Sunday, October 13, 2024

Understanding Native American Royalty Rights: An Audit Perspective on Natural Resource Revenues


Native American and Indian tribes hold a unique position in the United States, both as sovereign entities and as major stakeholders in the use and development of natural resources, including gas, oil, and land-use agreements. These rights are often governed by federal laws, treaties, and contracts, and one of the most significant economic benefits available to tribes is the ability to collect royalties from companies that extract resources from tribal lands. This blog post explores the types of royalties tribes are entitled to, whether there is a statutory audit right to ensure accurate payments, and how audits can ensure that royalties from these resources are correctly reported and paid.

Types of Royalties Tribes Are Entitled to Collect

Tribes often own substantial land and mineral resources, and they are entitled to various types of royalties based on their land's use for resource extraction, particularly oil, gas, and minerals. The types of royalties may vary depending on the nature of the resource and the specific agreements in place:

  • Oil and Gas Royalties: Tribes can lease their lands for oil and gas production, and in return, they receive royalties from the revenue generated. These royalties are typically calculated as a percentage of the gross value of the extracted resources, usually ranging from 12.5% to 20%, depending on the agreement.

  • Mineral Royalties: Similar to oil and gas royalties, tribes can receive payments for the extraction of minerals like coal, uranium, and precious metals. Mineral royalties can vary based on the resource, the method of extraction, and the negotiated lease terms.

  • Land Use Royalties: Tribes may receive compensation for land use, such as grazing, forestry, and other surface activities. These royalties may be less substantial than those derived from mineral extraction but can still form an important revenue source.

  • Renewable Energy Royalties: With the rise of renewable energy, some tribes are entering into agreements for wind, solar, and geothermal projects. These arrangements also typically include royalty payments based on the energy produced.

Federal Laws Governing Tribal Royalties

Tribal royalty rights are shaped by a complex framework of federal laws, regulations, and treaties, including:

  • The Indian Mineral Leasing Act of 1938 (IMLA): IMLA gives tribes the right to lease their lands for mineral extraction, including oil and gas. The Act ensures that tribes benefit financially from their land and mineral resources. See link here for details.

  • The Indian Tribal Energy Development and Self-Determination Act: This legislation allows tribes more control over energy projects on their lands, enabling them to negotiate royalty rates and terms directly. See link here for details.

  • The Federal Oil and Gas Royalty Management Act (FOGRMA): FOGRMA ensures that accurate payments are made to tribes for oil and gas extracted from their lands. Under FOGRMA, the Department of the Interior oversees the collection and distribution of royalties owed to tribes. See link here for details.

Statutory Audit Rights for Tribes

FOGRMA also grants tribes the right to audit companies that lease their lands for resource extraction. Click here for a summary. This statutory audit right is critical for ensuring that royalty payments are accurate and fully reflect the terms of the lease. The act provides tribes with access to the records of lessees, enabling them to conduct audits and ensure compliance with the terms of the lease.

In addition to FOGRMA, many contracts between tribes and resource extraction companies include specific audit clauses, which give tribes the right to verify the accuracy of royalty payments. These clauses often specify the time frames, frequency, and scope of audits, allowing tribes to ensure that all production is accounted for.

How Audits Can Identify Amounts Owed to Tribes

Audits are an essential tool for tribes to claim royalty underpayments owed for the value of the resources extracted from their lands. See an example of public claims by clicking here. Forensic auditors with expertise in royalty, profit participation, and contract compliance can review a variety of records, including:

  1. Production Reports: Auditors verify that the volume of oil, gas, or minerals extracted matches the reported figures used to calculate royalty payments.

  2. Revenue Records: Auditors check whether the revenue reported by the lessee accurately reflects the sales price of the extracted resources.

  3. Deductions and Allowances: Some leases permit companies to deduct certain costs (such as transportation and processing) before calculating royalties. Auditors review these deductions to ensure they are appropriate and comply with the contract terms.

  4. Payments: Auditors compare payment records to the royalty statements provided to tribes, ensuring that payments are timely, accurate, and in accordance with the agreed-upon rates and/or minimums.

Conclusion

Native American and Indian tribes have significant rights to royalties derived from the use of their lands for resource extraction. Through federal laws like FOGRMA and contract-based audit rights, tribes can ensure that the companies extracting these resources pay what is owed. Forensic audits play a key role in verifying the accuracy of reported production and revenue, helping tribes protect their valuable resources and secure their economic interests.

