Forensic accounting services can play a pivotal role in cases involving financial fraud, breach of contract, hidden assets, lost profits and economic damages. As demand for these services continue to increase, the American Institute of CPAs (AICPA) has proposed a new professional standard for CPAs who perform forensic services. The exposure draft aims to “protect the public interest” and improve the delivery of forensic services, which legal counsel should rely on when evaluating a practitioner’s credentials.
The AICPA’s Statement on Standards for Forensic Services No. 1 (SSFS No. 1) applies specifically to services forensic accountants provide as part of either investigative or litigation engagements. The exposure draft defines investigative engagements as those in which forensic accountants apply their skills to collect, analyze, evaluate or interpret evidential matter in response to concerns about a wrongdoing. Litigation engagements are defined as those that involves actual or potential legal or regulatory proceeding before a trier-of-fact, regulatory body or alternative dispute resolution forum for which a forensic accountant may serve as an expert, consultant, neutral, mediator or arbitrator.
Any services a forensic accountant provides that is beyond the scope of an actual investigation or litigation engagement would not be bound by the SSFS No. 1. As an example, the new standard would not apply to a forensic accountant who is retained to collect data for a matter that is neither a litigation nor an investigation engagement.
In addition to requiring that forensic accountants retained for investigation and litigation engagements exercise professional competence, due care, honesty and objectivity, the proposed standard also references the need for forensic accountants to obtain “sufficient and relevant data to afford a reasonable basis for conclusions and recommendations.” While SSFS No. 1 allows forensic professionals to provide expert opinions relating to their objective evaluation of evidence and whether or not such evidence is consistent with certain elements of fraud, it prohibits forensic accountants from providing opinions as to the ultimate conclusion of fraud or legal determinations. That responsibility is reserved solely for judges or other triers-of-facts.
Finally, the standard prohibits forensic professionals and their firms from performing certain services on a contingent fee basis or entering into engagements in which there is a conflict of interest that may impair the forensic accountant’s judgement and objectivity. Attorneys who engage forensic accountants should stay up-to-date on any additional changes to the exposure draft and the additional final adoption of SSFS 1, which is scheduled to go into effect on May 1, 2019.
About the Author: Richard A. Pollack, CPA/ABV/CFF, ASA, CBA, CFE, CAMS, CIRA, CVA, is director-in-charge of the Forensic and Litigation Support practice with Berkowitz Pollack Brant, where he has served as a litigation consultant, expert witness, court-appointed expert, forensic accountant and forensic investigator on a number of high-profile cases. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
In a crucial 4-3 decision, the Florida Supreme Court in Delisle v. Crane, Case (No. SC16-2182) (Oct 15. 2018), clarified the law governing the admissibility of expert witness testimony in Florida, moving away from the strict Daubert standard used in federal courts to the less rigorous Frye standard. Previously, Florida trial courts that were unsure of which standard to apply when analyzing expert testimony and corresponding pretrial motions typically utilized the Daubert standards enumerated under Federal Rule of Evidence 702.
In 2013, the Florida Legislature passed a law modifying Florida Statute Section 90.702 to adopt the Daubert standard, despite the Florida Supreme Court’s repeated affirmations of Frye. The recent decision in Delisle held that the Legislature overstepped its authority when it adopted Daubert and enacted the 2013 legislation because the manner in which trials and litigation are to be conducted are “procedural” matters, which are entirely within the province of the Florida Supreme Court under Article V, Section 2(a) of the Florida Constitution. The new ruling invalidates Florida Statute Section 90.702 and rejects the Daubert standard for admitting expert testimony in Florida courts.
What are Frye and Daubert?
The Frye and Daubert tests are competing tests that courtroom judges use, prior to trial, to examine the reliability and admissibility of expert testimony that a party seeks to introduce into evidence once the trial begins. The assessment usually follows a request (or Motion) by one of the parties in the legal proceeding. However, that is where the similarities between these two competing standards for assessing the admissibility of expert testimony end.
First, Frye does not apply to all expert testimony. Rather, it applies narrowly to testimony that a judge determines to be “new or novel scientific evidence” that is not firmly well-established in the scientific community. Only after a Court makes such a determination will it then consider the substance of the admissibility of expert testimony.
