.

There are techniques that can be used to discover this fraud. A manipulation of inventory can be discovered via trend analysis; I recommend a five-year analysis period. Gross profit is defined as sales minus cost of goods sold. The ratio of gross profit to sales should be fairly consistent from year to year. If not, significant changes in gross profit can and should be investigated and explained. For example, the introduction of new product lines or the utilization of more efficient technology may increase gross profit. Reducing prices due to enhanced competition will reduce gross profit. Using trend analysis will identify the reason(s) for gross profit fluctuations. If the reason(s) for gross profit fluctuations cannot be identified, one must look to the possibility of inventory manipulation.

Proper accounting mandates the maintenance of beginning and ending inventory records sufficient to support inventory levels. If inventories cannot be supported by contemporaneous records, reliance on same will pose a risk. Additionally, a system that utilizes a perpetual inventory will usually indicate a higher degree of reliability.

The existence of larger adjustments to inventory, both late in the year and early in the following year, may be a sign of manipulation. Inquire about the frequency of physical counts of inventory, which should be performed at least annually. Inventory will usually be adjusted to account for differences between perpetual records and physical counts. In a well-designed and maintained inventory system, these adjustments should not be significant. Beware of large adjustments to inventories as a possible sign of manipulation.

A cross-check on the validity of the value of inventory is to review insurance coverage. When the level of insurance coverage is significantly different than the book-carrying value of the inventory, there exists a warning sign of manipulation.

The manipulation of inventory can also be used to camouflage an operating loss, i.e., turn a loss into a break-even or a profit. This is accomplished by inflating ending inventory over actual levels.

Since inventory is an asset that is more difficult to substantiate after the fact, it is often used to reduce profit (by reducing ending inventory) or increase profit (by increasing ending inventory). Consequently, the reasonableness of inventory levels must be ascertained in a forensic investigation or business valuation.

Terry Silver is a certified public accountant, certified valuation analyst and certified in financial forensics for Citrin Cooperman, an accounting, tax and business consulting firm in Philadelphia, where he is a partner with more than 33 years of experience as an accountant and auditor. He focuses his practice on business valuation and financial forensic services, expert testimony and matrimonial actions. He can be reached at tsilver@citrincooperman.com or 215-545-4800.

Reduce Costs of Litigation Support With Specialized Software

By David A. Anderson
Special to the Legal

Using specialized data-mining software in complex litigation support and forensic accounting engagements can yield significant cost and time savings. In most forensic accounting engagements, time is of the essence and, when litigation is involved, deadlines for discovery or accepting proposed settlement offers can become a major issue.

If it normally takes several weeks to perform a particular analysis of large amounts of data and the analysis results in a dead end, the use of data-mining software can be especially valuable in affording time to conduct alternate analyses. A recent engagement of mine, which I detail below, required only one person working for three days as opposed to a team of two people working for several weeks to perform the analyses and obtain the results.

In this particular engagement, a multi-location retailer believed that its controller may have been defrauding the company through a variety of means. It was suspected that the controller was purchasing goods from the company without payment and making fraudulent payments to one or more of her own businesses through accounts payable.

The controller had been married multiple times and had been known by eight different names including alternate spellings. In addition, she had lived at six different addresses during her tenure as controller.

I obtained an electronic copy of all company sales and accounts receivable transactions for the 10 years that the controller had been with the company. This consisted of more than 1 million transactions in more than 250,000 customer accounts.

Using specialized data-mining software, I was able to analyze customer accounts and transactions for matches with any of the controller’s names or known addresses. I also reviewed the write-offs of any balances in such customer accounts.

I determined that the controller had purchased goods through eight different customer accounts, that a former spouse had purchased goods through two different customer accounts, and that a former live-in boyfriend had purchased goods through yet another two different customer accounts. During further research of nonpayment account reductions in balance, I found that on 13 different occasions the controller had written and processed either credit memos or write-offs to these accounts. Each of these nonpayment account reductions was determined to be improper and had been processed without the proper approvals.

I also obtained the company’s vendor files. Using the same data-mining software, I compared the billing and payment addresses of the company’s 1,200 vendors with the known addresses of the controller. I was able to determine that payments had been made over several years to a consulting company with the same address as one of the controller’s known addresses.