A proactive approach, including regular audits, can help tribes assert their rights and ensure they receive full and accurate royalty payments. My firm Boschan Corp. provides this service. To clear conflicts and discuss your matter - please click here or call (424) 248-8866. 

Wednesday, October 9, 2024

How to Effectively Depose a Financial Expert: A Guide for Attorneys

Depositions can make or break a case, especially when it comes to financial experts who may provide critical testimony. For attorneys dealing with intellectual property, royalty disputes, or damages claims, a strong deposition of an opposing expert is key to uncovering flaws in their analysis, challenging their damages conclusions, or shoring up your own case. Here's how to prepare and execute an effective deposition of a financial expert according to me, your expert.


Forensic Accountant Cedar Boschan

Involve Your Financial Expert Early

Retaining your own financial expert before discovery begins is crucial, especially in complex cases. Early involvement allows your expert to advise on discovery requests, such as interrogatories and document production, that will provide the data necessary for a thorough analysis. This proactive approach can lead to a more accurate understanding of the case’s financial aspects, allowing your expert to better rebut opposing testimony.

Involving your expert early also helps you anticipate weaknesses in the opposing expert's report, giving you a strategic advantage in depositions​

Understand the Opposing Expert’s Background and Qualifications

Review the expert’s qualifications, including their education, certifications, and professional experience. A financial expert with less relevant experience may struggle to explain complex valuation or auditing principles under pressure. Look for gaps in their credentials or areas where they may be overreaching.

Know the Opposing Expert's Report Inside Out

Start by thoroughly reviewing the expert's report and any supporting materials. Identify the key points of their analysis, especially any assumptions or methodologies that seem questionable. Make sure you understand the subject matter enough to spot inconsistencies or potential errors. Collaborating with your own financial expert during this stage can provide deeper insights into the opposing expert's weaknesses.

Decide Your Deposition Approach: Tie Them Down or Impeach?

When cross-examining a financial expert during deposition, it’s tempting to go after them aggressively. However, this can backfire.

Before you start, consider your goal for the deposition. Do you want to tie the expert to their opinions so they can’t modify them later, or are you aiming to impeach their credibility and methodology?  These two approaches require different strategies:
  1. Tie them down: Focus on obtaining the expert’s opinions and gathering information underlying and locking them into a position that limits their flexibility at trial. Use this strategy when the expert seems sound but could be vulnerable under scrutiny. By getting clear answers, you can later work with your own financial expert to identify areas of weakness to address during trial. Leaving the hard-hitting cross-examination for trial ensures you won’t accidentally educate the expert on your strategies.

  2. Impeach: Alternatively, if you aim to discredit the expert, look for opportunities to expose flaws in their methodology, challenge assumptions, or highlight bias. This approach can be risky as it may inadvertently "show your hand." In other words, it may cause the opposing expert to prepare by strengthening their testimony at trial, especially if they can correct their mistakes or clarify their testimony before then. To avoid this, it’s important to carefully plan your cross-examination with your financial expert early-on.
Tip: In many cases, a hybrid strategy can be employed - locking down the expert’s opinions while subtly probing for impeachment opportunities without showing your hand. 

Leverage Your Expert to Assist with Drafting Deposition and Cross-Examination Questions

Ask your expert to identify credibility weaknesses questions using tactics such as:
  • Challenge their expertise if it appears they are not specialized in the relevant area (e.g., royalty audits vs. damages calculations)
  • Ask about their track record in court or deposition to see if they have any vulnerabilities as a witness
  • Establish bias or conflicts of interest including financial incentives, such as compensation structure
Sample questions:
  • How many times have you testified for the opposing party or similar clients?
  • What percentage of your income comes from working as an expert witness?
  • Are there any professional or personal relationships with the party that could affect your impartiality?
An expert’s credibility can be damaged if you can show they selectively included or ignored data that doesn’t support their conclusions.  Therefore, ask your expert to highlight inconsistencies or omissions in the opposing expert's report or record. You can use the deposition to further uncover inconsistencies in the expert’s testimony, either with their report, other testimony, or known facts of the case. 