The initial assessment required under Frye includes a determination that the expert testimony seeking to be admitted is generally accepted in the field. According to Frye, “in order to introduce expert testimony deduced from a scientific principle or discovery, the principle or discovery ‘must be sufficiently established to have gained general acceptance in the particular field in which it belongs.’” Thus under Frye, the experts’ methods and techniques must be “generally accepted” in the scientific community. In practice, it means a judge should evaluate evidence whether a testifying expert forms their opinion from generally accepted principles. This might require a judge to review the expert testimony, scientific and legal publications, and judicial opinions to assess general acceptance of the principles underlying an expert’s opinion.
In comparison, Daubert applies to ALL expert opinions, not just those opinions determined to be new or scientifically novel. Under Daubert, the initial assessment performed by the Court includes an evaluation of the expert’s methods and requires the expert testimony to be not only generally accepted (Frye) but also, “scientifically reliable” and relevant to assist the trier of fact in determining pertinent issues in the case at hand. The Court makes these determinations after a Daubert motion is made and a hearing is conducted. Court hearings to assess the admissibility expert testimony under the Daubert test are often lengthy, technical, and costly; more costly, on average, than hearings under the Frye test. The hearings performed under Daubert to determine admissibility are sometimes referred to as “mini trials,” in which a judge might hear evidence and arguments and before ruling that all or some portion of an expert’s opinions are admissible or inadmissible. These mini trials, also known as Daubert hearings, address many of the substantive issues that are expected to be litigated at trial.
The Florida Supreme Court in Delisle summarized these two competing tests as follows:
“Frye relies on the scientific community to determine reliability, whereas Daubert relies on the scientific savvy of trial judges to determine the significance of the methodology used.” Moreover, Daubert covers more subject areas and involves a multi-factorial analysis to determine admissibility. In contrast, Frye is simply general acceptance inquiry.
The Delisle Opinion and Its Effect on Forensic Accounting Expert Witnesses
Delisle will have a profound impact on litigation in Florida. It ensures that the Frye standard will remain in Florida courts, and, in turn, make it more difficult to strike or exclude expert testimony. This, according to most scholars, is because Daubert involves a much more vigorous threshold for admitting scientific evidence. Without the Daubert requirements of an evidentiary hearing or the scientific reliability and relevancy of expert testimony, there likely will be less barriers to the introduction of expert opinions.
By reverting to the Frye standard, Florida courts will likely raise fewer challenges to litigation involving testimony from forensic accountants and valuation analysts. This is not only because Frye applies only to expert opinions relating to new scientific principles (which arguably does not include many areas of forensic accounting), but also because Frye (unlike Daubert) allows experts to provide testimony that relies solely on their experience and training without regard for scientific fact. This exception is so inclusive that Florida state courts infrequently hear challenges to the admissibility of expert testimony.
Testifying experts are now clearly under one evidential standard for admissibility in Florida courts (Frye) and a different one in Federal courts in the US (Daubert). For forensic accounting expert witnesses, this likely means there will be fewer challenges to exclude expert testimony in Florida cases.
About the Author: Richard S. Fechter, JD, CAMS, CFE, is associate director of Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice, where he has extensive experience conducting forensic accounting investigations and providing expert analysis on the economic, finance, and accounting issues pertaining to economic damages and other business matters in complex commercial disputes. He can be reached in the firm’s Miami CPA office at (305) 379-7000 or via email at email@example.com.
Daubert vs. Frye – Key Differences
|Applies to all expert opinions, whether they are consider new or not.
||Applies only to expert opinions considered to relate to a “new or novel” scientific issue.
|State statute and the courts determine admissibility of expert testimony.
|Experts’ opinions must be generally accepted in the scientific community to be admissible in Court.
|Expert’s testimony must be based upon sufficient facts or data.
|No sufficient facts or data requirement
|Expert’s testimony must be the product of reliable principles and methods (i.e., scientifically reliable).
|No reliability requirement
|Expert’s testimony must be relevant to the case at issue.
|No relevancy requirement
|The expert must apply the foregoing principles and methods reliably to the specific facts of the case.
|No reliability requirement
|Determination of whether the principles and methodologies of the offered expert testimony are reliable by considering:
· Whether the expert’s theory or technique can, or has been, tested;
· Whether the theory or technique has been subject to peer review and publication;
· Whether there is a known or potential rate of error of the technique or theory for a particular scientific technique; and
· Whether the theory or technique is generally accepted in the relevant scientific community.
|No review of principles and methodologies used or how those principles and methodologies were applied to facts of case at issue
|Judges act as “gatekeepers” who regulate the admissibility of expert testimony based on relevant factors.
|Admissibility of expert testimony depends on the standards set by the expert’s scientific community.
