In the wake of the recent financial crisis, current securities fraud litigation focuses on whether shareholders can show that a company’s failure to write down impaired assets caused the loss of share value. Under tightening federal standards, the complaint may not survive a motion to dismiss if the plaintiffs fail to enlist a financial expert to help them evaluate and apply certain fair value accounting concepts in the initial allegations. Consider the following excerpts from recent federal cases, available at BVLaw:

• “The valuation of assets and the timing of mark-downs” ordinarily involve questions of business judgment, the court noted in Stratte-McClure v. Morgan Stanley, 2011 WL 1362100 (S.D.N.Y.)(April 4, 2011). “However, where parties maintain high valuations on assets in the face of red flags that the valuations are inaccurate,” valid securities fraud claims may arise.

• “This type of valuation is not an exact science,” the court observed in Fulton Co. Employees’ Retirement System v. MGIC Investment Corp., 2010 WL 5095294 (E. D. Wis.)(Dec. 8, 2010). “Rather, these principles tolerate a range of ‘reasonable’ treatments, leaving the choice among alternatives to management.”

• Accordingly, to survive a motion to dismiss, the complaint must 1) identify the accounting principles that govern the valuation of the assets; and 2) plead facts that give rise to a reasonable belief that the defendants did not properly apply such principles.

• Moreover, should the valuation fall on the “extremely difficult end of the spectrum, due to the limited number of observable transactions involving such assets,” the complaint must provide enough information to enable a court to conclude that a fraudulent statement (or omission) regarding asset value had occurred, the Fulton court held. It is not enough to list the asset values and then simply assert that they were not reported at fair value. Rather, the plaintiff “must take the pleaded facts, run them through the fair-value machinery, and show that one could not reasonably come up with the values that the defendants reported.”

Are you ready to educate courts, clients? Join Mark Zyla (Acuitas, Inc.) on January 26 for Goodwill Impairment: Qualitative Assessments & the FinREC Exposure Draft. Zyla, a member of the AICPA task force that just released the working draft of the Accounting and Valuation Guide, Testing Goodwill for Impairment, will discuss the contents of the exposure draft, its current feedback and comment process, plus answer your questions regarding the new qualitative “machinery” of goodwill assessments.