Ask the opposing expert to clarify:
  • Why they chose certain data points while ignoring others
  • If any alternative methods were considered and why they were rejected
  • If there is any academic or industry criticism of the approach they used
A financial expert’s methodology is a crucial point of attack. Ask your expert to look closely at the processes the opposing experts used to arrive at their conclusions and ask detailed questions designed to disclose the following:
  • Were industry standards followed? 
  • Did they selectively ignore data? 
  • Did they combine nominal and real rates —an error that skews projections and can be a major vulnerability during trial?
  • Are they using current or historical data inconsistently?
  • Did they overlook important factors, like work-life expectancy or inflation projections?
  • What generally accepted specific methods did you rely on for your analysis?
  • How do those standards apply to the facts of this case?
  • Have you ever used a different method in similar cases? Why or why not?
  • What assumptions did they base their analysis on?
  • Are the expert's assumptions well-supported by the evidence?
  • Has the expert made any mathematical or interpretive errors?
Have the opposing expert explain complex calculations in layman’s terms. Their inability to articulate their process clearly could cast doubt on the reliability of their analysis.

Test Their Limits: Push Beyond the Opposing Expert's Comfort Zone

Experts, no matter how experienced, have limits. Use the deposition to find those limits by probing deeply into their knowledge of specific accounting principles, economic theories, or valuation techniques. This can reveal overconfidence or expose gaps in their expertise, especially if the expert is more generalist than specialist.

Explore their depth of knowledge by asking:
  • Can you explain the basis for [specific financial principle] in this context?
  • How would this approach differ if the facts were [adjusted scenario]?
  • Have you ever been criticized for this methodology in past cases?

Stay Focused: Avoid Tangential Debates with the Opposing Expert

While it may be tempting to engage in deep financial debates, remember that your goal is to collect information and expose weaknesses. Avoid getting bogged down in overly technical details that distract from your strategy. Keep the deposition focused on the big picture: undermining the expert’s credibility and methodology while gathering useful admissions.

Prepare for Trial Using the Opposing Expert's Key Admissions

Finally, try to lock the opposition's expert into key admissions that will support your case or undermine theirs. These admissions can be used during trial to cast doubt on the expert’s analysis or reliability. Aim for clear, concise statements on points where the opposing expert’s opinion is weakest or most vulnerable. 

During trial, your financial expert can then highlight these weaknesses, helping to undermine the opposing expert’s credibility in front of the jury.

Key admissions to target:
  • Concessions about the limits of their analysis
  • Acknowledgment of alternative approaches they could have taken
  • Agreement that certain assumptions were subjective or speculative

Final Thoughts

Deposing a financial expert requires careful preparation and an understanding of both legal and financial principles. By asking the right questions and maintaining focus, you can reveal flaws in the expert's analysis, highlight biases, and make their testimony less compelling at trial.

Attorneys handling cases involving forensic accounting or intellectual property rights should be well-versed in these techniques to ensure a successful deposition. With the right approach, you can turn a financial expert from a strong adversary into a liability for the opposing side.

Tuesday, October 8, 2024

7 Tips to Ensure Your Expert’s Opinion is Admitted as Evidence

Successfully admitting expert testimony can be a game-changer in litigation, but it requires careful attention to legal standards and preparation. As a forensic accounting expert with experience in intellectual property infringement and other damages claims and rebuttal, I’ve seen how crucial these steps can be to ensuring the admissibility of expert opinions. Below are seven tips to strengthen your case—and legal grounds on which opposing counsel could move to disallow expert testimony if these tips are overlooked.




1. Understand the Admissibility Standards (Daubert & Frye)

Legal Risk: If the methodology used by your expert doesn’t meet the required standard, the court may deem the testimony inadmissible.  For example, see Waymo v Uber et al.

Under the Federal Rules of Evidence, particularly Rule 702 (expert witness testimony) federal courts and many states have adopted the so-called "Daubert Standard."  Under Daubert, an opposing party can argue that the methods used are not scientifically valid, are not based on sufficient data, or have not been subject to peer review. This standard tends to be strict in ensuring that the expert's methodology is sound and applicable. Please click here to learn more about the Daubert Standard.

Some states, including California (at least historically), instead follow the so-called "Frye Standard," a test which requires that the expert’s testimony be based on scientific methods that are “generally accepted” in the relevant field. Frye is seen as a more lenient standard than Daubert in some respects. Please click here to learn more about the Frye Standard.

2. Choose the Right Expert

Legal Risk: If your expert’s qualifications are insufficient, opposing counsel could challenge them under Federal Rule of Evidence 702 or an equivalent local statute. They may argue that the expert lacks the necessary education, experience, or training in the relevant field, thereby disqualifying their testimony. This point merits its own blog post, perhaps.