 Frye v. United States, 293 F. 1013 (D.C. Cir. 1923)
 The Frye standard was originally codified under Florida Statute Section 90.702,
“If scientific, technical, or other specialized knowledge will assist the trier of fact in understanding the evidence or, in determining a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education may testify about it in the form of an opinion; however, the opinion is admissible only if it can be applied to evidence at trial.”
The language from this original statute is expected to be reinstated at the next legislative session.
 See Bundy v. State, 471 So. 2d 9 (Fla. 1985); Hadden v. State, 690 So. 2d 573 (Fla. 1997).
 Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 593-94 (1993).
 See, Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999) (applying Daubert standard to non-scientists).
Entertaining clients, referral sources and employees with tickets to sporting events, country club outings, fishing trips or other forms of business promotion are common business practices. No matter how significant these costs, businesses have had the reassurance that the IRS would permit them to deduct all or a portion of these meals and entertainment (M&E) expenses from their taxable income. This benefit changes in 2018 with the passage of the Tax Cuts and Jobs Act (TCJA), which limits or, in some instances, eliminates the deductibility of M&E expenses and potentially puts businesses at greater risk of falling victim to expense report fraud.
While taxpayers are accustomed to keeping track of the costs they incur for activities that are “ordinary, necessary and directly related to the active conduct of a trade or business or for the production or collection of income,” the language of the new tax law complicates the rules regarding the deductibility of these expenses beginning in 2018. Gone are deductions for entertainment expenses, while certain meals enjoyed outside of entertainment activities may be 50 percent deductible when they meet certain criteria. As a result, businesses and workers that frequently entertain clients or referral sources will likely feel the loss of the tax savings that they once enjoyed. This, in turn, may create an environment in which employees seek out ways to get around the new rules and manipulate their expense reporting.
What is Expense Reimbursement Fraud?
According to the Association of Certified Fraud Examiners’ 2018 Report to the Nations, expense reimbursement fraud is one of the most common types of occupation fraud. While it can be easy to identify, once detected, it often indicates just the tip of the iceberg in a larger scheme that can cost businesses millions of dollars. Therefore, it is critical that businesses understand the following forms of expense report fraud that employees commonly commit, and be vigilant in recognizing early warning signs:
- Mischaracterizing expenses by falsely claiming purchases for personal use are business expenses;
- Creating fictitious expenses by producing bogus receipts for expenses that they never incurred;
- Padding expense reports by overstating or inflating legitimate expenses;
- Remitting the same receipt more than once in an effort to yield multiple reimbursements for one expense.
Importantly, businesses must recognize that even a minor embellishment, such as rounding up the costs of a business lunch, can quickly turn into a more elaborate scheme that can go unnoticed for years. To avoid falling victim to fraudulent schemes and exposing themselves to millions in losses, businesses should have in place appropriate controls to prevent deceptive business practices and/or to monitor and detect misuse and abuse.
Preventing Expenses Report Fraud
While the TCJA represents some of the most significant changes to the U.S. Tax Code, its rapid enactment into law leaves taxpayers with numerous uncertainties in how they should interpret many of its provisions. However, there are certain steps that businesses can and should take to reduce their exposure to fraud and the economic and reputational losses that they will incur because of these schemes.