As demonstrated by this particular engagement, the benefits of using specialized data-mining software in complex litigation support and forensic accounting engagements can be substantial and should be seriously considered in such cases for cost and time savings.

David A. Anderson is a director in the valuation and forensic services group of Citrin Cooperman, an accounting, tax and business-consulting firm in Philadelphia. He has more than 30 years’ combined experience in public accounting and consulting as well as service at the CFO and COO levels in private and public companies. He specializes in business valuations, insolvency and reorganization, and litigation support including commercial and matrimonial litigation. He can be reached at danderson@citrincooperman.com or 215-545-4800.

Coming Clean With the IRS on Client Foreign Assets

By B.J. Hoffman
Special to the Legal

After collecting more than $4.4 billion from approximately 15,000 U.S. taxpayers who sought to “come clean” and report income from foreign bank accounts, the Internal Revenue Service has opted to open, for a third time, the voluntary compliance program, albeit with a higher penalty rate than in the past.

The reopening of the Offshore Voluntary Disclosure Program (OVDP) helps people with unreported offshore accounts to get current with their U.S. taxes. The IRS reopened the program in response to the continued interest from taxpayers and tax practitioners, following the success of the 2011 and 2009 programs.

The IRS continues to work on a range of international tax matters with the Justice Department to ferret out and prosecute U.S. tax evaders. Efforts include attacks on improper international tax shelters, along with an overall effort to compel foreign financial institutions to disclose the identities of American account owners.

The new OVDP program requires individuals to pay a maximum penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or the value of foreign assets, during the eight full tax years prior to the disclosure.

When filing for OVDP, participants must submit all original and amended tax returns and include payment for back-taxes and interest for up to eight years, as well as pay accuracy-related penalties of 20 percent of the tax on the previously unreported foreign income. Participants face a 27.5 percent penalty, but some taxpayers can qualify for either a 12.5 percent or 5 percent penalty. People whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the new OVDP will qualify for a lower rate of 12.5 percent. Under certain circumstances, as in a U.S. citizen residing outside of the U.S. who has included the income on their foreign tax returns, the penalty is 5 percent. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt out of the OVDP. In this instance, the taxpayer will no doubt be audited by the IRS and face the potential of higher penalties.

Over the past few months, it has been reported that several Swiss Banks (in addition to UBS, which cooperated under the first disclosure program) have turned over to the IRS bank records pertaining to U.S. persons. In those situations where the U.S. taxpayers did not participate in the first two OVDPs, the IRS is initiating audits, which could lead to severe civil and or criminal penalties.

This OVDP offers those who have not yet come forward an opportunity to come into tax compliance without fear of criminal prosecution, and with a clear understanding of the penalties to be imposed.

Although “coming clean” can be painful in terms of paying significant delinquent income tax, penalties and interest, the ability for a taxpayer to set aside potential criminal exposure is usually incentive enough to seriously consider joining the program. Another benefit to participants may be the ability to repatriate foreign assets without fear of leaving the problem to their heirs, especially when taxpayers consider how to effectively pass such wealth on to their estates. When initially “sheltering” assets abroad, taxpayers likely never considered the future impact on their children in terms of potential tax or criminal exposure, and the general administrative difficulties that relate to the future inheritance of a legal “time bomb.”

B.J. Hoffman is a certified public accountant and certified fraud examiner for Citrin Cooperman, an accounting, tax and business consulting firm. He is a partner in the Philadelphia office. Hoffman provides clients with a mix of audit, tax and litigation support services. He often works with closely held entities in a variety of industries including professional service firms and real estate enterprises. He can be reached at bjhoffman@citrincooperman.com or 215-545-4800.

Business Valuations – Assessment of Risk

By Terry Silver
Special to the Legal

Business valuations that utilize the Income Approach judge, weigh and calculate the risk associated with the business being valued. Financial markets assess risk by the assignment of a rate of return. Low-risk investments such as U.S. Treasury bonds carry low interest rates to reflect the lower risk. Alternatively, high-risk investments reward the investor with higher returns.

In valuing a privately owned company, where public markets do not assess the risk, the assessment is determined by the valuation analyst. This assessment is one of the most significant and subjective aspects of business valuation.