3. Establish Relevance Early-On

Legal Risk: Testimony must assist the trier of fact in understanding or determining a fact at issue. Under Federal Rule of Evidence 702(a), opposing counsel may argue that the expert’s testimony is irrelevant if it does not directly relate to the issues of the case or if it fails to address a matter outside the common understanding of a layperson. Ensure that the expert is clear on the scope of their deliverable, especially with respect to supplementary or rebuttal reports.

4. Thoroughly Vet Your Expert’s Methods

Legal Risk: As mentioned above, if the methodology your expert relies on is questionable, Daubert or other motions can be used to exclude testimony on the grounds that it lacks reliability or scientific validity. Opposing counsel may argue that the expert’s techniques are speculative or insufficiently tested, or that they fail to meet professional standards. Therefore, take measures to ensure your experts are complying with the standards you designate. I recommend you research recent and historic case law because outdated or discredited methodologies can lead to the exclusion of expert testimony under Daubert. Opposing counsel may argue that the expert relied on outdated science, recent case law rejecting the methodology, or new standards that call into question the validity of the expert’s approach.

5. Require a Detailed Expert Report (or Declaration)

Legal Risk: A weak or vague expert report is vulnerable to attack under Federal Rule of Civil Procedure 26(a)(2)(B), which requires a complete statement of all opinions and the basis for those opinions. Opposing counsel may file a motion to exclude testimony on the basis that the expert report is incomplete, unsupported by sufficient facts, or based on inadmissible information.

However, state laws differ. In California, experts are not required to prepare written reports as part of the discovery process in state court. This is in contrast to federal court, where Rule 26 of the Federal Rules of Civil Procedure mandates expert reports.

The relevant statute in California is California Code of Civil Procedure (CCP) § 2034.210-2034.310. Under this statute, parties are required to disclose the identity of expert witnesses they intend to call at trial, along with a declaration summarizing the expert’s qualifications, a general substance of their testimony, and the expert’s hourly and daily fees for services; there is no statutory requirement for a detailed written report like there is under federal law.

Instead, in California state court, the discovery process involving experts focuses on depositions. During expert depositions, attorneys can probe the substance of the expert's anticipated testimony and the basis for their opinions. This approach allows for expert discovery without a formal report requirement.

Thus, in California, if an attorney requests expert opinions or methodologies, many an expert may disclose them through declarations or testimony, rather than a written report.  That said, for a damages expert like myself who prepares complex calculations, I find I need to prepare, at minimum, report schedules/exhibits that set forth my calculations in order to testify about specific amounts and remind myself of the details.

6. Anticipate Challenges to Credibility & Prepare for Deposition and Trial Testimony

Legal Risk: Legal Risk: Inconsistent or poor testimony under cross-examination can damage an expert’s credibility, leading to a motion to strike the testimony as unreliable. Opposing counsel could file a motion under Federal Rule of Evidence 702(d), claiming that the expert has not reliably applied their methods to the facts of the case or challenging an expert’s credibility by pointing to prior inconsistent statements, or limited experience in the field. I suggest role playing with your expert to ensure they know how to respond to credibility attacks and your direct examination at minimum.

7. Emphasize Objectivity

Legal Risk: If your expert appears too aligned with your client’s case, they could be disqualified for appearing as an advocate rather than an independent professional. Opposing counsel may argue under Daubert or Federal Rule of Evidence 403 (which balances probative value against prejudice) that the expert’s bias renders their testimony unfairly prejudicial or untrustworthy.  As part of this, do not engage the expert on a contingent basis - if they have a financial stake in the outcome of the case, their testimony can be excluded. This is one reason why my firm bills hourly.

Conclusion

Hopefully some of these tips will help you overcome challenges to your expert. For information about Boschan Corp.'s expert services, please click here or call us at 424-248-8866.

Sunday, October 6, 2024

Understanding Forensic Audits: Beyond Fraud Detection

When most people hear the term "forensic audit," they often think of investigations to uncover fraud or criminal financial misconduct. While that is a significant use of forensic audits, fraud detection far from the only use. In fact, a forensic audit serves a much broader purpose, especially in industries where compliance with contractual and statutory obligations is critical. At my accounting firm Boschan Corp., we focus on forensic audits to ensure that parties uphold their contractual agreements and meet specific statutory requirements.