- Establish and educate employees about changes to written corporate expense policies, for which non-deductible entertainment expenses should be separate from potentially deductible meal expenses;
- Assess membership and other fees associated with professional trade organizations (deductible), entertainment venues (nondeductible) and event sponsorships (for which the fair market value of the sponsorship may be deductible);
- Require employees to submit original receipts that describe the expense, the names of the attendees/participants, the business purpose of meetings/meals, and the topics of business discussed;
- Require employees to attach to receipts additional proof that an expense is work-related (i.e. conference brochure) and not a form of entertainment;
- Establish a policy that requires supervisors/managers, payroll or HR personnel to review/approve every one of workers’ expense reports prior to reimbursements;
- Compare workers’ expenses to their work schedules, prior month and prior year expenses;
- Avoid reimbursing workers in cash;
- Consider using the IRS-recommended per diem rates for meals and mileage;
- Consider the use of corporate credit cards to track employee’s expense activities and compare them to expense reports;
- Verify mileage claims and require employees to detail claims of miles traveled by including exact addresses of locations;
- Conduct spot audits to detect anomalies or flag unverified expenses; and
- Strictly enforce expense-reporting policies, investigate suspicious claims and establish a formal system for managing the process and prosecuting fraudsters.
Businesses should not overlook the potential impact expense reimbursement fraud can have on their operations, their corporate reputation and their net income.
About the Author: Richard A. Pollack, CPA/ABV/CFF/PFS, ASA, CBA, CFE, CAMS, CIRA, CVA, is director-in-charge of the Forensic and Litigation Support practice with Berkowitz Pollack Brant, where he has served as a litigation consultant, expert witness, court-appointed expert, forensic accountant and forensic investigator on a number of high-profile cases. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Attorneys involved in economic damages cases understand that they have an obligation to prove lost profits with “reasonable certainty” based on their use of “best evidence.” However, the courts have not agreed on one universally accepted standard or criteria for what specifically constitutes best evidence; such decisions inevitably rely on the facts and circumstances of each individual case. Therefore, two courts faced with similar issues may reach entirely different opinions when deciding whether a plaintiff has supported its damage claim using the best evidence.
In Eastern Fireproofing Co. v. United States Gypsum Co., No. 57-938-G (US District Court Mass., 1970), the court stated:
“a plaintiff may not conjure up favorable estimations and hold back more solid but less favorable evidence otherwise available. And the admissibility of a particular class of evidence will depend to a degree upon the availability of less speculative evidence. On the other hand, there is no rule of law that only the best available evidence may be used. This would necessarily imply a determination of what class of evidence is best and it seems that such a determination cannot be made without infringing on the proper function of the jury as the finder of fact.”
With this in mind, attorneys have an opportunity to strengthen damages cases when they focus on reliable facts and sound methodology that other experts have attempted to use to meet or fail to meet the reasonable certainty standard. Following are just some of the factors that attorneys should consider when proving or disproving economic damages.
Use of Plaintiffs / Defendants Historical Financial Data
Supporting claims for economic damages in a commercial dispute typical starts with an historical review of a plaintiff and/or defendant’s financial data that preceded the alleged bad act of the other party. This assessment can include historical revenue, costs and profits/losses in the years leading up to a point in time and compare it to the same facts that occurred during and after the alleged damages period. Yet, experts should also consider whether or not there are factors other than the defendant’s alleged bad acts that could have caused a change in the injured party’s financial results. This may include changes in the economy, competition, technology, governmental regulation, the introduction of alternative products, etc.
Use of Contemporaneous Third-Party Market Data
The availability of contemporaneous, third-party market data can potentially help a plaintiff’s expert establish claims for damages. Conversely, defendants’ experts have been successful using contradictory data to demonstrate flaws in the plaintiffs’ analyses. Therefore, expert witnesses should tread carefully and consider the credibility and relevance of the data they use as a foundation for their testimony and make efforts to consider how other information could potentially lead to different conclusions. Moreover, they should be prepared to explain how they weighed alternative sources of data and the reasons why one set of data was preferable or more reliable than an other.
Use of Plaintiffs Other Businesses
When a plaintiff’s business does not have a sufficient track record to establish evidence of profitable operations, its historical financial data may not be an appropriate basis for estimating future profitability. Under these circumstances, some courts have accepted the historical data of a plaintiff’s other businesses as a benchmark or yardstick to establish economic damages.
However, the plaintiff ultimately bears the responsibility to demonstrate sufficient comparability between the subject business and the other benchmark businesses and make adjustments to account for differences to the extent applicable.
