In the fall-out of subprime fiasco, securities fraud cases are focusing on whether companies accurately wrote-down these “toxic” assets according to then-applicable fair value accounting standards (FAS 157 and 115). As BV analysts and fair value experts know, these fair value determinations are especially complex due to the lack of an observable market. Now a federal district court decision recognizes the “extreme technical difficulty” of these asset valuations. As a result, it is not enough for plaintiffs to merely list the asset values and then assert they were not reported at fair value. Instead, the complaint must explain why the listed values show the defendant failed to comply with applicable accounting principles and/or were beyond the range of reasonable values. In other words, a 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,” the court held.
For example, in this case the plaintiffs pointed to certain “red flags” of fraud—a decline in the ABX index, for example, and over $145 million of margin calls by secured lenders during the month of July 2007, alone. “The problem is that none of it tells me anything about whether the [reported] values . . . were justifiable,” the court observed. A “confidential witness” was ready to testify that the values were overstated, but the complaint failed to indicate that his opinion was competent, “or that his understanding of ‘value’ was in any way similar to the accounting concept of fair value,” the court said, in dismissing the case. The decision may prompt more securities fraud plaintiffs to enlist sufficient technical expertise at the earliest stages of litigation, including drafting an adequate complaint. Read the complete digest of Fulton Co. Employees’ Retirement System v. MGIC Investment Corp., 2010 WL 5095294 (E. D. Wis.)(Dec. 8, 2010) in the March 2011 Business Valuation Update; the court’s decision will be posted soon at BVLaw.