What Is a Forensic Audit?

A forensic audit is a detailed examination of an entity’s financial or operational records for a legal purpose (often identifying damages claims for potential civil court proceedings). Unlike standard audits, which focus on financial statements’ accuracy and adherence to accounting standards, forensic audits delve deeper into specific agreements or other legal obligations. This may involve investigating transactions, reviewing records, and interpreting data to determine whether all requrements set forth in a contract or law have been met.

Our Focus: Contract and Statutory Compliance

At Boschan Corp., we conduct forensic audits not to detect fraud but to ascertain compliance. This type of audit is especially important in sectors like intellectual property, where royalties, profit-sharing, or licensing agreements can be complex and subject to misinterpretation. Our forensic audits help clients ensure that their counterparties are fulfilling their end of the deal.

For example, imagine a scenario where an artist or inventor enters into a licensing agreement with a company to manufacture and sell products based on their creation. Over time, the licensor may wonder if they are receiving the correct royalty payments as per their agreement. A forensic audit of the licensee’s records can clarify whether the terms of the contract are being met and if the payments due are accurate.

We also perform audits related to statutory compliance. This could involve reviewing whether a company is meeting specific legal obligations, such as those relating to privacy or labor standards, or payment of certain statutory royalties, such as those under the music industry’s statutory license.

Why Forensic Audits Matter

Forensic audits serve as an essential tool for resolving disputes and ensuring fair dealings. When parties enter into complex contracts or agreements, misunderstandings or differences in interpretation can arise. Our forensic audits help clarify these ambiguities and provide clear, objective evidence to support our clients’ positions.

Whether you’re an artist seeking to verify royalty payments or a company ensuring that your statutory privacy obligations are met, forensic audits can provide the transparency and peace of mind you need.

Conclusion

A forensic audit is about more than detecting wrongdoing; it’s about ensuring accountability and compliance. At Boschan Corp., we specialize in using forensic audits to ensure that our clients’ contracts and legal obligations are met fairly and transparently. If you believe a counterparty may not be living up to the terms of your agreement, a forensic audit can provide the clarity you need to move forward confidently.

Thursday, October 3, 2024

Navigating Corporate Challenges: The Essential Role of Entertainment and IP Expertise on Corporate Boards

In today's rapidly evolving business landscape, corporate boards are facing unprecedented challenges. Whether it's adapting to digital transformations, managing intellectual property (IP) in the age of technology, or navigating an increasingly complex legal and regulatory environment, companies are in need of board members with specialized expertise. One area that is often overlooked—but becoming increasingly critical—is the entertainment and IP sectors. Directors who can bring a deep understanding of these areas offer invaluable insights that can strengthen risk management, improve strategic planning, and bolster governance practices.

The Increasing Importance of Intellectual Property

As companies shift from a product-based economy to one driven by content, creativity, and innovation, the importance of intellectual property as a corporate asset has soared. IP management now touches industries far beyond entertainment and media, affecting sectors from technology to consumer goods. Content creation, brand identity, and patented technologies all fall under the umbrella of IP assets, which means that boards need directors who can not only appreciate the value of these assets but also ensure their protection and proper monetization.

Understanding the intricacies of IP is crucial for effective governance. Boards that fail to incorporate IP expertise risk exposing the company to unnecessary litigation, loss of competitive advantage, and missed opportunities for licensing or partnerships. For example, directors who have firsthand experience in IP-heavy industries are better equipped to identify emerging risks, such as the implications of artificial intelligence (AI) on copyright, or the legal ramifications of digital streaming and content sharing platforms.

Risk Management and Legal Oversight

With the fast pace of innovation in digital and creative sectors, corporate boards are also tasked with understanding the legal frameworks that govern intellectual property. This is not limited to traditional industries like film and music but now encompasses technology, biotech, and even manufacturing, where patents and trademarks play a crucial role.

Boards need to be proactive in managing IP-related risks, whether it’s defending patents or copyrights in court, or ensuring compliance with new regulations like data privacy laws and global trade agreements. Legal missteps can be costly, not only in terms of financial penalties but in reputational damage. Having directors who understand these legal intricacies can provide essential guidance, preventing issues before they arise and ensuring that the company remains in compliance with shifting regulatory landscapes.