Reliance on Specific Customer Sales Data
Ideally, the identification of specific lost sales caused by the defendant’s bad acts helps to substantiate a claim for lost profits and can be very persuasive to a jury. With this in mind, it is generally a useful exercise to review historical sales patterns, analyze communications with customers and attempt to demonstrate sales that a plaintiff would have made but for the defendant’s actions. From a practical standpoint, however, it is rare that the plaintiff can identify the name of the customer, along with the date, amount of the would-be sale and the reasons for the loss. When it is not possible to identify these specific lost sales, some plaintiffs have been able to overcome this lack of direct information by analyzing changes in customer behavior and sales patterns, and demonstrating their connection to the specific allegations.
Use of Contemporaneous Pre-Litigation Projections and Transactions
The court’s decision in Reese Schonfeld vs. Russ Hilliard, Les Hilliard and International News Network, Inc., 218 F.3d 164; 2000 U.S. App. LEXIS 15684 is frequently cited in economic damages cases to demonstrate that a plaintiff’s contemporaneous, arm’s-length transactions involving investments in or the sale of ownership interests in the subject company may provide more reliable evidence of damages than lost profit calculations, especially when the lack of a track record would require the development of potentially “speculative assumptions.”
Similarly, the courts have often found that financial projections prepared by one or both parties prior to any litigation to be more persuasive than those prepared solely for, or in response to, litigation.
With this in mind, attorneys should be prepared to share with their experts their clients’ accounting and operational data, budgets, financial forecasts and projections, pre-trial business and marketing plans, sales and pricing agreements, memorandums of understanding and other transactional contracts, all of which may be useful to identify and substantiate assumptions used to quantify damages.
Use of Multiple Regression Analysis / Statistical Analyses
Multiple regression analysis, sampling methodologies and other statistical analyses have become increasingly common and accepted methods used to establish reasonable certainty in damages calculations. However, the effectiveness of such statistical approaches are dependent on an expert’s understanding of how to conduct them properly, based on verifiable facts, to avoid common errors that could invalidate the results.
Plaintiffs, along with their counsel and retained experts, should work collaboratively to identify the best evidence available to establish with reasonable certainty a defensible claim for economic damages. In determining what constitutes best evidence, it generally is advisable that the parties identify other information that may be contrary to the data they relied upon and that they be prepared to explain how they considered this additional information in the preparation of the damages claim.
About the Author: Scott Bouchner, CMA, CVA, CFE, CIRA, is a director with Berkowitz Pollack Brant’s Forensic Accounting and Business Valuation Services practice, where he serves as a litigation consultant, expert witness, court-appointed expert and forensic investigator on a number of high-profile cases. He can be reached at the CPA firm’s Miami office as (305) 379-7000 or via email at email@example.com.
Berkowitz Pollack Brant directors Richard A. Pollack and Scott Bouchner were invited to join experts in the fields of accounting, economics, finance and law to write a chapter for a recently published guidebook about lost profits, damages and business valuations. Here is an excerpt of their contribution to “Lost Profits Damages: Principles, Methods, and Applications”, which Quickreads and The National Association of Certified Valuators and Analysts (NACVA) calls “a must have for aspiring and experienced lost profits damages experts.”
To order a copy of “Lost Profits Damages: Principles, Methods, and Applications”, visit http://www.valuationproducts.com/lostprofits/.
Mitigation of Damages in Lost Profits Calculations
The concept of mitigation of damages pertains to the legal principle that an injured party cannot recover damages that it could have otherwise avoided with reasonable effort. As discussed in the Restatement (Second) of Contracts,
- Except as stated in Subsection (2), damages are not recoverable for loss that the injured party could have avoided without undue risk, burden or humiliation.
- The injured party is not precluded from recovery by the rule stated in Subsection (1) to the extent that he has made reasonable but unsuccessful efforts to avoid loss.
Like breach of contract actions, this principle of mitigation is similarly applicable in tort cases, as discussed in Restatement (Second) of Torts.
- Except as stated in Subsection (2), one injured by the tort of another is not entitled to recover damages for any harm that he could have avoided by the use of reasonable effort or expenditure after the commission of the tort.