The analyst must develop the discount rate, which can be thought of as a “cost of capital,” or the expected rate of return that the market requires to attract funds to a particular investment. This rate of return reflects both the time value of money and risk. The key question in the development of this discount rate is: What is an appropriate rate of return to expect if the future cash flows were purchased?

The market value of invested capital (MVIC) of a company is the total value of the company to all invested capital, not just equity stakeholders, but also debt holders. The MVIC includes the market value of all outstanding classes of stock, including long-term, interest-bearing debt. This is useful because it allows comparisons with other companies with varying capital structures.

When using the Income Approach to determine the MVIC, it is critical that the discount rate is relevant and appropriate to the economic income being discounted. In particular, the weighted average cost of capital (WACC) should be utilized when one is discounting cash flows to all capital providers. The result of this calculation gives rise to the MVIC. Said differently, it is the value of the entire investment to all stakeholders, both equity and long-term debt holders. Once the MVIC is determined, one would subtract the interest-bearing debt to arrive at the value of the company’s equity.

To determine the WACC, one needs to determine the company’s cost of equity and debt. Many analysts utilize either the Morningstar-Ibbotson Association Yearbook or the Duff & Phelps Risk Premium Report, and sometimes both. In our business valuations at Citrin Cooperman, we utilize both sources of data to assess risk. We seek to quantify market return, small stock risk and specific company risk (inclusive of macro-environmental and industry risk), using a build-up approach to arrive at the cost of equity. We then compare this result to a blending of historical equity risk indicators over a multi-year period from various business portfolios. If the multiple data sources yield comparable results, there is a higher degree of confidence in our research.

The cost of equity is converted into the WACC by weighting with the tax-impacted debt interest rate via an iterative process. The development of WACC is critical to the valuation conclusion. Care, knowledge and credible research all contribute to the WACC calculation, determined with specific company, industry and economic knowledge and information.

Terry Silver is a certified public accountant, certified valuation analyst and certified in financial forensics for Citrin Cooperman, an accounting, tax and business consulting firm in Philadelphia, where he is a partner with more than 33 years of experience as an accountant and auditor. He focuses his practice on business valuation and financial forensic services, expert testimony and matrimonial actions. He can be reached at tsilver@citrincooperman.com or 215-545-4800.

Valuation Issues in Shareholder and Partnership Agreements

By David A. Anderson
Special to the Legal

Several years ago, four recent college graduates joined together and formed a small software company. Over the course of a few years, the company thrived and grew, eventually attracting the attention of a certain software giant. The software giant offered the four entrepreneurs $100 million for their company. One of the four was eager to sell, but his fellow shareholders were not. Eventually, the deal fell through. Following this, the eager-to-sell shareholder became dissatisfied with his fellow shareholders and, shortly thereafter, quit his job. In accordance with the shareholder’s agreement, he demanded payment for his 25 percent ownership in the company. What he received was a check for $375,000 instead of the $25 million he expected. As a result, costly litigation ensued.

What happened? Why didn’t he receive the $25 million check that he anticipated? The answer lies in the shareholder’s agreement. When the four founders signed their shareholder’s agreement, it contained a standard buy/sell clause. The clause stated that the company would redeem the shares of the departing shareholder for his proportionate share of the book value of the company, without any valuation discounts. (Book value is defined as the difference between the recorded value of assets in the general ledger of a company and the recorded value of liabilities.) It also stated that the company’s accountant would prepare an annual statement of value for the company based upon book value. Each shareholder would sign the statement of value, confirming his or her acceptance of this determined value of the company. Therein lies the problem for our disappointed shareholder – the statement he signed four months earlier acknowledged a company book value of $1.5 million, therefore his proportionate share of book value was only $375,000.

Attorneys preparing shareholder and partnership agreements should be aware of this and other potential problems regarding provisions for valuation of shares or partnership interests. Book value is generally not a good measure of value because most assets are recorded on the books at their historical cost. In the example above, the value of the developed software was recorded on the books, based upon the cost to develop it. However, the market value of the software became significantly higher than the development cost. This is why many agreements contain buy/sell clauses using the fair market value of the company, as determined by an experienced and competent valuation expert as the basis (and perhaps containing discounts to account for the lack of control or lack of marketability of the ownership interest).

Suppose that our example software company had such a clause. Would our shareholder get $25 million or an appropriately discounted amount? That might depend on the ability of the company to pay. In this case, the company might not have been able to raise the buyout amount. This predicament points to the critical need for the agreement to address how a buyout can be facilitated without putting the company at risk.

Careful consideration of valuation issues when preparing shareholder and partnership agreements will help protect the entity and signing parties and help avoid costly litigation.

David A. Anderson is a director in the valuation and forensic services group of Citrin Cooperman, an accounting, tax and business-consulting firm in Philadelphia. He has more than 30 years’ combined experience in public accounting and consulting as well as service at the CFO and COO levels in private and public companies. He specializes in business valuations, insolvency and reorganization, and litigation support including commercial and matrimonial litigation. He can be reached at danderson@citrincooperman.com or 215-545-4800.

Written Expert Reports - Retaining Counsel Assistance and Proofreading

By Joseph S. Barbagallo
Special to the Legal

In my previous post, Legal Proceedings and Written Expert Reports, I discussed the considerations that legal professionals should keep in mind regarding written expert reports. This post is an extension of that article but focuses on the potential disadvantage of the expert significantly relying upon counsel's assistance in the editing and proofreading of his/her report.

Attorneys are "word smiths," and as such, it is common for counsel to offer "stylistic changes" to the expert's report. Of course, the more assistance counsel provides, the more vulnerable the expert report will be on cross-examination.

All things being equal, a well-written expert report that is free of grammatical mistakes is more compelling than a sloppy, error-laden alternative. Recognizing this fact, counsel might be tempted to offer typographical or grammatical suggestions. Quite frankly, if these suggestions are minor, then the ramifications carry very little risk or exposure to the expert.

However, wholesale or substantive changes to the expert's report might render a perceived impairment of the expert's credibility and independence. To reduce the chance of that perception, attorneys should refrain from revising the expert's opinion or report in any significant way. 

I am aware of some recent changes in the federal rules of evidence that reduce the discoverability of an expert's draft report(s) by opposing counsel. Notwithstanding, opposing counsel is still permitted to request details as to what information was provided to his/her expert by the attorney. Legal professionals and experts should be mindful that wholesale changes offered by an attorney to his/her expert may become the fodder of vigorous cross-examination and detract from an expert's otherwise favorable opinion and professional stature.

Advice given to counsel for deposing an expert witness might include the following:

- Determine whether the expert was asked to prepare a report or written documents;
- If a report was prepared, inquire as to the nature of the information provided by counsel;  
- Inquire as to the instructions or information given to the expert;
- Determine if opposing counsel participated in the preparation or editing of the report; and
- Consider questioning the expert about any differences in the contents of various reports, the answers to any expert interrogatories and testimony at deposition. However, part or all of this inquiry may be postponed until cross-examination at trial.

Since each mistake in a report lessens the expert's credibility, reports need to be carefully proofread for mistakes. Opposing counsel, upon finding a mistake, will argue that if there is one mistake there may be others, and the entire report is suspect. Corrections need to be made for substantive mistakes, as well as for incorrect grammar, typographical errors and misspelled words. But those corrections are properly the province of the expert and not the attorney.

In today's computer-driven world, spelling mistakes should never occur. But they do happen. Computer editing suggestions can and do take words out of context, and the spell check and grammar programs cannot always differentiate between homophones and heterographs. 

Since it can be difficult for an expert to proofread his own work, the expert and at least one other person should read it several times. Any spelling or grammatical error can make the expert look sloppy and needlessly damage his/her credibility. Imagine the expert being questioned on cross-examination as to whether he was careful and diligent in his investigation, formation of an opinion and preparation of his report.

The obvious answer from the expert would be yes. The next questions could be, "Were you rushed in the preparation of your report?" or "Did you carefully review your report for errors before it was submitted?" After the spelling or grammatical error is pointed out and the expert is forced to admit the mistake in the report that was carefully reviewed, the next question most likely would be, "Are there any other mistakes in your report?"

In any case involving the use of an expert, it is critical for the expert and counsel to have a clear understanding and communication from the initial "expert conference" until the end of the case. Once it is determined that a written report will be prepared, communication must continue between the expert and counsel concerning format, assumptions, content, language and opinions offered by the expert. From there, it is incumbent on the expert, not the attorney, to draft a clear and well-written report.

Joseph S. Barbagallo is a partner with Citrin Cooperman, an accounting, tax and business-consulting firm in Philadelphia. With more than 35 years of experience, he focuses his practice on business valuation and financial forensic services, expert testimony and litigation consulting services in fraud cases. He can be reached at jbarbagallo@citrincooperman.com or 215-545-4800.

Fresh Ink: Inside Today's Legal (and PLW!)

By Jaime Bochet
Of the Legal Staff

Welcome to your daily round-up of stories in today's edition of The Legal Intelligencer. Click the links below to access stories directly, or head to The Legal homepage.  (Some stories may require registration or a paid subscription.)

As is the case every Tuesday, today's paper is especially full, because it includes our Pennsylvania Law Weekly section, which includes analysis pieces, our Verdicts & Settlements section, and contributed columns by Samuel Stretton (Ethics), Robert M. Bovarnick (Politics), Jim Malone (Taxation) and Cliff Rieders (Civil Practice).

But let's begin with The Legal.

Topping today's front page, U.S. Courthouse Correspondent Shannon P. Duffy has an analysis of last week’s decision from the 3rd U.S. Circuit Court of Appeals that ordered a new sentencing for former state Sen. Vincent J. Fumo. The decision is sure to be mined by prosecutors and defense lawyers for the guidance it provides on how to conduct sentencings in complicated white-collar crime cases.

Below the fold, senior staff reporter Gina Passarella has the fourth in her weekly series examining the impact of e-discovery on the practice and business of law. This week, she writes that the list of judges who are at the forefront of e-discovery case law roll off the tongues of e-discovery lawyers like Con-law professors can spout the intricacies of the Bill of Rights. To read all the previous parts in this series, as well as related content, click here.

Inside, in our Page 3 Regional News section, Gina adds yet another chapter in the Wolf Block saga. The defunct law firm has filed an appeal with the state's Superior Court related to a discovery dispute in the legal malpractice case filed against the firm by car dealership owner Alan Potamkin.

As always, our People in the News section is on Page 2, along with a Letter to the Editor today from Astor Weiss attorney Jerrold Moss regarding one of Sam Stretton's recent Ethics columns. The top stories from our sister publications across the country make up the Page 4 National News section.

The Legal's contributed columns today include an "Asset Management" column by David B. Bruckman of Citrin Cooperman Wealth Management, who wonders if purchasing life insurance on adult children is prudent.

Our second contributed article is a Commentary by Richard Q. Hark of Hark & Hark, who writes that amendments to Pennsylvania's law change the self-defense landscape.

Today's Pennsylvania Law Weekly section begins with an analysis piece by reporter Ben Present, who writes that after hearing that Lackawanna County Common Pleas Court Judge Terrence R. Nealon sent a private e-mail in 2004 advising his fellow Democrats how to oppose a county voting redistricting plan -- a case over which he was presiding — "shocked" courtwatchers statewide reacted to a practice they said was "a thing of the past" -- ex parte communications.

Also on the PLW front page, we have another analysis piece by reporter Zack Needles. Now that former Luzerne County Common Pleas Court Judge Mark A. Ciavarella is serving a nearly three-decade term in federal prison for his part in the county's judicial scandal, all eyes have turned to his alleged co-conspirator and fellow former Luzerne County Judge Michael T. Conahan, whose sentencing hearing is set for Sept. 23. 

The PLW has much more, so head to the main website of that section to check out even more.

Have questions or comments about any of today's stories, or our coverage as a whole? E-mail me or any of the reporters directly. We hope you'll enjoy today's Legal and PLW!

Jaime Bochet is the Magazines & Supplements Editor for The Legal. Follow her on Twitter at @JaimeBochetTLI or e-mail JBochet@alm.com.

Legal Proceedings and Written Expert Reports

By Joseph Barbagallo
Special to the Legal

Counsel should, early on in a case, determine whether its retained expert should prepare a written report. It is extremely important that the expert coordinates with counsel and does not prepare any unrequested reports.

There are many reasons why counsel may want an expert to prepare a written report. Some of the reasons include the following:

- It may be required by the court (for example, in federal court under Federal Rule of Procedure 26(a)(2)(B);
- Those that are introduced into evidence and marked as exhibits may be taken into the jury room for review and deliberation by jurors;
- It may assist in settlement negotiations, in some arbitration proceedings or during bench trials; or
- It may be needed to support or oppose a motion for summary judgment.

Before the preparation of a written report, an attorney-expert conference should be arranged, either by telephone or, preferably, face to face. The purpose of this early conference is to determine whether a written report is appropriate, and if so, the type of report, the issues that counsel wants the expert to address, any factual statements that the expert may rely upon and the opinions that the expert will likely offer. Assuming that there is a "meeting of the minds," then the expert should be able to commence his or her work.

It is critical that experts not opine in areas that are beyond their true expertise. Experts who do this will open themselves to a difficult cross-examination and/or even worse a Daubert Challenge.

Experts should avoid using legal terms or expressing legal opinions in their reports, and at all times they should only express themselves in language that they completely understand.

Any factual assumptions relied upon by the expert should be specifically expressed in a detailed and unambiguous manner. Factual assumptions should be based on reliable, verifiable information and should cite the source of the information used.

Obviously, an expert's purpose in a case is to express an opinion, and a written report may be used to communicate that opinion. The expert's opinion, therefore, needs to be effective, defensible and stated in a clear, confident and explicit manner.

The use of hedge words such as "I feel," "I believe" or "it would seem" should be avoided. A more effective way to express an expert opinion would be to state that the opinion is "based upon a reasonable degree of professional certainty." It is also a good idea for the expert to avoid the use of absolute words such as "always" and "never."

In my next post, I will further discuss retention issues, proofreading for mistakes and other considerations related to providing a written expert report.

Joseph S. Barbagallo is a partner with Citrin Cooperman, an accounting, tax and business-consulting firm in Philadelphia. With more than 35 years of experience, he focuses his practice on business valuation and financial forensic services, expert testimony and litigation consulting services in fraud cases. He can be reached at jbarbagallo@citrincooperman.com or 215-545-4800.

Warning Signs of a Bad Expert Witness

By Terry Silver
Special to the Legal

In my Nov. 30 blog entry titled "What to Look for in an Expert Witness," I discussed the preferred traits of a successful expert witness, including qualifications, credentials, experience, preparation, use of team approach, having communication skills sufficient to be understood by a judge and jury, and lastly, having a likable enough personality. The above qualifications should also be sought in an expert witness, because when an expert witness does not possess most of them, difficulty in litigation often ensues.

There are some warning signs I would like to highlight to identify a bad expert witness. (In these examples, all the facts are for illustrative purposes only, and any similarity to a particular fact pattern is only by coincidence.)

At the outset, an inaccurate expert report was submitted; specifically, the business valuation conclusion did not adhere to the valuation premises set forth in the report. This resulted in the need to supply an amended valuation report just prior to the date of trial. This in turn resulted in significant erosion in this "expert's" credibility.

Additionally, the expert report contained a scope limitation described as a deemed inadequacy of fee payments to the "expert." The "expert" did not provide any detail regarding the impact that the supposed scope limitation had on the expert report. Consequently, the report conclusions could be deemed questionable, if not completely incredible, due to this unresolved scope limitation.  

During the course of pre-trial activity, this "expert" was not amenable to scheduling changes, and requested exhaustive and unnecessary discovery requests that prolonged the discovery process, adding unnecessary time and fees. In the course of pre-trial negotiations, the "expert" was often combative toward opposing counsel and myself and openly advocated for their client. 

The impact that this unqualified "expert" had on this case was significant.

This "expert" is an anomaly inasmuch as his/her skills and abilities are far below typical. The purpose of my past entry  was to present criteria that counsel should seek in their expert; this entry presents an example of what can occur when the wrong expert is selected. In this highly financially oriented case, the business valuator is a crucial team member and determinative of the level of success or failure. Qualification and experience are essential, but the expert's ability to work within a team are the traits that should be most sought after by counsel.

Terry Silver is a Certified Public Accountant, Certified Valuation Analyst and Certified in Financial Forensics, for Citrin Cooperman, an accounting, tax and business consulting firm in Philadelphia, where he is a partner with more than 33 years of experience as an accountant and auditor. He focuses his practice on business valuation and financial forensic services, expert testimony and matrimonial actions. He can be reached at tsilver@citrincooperman.com or (215) 545-4800.