Moreover, effective risk management in the realm of IP extends beyond merely understanding legal obligations. It involves actively participating in strategic discussions about how to leverage intellectual property for growth, how to guard against infringement, and how to capitalize on new revenue streams from licensing or joint ventures.

Strategic Thinking for the Digital Age

In addition to legal and risk management concerns, strategic thinking is another area where corporate boards can benefit from entertainment and IP sector expertise. In the digital age, traditional business models are being disrupted at an unprecedented rate. Boards need to be forward-thinking, anticipating not only potential risks but also opportunities for growth and innovation. This is particularly true for companies looking to expand into digital content, media platforms, or technologies that rely heavily on creative assets.

Strategic board members with experience in industries driven by intellectual property and creativity are often well-versed in adapting to change, as these sectors are regularly impacted by technological advancements and shifts in consumer behavior. A director with a deep understanding of how IP and digital content evolve can offer critical insights during key decision-making processes, whether it's exploring new partnerships, expanding into new markets, or defending against potential disruptors.

Governance and Compliance: More Than Just Box-Ticking

In the wake of high-profile corporate scandals, governance has become a central focus for boards across all industries. But while regulatory compliance is a key aspect of good governance, it must go beyond mere box-ticking. Effective governance involves fostering a culture of accountability, transparency, and proactive decision-making.

Boards can gain a competitive edge by including members who understand their fiduciary duty to investors and how to integrate compliance with broader business goals. For companies managing complex portfolios of IP assets, this can mean ensuring proper royalty auditing, monitoring licensing agreements, and enforcing rigorous standards in contract negotiations. Strong governance in these areas is essential not only for maintaining shareholder trust but also for securing the company’s long-term financial health.

Adapting to Regulatory Change

The intersection of government policy, public relations, and intellectual property is another area where experienced directors add value. Rapid changes in technology, coupled with evolving public policy, mean that boards must be constantly aware of how regulatory shifts could impact their business. Whether it’s negotiating the evolving frameworks surrounding digital copyright, managing data privacy regulations, or complying with new international trade agreements, businesses need directors who understand the broader implications of these changes.

Directors with experience navigating these regulatory waters can help boards anticipate challenges, develop strategies to adapt, and maintain compliance without sacrificing innovation. For example, upcoming changes in copyright law may have significant implications for companies producing digital content, and directors with specialized knowledge can ensure that the company is well-positioned to adapt to these changes.

Conclusion

The need for specialized expertise on corporate boards is clear, particularly in industries driven by intellectual property and rapid technological change. As companies face growing challenges related to governance, risk management, and legal oversight, having directors who understand the nuances of IP management, regulatory compliance, and strategic innovation can be the difference between thriving and merely surviving in today's competitive environment. As the role of intellectual property continues to expand, companies that invest in board members with this unique expertise will be better equipped to manage risks, seize opportunities, and drive long-term value.

Thursday, September 26, 2024

Can a Lay Witness Offer an Expert Opinion?


Can a Lay Witness Offer an Expert Opinion? If you're a trial attorney, this question may come up more often than you'd expect, because introducing lay witnesses is one method of surprising the counterparty, since there are fewer disclosure requirements and procedures for lay witnesses than for expert witnesses in US federal and state legal proceedings.

As an expert witness (not an attorney) I find that the distinction between lay and expert witnesses is critical. Lay witnesses typically provide testimony based on their personal knowledge or observation, whereas expert witnesses are called upon to offer specialized knowledge that aids the court in understanding complex matters. However, the question often arises: can a lay witness ever give an opinion that might resemble expert testimony? The answer lies in a careful analysis of the rules of evidence and case law, which you should discuss with your legal counsel. The below represents my understanding as a non-lawyer, thus it should not be taken as legal advice.

The Role of Lay Witnesses

A lay witness is someone who testifies about facts they personally observed or experienced. According to Rule 701 of the Federal Rules of Evidence, a lay witness may offer an opinion, but only if it is:

Rationally based on their perception: The opinion must stem directly from the witness's personal observations and experiences, not from specialized or technical knowledge.

Helpful to understanding their testimony or determining a fact in issue: The opinion must assist the court or jury in grasping what the witness saw or experienced, providing clarity to otherwise factual testimony.

Not based on scientific, technical, or other specialized knowledge: If an opinion requires specialized knowledge, it falls under the domain of an expert witness, per Rule 702.