- One is not prevented from recovering damages for a particular harm resulting from a tort if the tortfeasor intended the harm or was aware of it and was recklessly disregardful of it, unless the injured person with knowledge of the danger of the harm intentionally or heedlessly failed to protect his own interests. 
Contrary to common understanding, there is no absolute “duty to mitigate” as an affirmative obligation. While the failure to do so could result in a reduction of the damage award, establishing liability and determining the gross damages award are not dependent upon the plaintiff’s efforts to mitigate. The plaintiff is required to act in good faith and take appropriate actions to overcome the damages purported caused by the defendant.
Also referred to as the avoidable consequences doctrine, mitigation “finds its application in virtually every type of case in which the recovery of a money judgment or award is authorized.”
The implications of mitigation in the computation of lost profits, however, are often overlooked or underappreciated by the damages expert. Plaintiff’s expert may focus upon analyzing plaintiff’s economic profits “but for” the alleged wrongdoing by defendant while substantially accepting plaintiff’s “actual” earnings as recorded for past damages computations or as projected for future damages calculations. Likewise, defendant’s expert may concentrate on rebutting the “but for” projections of plaintiff’s expert while also paying little attention to plaintiff’s recorded or projected post-injury economic profits. In contrast, the concept of mitigation is directed toward an analysis of whether plaintiff’s actual post-injury net economic profits could or should have been greater had plaintiff reasonably mitigated its losses. If so, plaintiff’s lost profits damages will be less when measured as the difference between the “but for” and successful mitigation-adjusted “actual” returns than if the mitigation adjustments were not performed. There may be circumstances, however, where the plaintiff’s efforts to mitigate its damages are unsuccessful, which could result in an increase in damages.
To the extent that the defendant is able to demonstrate that the plaintiff could have avoided or limited its damages by taking reasonable actions, it may be possible to reduce or eliminate the defendant’s obligation to pay for damages suffered by the plaintiff. Conversely, if challenged, the plaintiff should be able to offer evidence as to whether it was possible to mitigate its losses, what the costs of such mitigation efforts would have been relative to the potential benefits, what attempts, if any, were made to avoid losses caused by the defendant, and what were the results of these efforts. While the parties’ damages experts often address these issues, they may be better addressed in some instances directly by or in concert with industry experts and fact witnesses.
About the Authors: Richard A. Pollack, CPA/ABV/CFF/PFS, ASA, CBA, CFE, CAMS, CIRA, CVA, is director-in-charge of Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice. Scott Bouchner, CMA, CVA, CFE, CIRA, is a director with the practice. Both professionals have served as litigation consultants, expert witnesses, court-appointed experts and forensic investigators on a number of high-profile cases. They can be reached at the CPA firm’s Miami office as (305) 379-7000 or via email at firstname.lastname@example.org.
 Restatement (Second) of Contracts § 350. St. Paul, Minn: American Law Institute, (1981)
 Restatement (Second) of Torts § 918. St. Paul, Minn: American Law Institute, (1977); See also National Communications Assoc. v. AT&T, 93 Civ. 3707 (LAP) (New York 2001) (which states that “A plaintiff who fails to take reasonable steps to avoid the alleged loss ‘has broken the chain of causation, and loss resulting to him thereafter is suffered through his own act[; i]t is not damage that has been caused by the wrongful act of the [defendant]”), citing McClelland v. Climax Hosier Mills, 252 N.Y. 347, 359, 169 N.E. 605, 609-10 (New York 1930)
 See Restatement (Second) of Contracts § 350 (1981), which states “It is sometimes said that it is the “duty” of the aggrieved party to mitigate damages, but this is misleading because he incurs no liability for his failure to act. The amount of loss that he could reasonably have avoided by stopping performance, making substitute arrangements or otherwise is simply subtracted from the amount that would otherwise have been recoverable as damages.” Also see In re Std. Jury Instructions-Contract & Bus. Cases, 116 So. 3d 284, (Supreme Court of Florida 2013), which states that “[t]here is no actual ‘duty to mitigate,’ because the injured party is not compelled to undertake any ameliorative efforts.”
 See Sedgwick on Damages, 9th ed., sec.204, p. 390; 15 Am. Jur., sec. 27, p. 420; 25 C.J.S., Damages, sec. 33, p. 499.