In recent securities litigation cases, we have prepared damage models using multiple measures each time. These cases involved investors or fiduciaries alleging lost value due to suspected fraud, negligent misrepresentation and/or breaches of fiduciary duties. Based upon the applicable measures of relief in each case, we have calculated the following four damage models: out-of-pocket losses, benefit-of-the-bargain losses, reliance losses and a damage model applying an interpretation of the provisions of the Texas Securities Act (TSA).

The out-of-pocket measure of losses computes the difference between the value paid by the plaintiff and the value received. This model should place the damaged party back in his/her economic position prior to making the investment, as if the investment were not made. For the out-of-pocket model, there is not a rate of return applied to the losses. Therefore, the timing of payments and receipts is not considered.

The benefit-of-the-bargain measure of losses computes the difference between the value represented to the plaintiff and the value they actually received. This measure of damages should place the damaged party in the economic position a reasonable investor expected to achieve with comparable investments but for the misrepresentation or misconduct relating to the investment. This method calculates the expected return on the original investment from which the actual return is subtracted to calculate the economic loss. Much of the work on this particular model involves establishing the reasonably expected return of the investment. To establish this reasonable expectation of the investor, we typically review the representations made at the time of the investment such as offering memoranda, investment agreements, historical performance, etc. This allows us to understand the investment and identify comparable investments. Then, we research the performance of comparable investments during the relevant period to develop the expected return, which is compared to the actual return of the investment to calculate the economic loss.

The reliance measure of damages calculates a plaintiff’s losses incurred as a result of actions taken or not taken in reliance upon the misrepresentation of another party. This method seeks to return amounts lost after the point the investor relied upon the incorrect information provided by a party to the investor. A causal link must be established; but for the misrepresentation, the investor would have taken action differently. This alternative investor action could take different forms such as taking an action, not taking an action or a combination thereof. Another critical element of the reliance model is establishing the timing of those actions within the bounds of the agreements in place and/or the legal system. We note the increasing use of former judges as expert witnesses in this area. Once the alternative investor action is identified, its economic effect must be determined. This is a painstaking analysis to identify how the alternative investor action, such as replacing the CEO, would have changed the cash flows of the business. It requires analysis of applicable revenue and expense accounts to identify how each account would have changed. Moreover, the effects of other factors, such as market changes that would have affected the business regardless of management changes, must be identified and excluded to isolate the losses attributable to the defendants.

Under the TSA, we have been instructed that the proper interpretation allows the investor to recover the consideration he paid for the security plus interest thereon at the legal rate from the date of payment by the investor. This calculated amount is reduced by the greater of: (a) the value of the security at the time the investor disposed of it plus the amount of any income that he received on the security; or (b) the actual consideration received for the security at the time the investor disposed of it plus the amount of any income he received on the security. We have also been instructed that there is case law supporting a legal rate of return of six percent for TSA damage models.

If you have any questions regarding these damage models or would like to inquire about the calculation of one or more of these models for your client, please contact Jeff Compton or Jesse Daves at 713-659-5080.

In the case of Volkswagen of America, Inc. vs. Andrew Ramirez, Sr. Et. Al. (No. 02-0557, 12-31-2004), the Texas Supreme Court delivered an opinion on December 31, 2004 excluding the testimony of an expert witness due to lack of testing or independent studies supporting the expert’s theory. The opinion concluded that expert testimony is unreliable if the expert fails to make a connection between the data relied upon and the opinion offered. In this case, it was the explanation of how a broken wheel remained with the car throughout a loss of control and collision. The following factors were cited from a previous case, are to be considered in determining whether an expert’s testimony is reliable and admissible:

Although the expert in the Volkswagen case conducted certain tests, he failed to explain how the tests supported his scientific theory.

In commercial litigation, the expert’s opinion must be based on facts supported by the business records of the companies involved and/or industry and market sources. The financial expert’s testimony should be the result of the application of special skills in auditing, finance, quantitative methods, research and investigation and should be well documented and tested. If assumptions are used, the expert should provide an adequate foundation for the assumptions, including citing relevant accounting, auditing or other independent sources.

§ 18.091. PROOF OF CERTAIN LOSSES; JURY INSTRUCTION. (a) Notwithstanding any other law, if any claimant seeks recovery for loss of earnings, loss of earning capacity, loss of contributions of a pecuniary value, or loss of inheritance, evidence to prove the loss must be presented in the form of a net loss after reduction for income tax payments or unpaid tax liability pursuant to any federal income tax law. (b) If any claimant seeks recovery for loss of earnings, loss of earning capacity, loss of contributions of a pecuniary value, or loss of inheritance, the court shall instruct the jury as to whether any recovery for compensatory damages sought by the claimant is subject to federal or state income taxes. Added by Acts 2003, 78th Leg., ch. 204, § 13.09, eff. Sept. 1, 2003. Texas Civil Practice and Remedies Code.

Section 104 of the Internal Revenue Code excludes from taxation awards arising generally from personal injury, but not from punitive damages. While the concept that awards not taxed for income tax purposes should be reduced by income taxes to avoid an excess recovery, the services of a CPA are valuable to identify taxable versus non-taxable awards and explain to the jury how much tax should be removed.

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