In other words, lay witnesses can offer opinions that are grounded in everyday reasoning and personal experience. For example, a lay witness may testify that someone appeared “nervous” or “angry” based on their demeanor, or that a vehicle seemed to be speeding. These observations are not considered expert opinions because they are accessible to any reasonable person without specialized training.

The Role of Expert Witnesses

An expert witness, on the other hand, is specifically qualified by knowledge, skill, experience, training, or education. Experts are called to offer testimony on subjects that require a deeper understanding beyond common experience, such as medical diagnoses, technical data, or financial calculations. Their testimony must adhere to the standards of Rule 702, which governs the admissibility of expert opinions.

The Gray Area: When Lay Testimony Resembles Expertise

There are situations where the line between lay and expert opinion blurs. In such instances, courts scrutinize the nature of the testimony to determine whether a lay witness’s opinion crosses into expert territory.

For example, in United States v. Figueroa-Lopez, a lay witness was prohibited from giving an opinion that the defendant was acting in the manner of an experienced drug trafficker. The court ruled that this opinion required specialized knowledge and, therefore, fell under the purview of expert testimony.

However, there are cases where lay testimony can approach expert-like opinions without crossing the line (i.e., when opinions are grounded in firsthand knowledge gained from practical experience, not formal expertise).

Practical Scenarios: When Lay Witnesses May Offer Opinion

  • Eyewitness Accounts: A lay witness can offer opinions about the speed of a vehicle, the identity of a person they know, or the emotional state of someone they observed. These opinions are rooted in common sense and direct observation.

  • Business Practices: Business owners or employees with firsthand knowledge of standard operating procedures can provide lay opinions about routine matters within their industry. For instance, a restaurant owner may testify about typical food preparation procedures without being considered an expert.

  • Medical Conditions: A lay witness can testify about obvious, observable medical conditions (e.g., someone appeared to have difficulty breathing or seemed unconscious), but diagnosing a specific medical condition requires expert testimony from a medical professional.

Other Jurisdictions Differ, Including U.S. State Courts

Many US states have adopted rules that are similar or identical to the Federal Rules of Evidence, particularly Rule 701 (lay witness opinion testimony) and Rule 702 (expert witness testimony). However, states may interpret or apply these rules differently, leading to variations in what types of testimony are admissible in state courts.  For example,  New York has not formally adopted the FRE, but its courts follow a similar approach regarding lay and expert testimony. New York courts may allow a lay witness to offer opinions in certain situations where the witness has specialized knowledge from experience, but this remains limited. For instance, a New York lay witness might testify about common business practices in their industry without being formally qualified as an expert, as long as the opinion is based on personal experience and not technical or specialized knowledge.

Technically different states follow different standards for the admissibility of expert opinions, namely:

  • The Daubert Standard: Under Daubert (adopted by federal courts and many states), the judge acts as a gatekeeper to ensure that expert testimony is scientifically reliable and relevant. This standard tends to be stricter in ensuring that the expert's methodology is sound and applicable.

  • The Frye Standard: Some states, including California (at least historically), follow the Frye standard, which requires that the expert’s testimony be based on scientific methods that are “generally accepted” in the relevant field. Frye is often seen as a more lenient standard than Daubert in some respects.

Under California law, a lay witness may provide opinions that are rationally based on their perception and helpful to understanding the testimony or determining a fact. However, California courts may allow more flexibility in certain types of lay opinions, especially when it comes to areas like business practices or common knowledge.

The difference between Daubert and Frye standards primarily impacts expert testimony, but it also affects how strictly courts will distinguish between lay and expert opinions. A state following the Frye standard might allow lay opinions on subjects that Daubert jurisdictions would restrict to experts, depending on the situation.

Conclusion

While lay witnesses cannot offer expert opinions, they are permitted to provide certain types of opinion testimony based on their personal observations and experiences. The key is that their opinions must be rational, helpful to the trier of fact, and not based on specialized knowledge. This rule ensures that courts maintain the balance between reliable expert testimony and useful lay observations, all while upholding the integrity of the legal process.

Understanding the distinction between lay and expert testimony is vital in preparing for trial. Lawyers must ensure that lay witnesses stay within the bounds of what they are allowed to testify about, while also leveraging their observations effectively to support their case. As always, careful consideration of the rules of evidence will guide which opinions are admissible and which must be left to the experts.

When it comes to intellectual property infringement cases, having the right damages expert can make all the difference in a successful outcome. At my firm, Boschan Corp., we specialize in IP infringement damages and are here when you need a seasoned expert to support your case. As a trusted partner in forensic accounting, we’re ready to help. Visit our website: boschan.com for more information or call us today at (424) 248-8866 to clear conflicts and get started.


Sunday, February 18, 2024

How AI Impacts the Valuation of IP Assets: Betas

Watching NYU Professor Aswath Damodaran's recent video, Catastrophic Risks in Business and Investing, reminded me of a music investors' conference I attended last summer in New York.

At the conference, every panel discussion among music investment experts dedicated a few minutes to the looming elephant in the room - artificial intelligence (AI) - and whether it poses a catastrophic threat to music earnings in the future and, thus, catalog values today.


There is a business tool called SWOT analysis, which identifies a subject's strengths, weaknesses, opportunities and threats. It was as if all of the conference speakers - music investing experts - had reached SWOT consensus on talking points that AI was an "opportunity," not a threat. 

However, beneath this facade of optimism, perhaps there was denial? A psychologically predictable reluctance to confront the existential threat posed by AI to the music industry? None of the speakers delved into the tangible impacts of low-probability catastrophic AI risk on the valuation of music rights interests.

Yet, markets were already adapting based on perceived greater-than-zero risks and opportunities created when AI increases the supply of music at less cost to users than human-made sources (i.e., composers and performers). The largest music companies and some individual artists were already hedging by investing in AI initiatives. Investors were already reassessing portfolio allocations, seeking to invest in AI to balance their portfolios, leaving less cash available for human made music investments. And my firm was already incorporating in valuation projects the music sector's relatively high exposure to AI-related risk in two respects:

  1. Decreased prices (buyers/investors required greater return to compensate for greater relative risk)
  2. Increased costs of equity for firms (since investors demand greater returns) 

As an astute expert on the value of music rights, I recognize the imperative of recalibrating risk premiums to reflect the evolving landscape. Therefore, I can not overlook the imminent specter of AI-induced disruption in the music industry, even if the probability is very low that the market for human-made music might erode catastrophically someday. 

Drawing from the insights I gleaned years ago from Professor Damodaran's teachings at NYU, sector-wide risk is coalesced in the "beta" component of risk premiums in the discount rates we use to value income streams. The beta is where we should ideally adjust for the risk to a sector relative to the entire market for all sectors. The average beta across all investments is equal to one. For sectors with above-average risk, the beta will be greater than one. For below-average risk sectors, the beta will be less than one. 

While my firm Boschan Corp.'s music sector research and beta calculations are confidential, here are Betas by Sector as well as a video from the Professor himself. Keep in mind, these betas might be used only for investors:

    • Using the capital asset pricing model
    • With diversified portfolios 

Unfortunately, conventional methods for estimating betas remain rooted in historical data. Thus, they fall short in capturing the forward-looking nature of catastrophic risks. Hence, the need for a nuanced approach—one that accounts for the interplay between AI and the music industry, leveraging industry expertise and stakeholder insights to inform risk assessment.

At Boschan Corp. we undertake rigorous analysis to gauge the extent of AI integration within music companies (i.e., how much music companies are hedging with investments in AI), how much AI companies are investing in music, and we solicit diverse perspectives to ascertain the likelihood and magnitude of AI-induced disruptions ("How likely is it that half of all music consumed by consumers is not artist created by humans in the next ten years?"). 

Also, we can explore the merits of an alternate approach to address catastrophic risk on an asset or company-specific basis (not on a sector-wide basis) with valuations based on two or more cash flow forecasts:

  1. Assuming no catastrophe and
  2. Assuming catastrophic outcome(s)

Then, we apply the buyer/investors' risk probability to each scenario and sum the results.

In this case, how shall an investor estimate probability of the risk posed to the music industry by AI?

Whether through sector-wide adjustments or asset-specific valuations, the weakness of both methods is the same: How to determine the temporal and qualitative dimensions of catastrophic risk (i.e., probability over time and magnitude of the catastrophe).

In either case, in confronting the specter of catastrophic AI risks, human expertise remains our most potent weapon in mitigating uncertainty and seizing opportunity amidst disruption.

For investors navigating the labyrinth of uncertainty, Professor Damodaran's comprehensive resources on betas and risk dynamics serve as invaluable compasses, offering nuanced insights and practical frameworks to navigate uncharted terrain. He and NYU also have made available the following resources: