Expert Witness Lessons - Controlling the Discovery & Use of Unhelpful Expert Opinions
In Hospital Corp. of America, et al. v. Commissioner, T.C. Memo. 1996-559 (12/30/96), the Court addressed several procedural issues of which practitioners and taxpayers should be aware, the most important dealing with expert reports that may not be helpful to the taxpayer.
- The Court held that, although it has not adopted the Danielson rule (Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965)), it will apply that rule in cases where the applicable Court of Appeals (the Sixth Circuit in this case) has adopted the Danielson rule. This is just a specific application of the Tax Court's Golsen rule.
- The Danielson rule was inapplicable in the HCA case, however, because the parties had not reached agreement as to the valuation of the securities. The documents representing the parties agreement merely referred to the liquidation value, but that did not establish the value of the securities in question.
- For the same reason (no agreement), the Court found Section 1060 inapplicable.
- The Court then determined valuation based on the record before it. Before doing so, however, the Court addressed an interesting evidentiary question of whether an expert witness report prepared at the request of an affiliate of the taxpayer could be introduced against the taxpayer as an admission against interest. In the complex transaction, an ESOP retained an expert to provide a fairness opinion. The expert apparently reached an opinion of fair market value and the IRS desired to rely upon that opinion.
- The expert opinion was, of course, hearsay. The IRS sought to introduce the opinion under Rule 801(d)(2), Federal Rules of Evidence, as an admission against interest. The Court found none of the requirements under Rule 801(d)(2) were present. Rule 801(d)(2) requires that the out of court statement be made by the party against whom they are proffered or by someone in sufficiently close privy (e.g., agent) to the party so that that party should be held to it. Here, the ESOP was not within that relationship. More fundamentally, the Court expressed its concern that, even if there were such a relationship, the role of independent appraiser could ever permit the appraiser's statements to be treated as admissions against interest of the party engaging the appraiser. The independent appraiser, by definition, should be independent, owing allegiances to the public and to the courts as well as the party engaging it.
- Moreover, even if the independent appraiser were within the relationship required, the opinion is only as good as the qualifications of the expert and the bases for the opinion, neither of which the IRS proved or allowed to be subject to the type of examination required for testing the adequacy of expert opinions.
- Finally, the Court rejected the IRS's attempt to back door the opinion as a business record, finding that the IRS had not laid the proper foundation. Of course, even if the IRS had laid the proper record, it would still be subject to the infirmities noted above that the expert's qualifications and bases for the opinion must be tested; since they could not be tested, all the introduction would establish was that there was an expert opinion but that would be wholly unhelpful to the Court's duty to determine fair market value.
The Court's rejection of the IRS's attempt to use the ESOP's expert report is the most interesting to us and potentially important to other taxpayers and practitioners. It is not uncommon for taxpayers and their representatives to obtain the views of more than one expert either in a business transaction or, closer to the tax controversy practitioner's home, in a dispute with the IRS. If for any reason, the taxpayer does not like one expert's opinion, it can simply not rely upon it and rely upon a different expert. The IRS would, obviously, like to have access to and even rely upon the rejected expert.
In United States v. Bell, 95-1 U.S.T.C. ¶50,006 (N.D. Cal. 1994), prior to the audit, the taxpayer had engaged a law firm (Baker & McKenzie) to provide it legal advice regarding its transfer pricing practices and exposures. The law firm engaged an accounting firm to provide accounting and economic assistance. Both the taxpayer and the law firm provided information to the accounting firm personnel in performing their task. The accounting firm produced a report. After the audit commenced, the law firm re-engaged the accounting firm to produce a second report and one was produced. In both instances, the law firm had been careful to engage the accounting firm and had really crossed the "t"s and dotted the "i's". The Court sustained the taxpayer's assertion of the attorney-client privilege, citing inter alia the venerable Kovel (United States v. Kovel, 296 F.2d 918 (2d Cir. 1961)) doctrine. The Kovel doctrine holds that experts engaged by the law firm to assist it in rendering tax advice and representation to a taxpayer fall under the attorney-client privilege and thus are not subject to discovery. To contrast with Bell, the taxpayer and practitioner should review U.S. v. Adlman, 68 F.3d 1495 (2d Cir. 1995) as a lesson in how the expert engagement should not be made.
Of course, in Bell, the IRS was fishing to find something useful for its case. But the IRS may at any time spring a summons or a discovery document production request for the expert reports or opinions not relied upon by the taxpayer with the hope of finding something that might be admitted in the IRS's favor or might lead to paths of inquiry not yet discovered.
With the combination of Bell and HCA, taxpayers and their practitioners should have the parameters for shaping the engagements of experts in a way that should avoid their discovery and use by the IRS. Of course, if the taxpayer does not use the Kovel doctrine to shield the expert upon the original engagement, the expert's report might well be subject to discovery by the IRS. The Tax Court's analysis in HCA should offer a defense against the formal introduction of the expert's report or any portion at trial. But that could be poor comfort if the expert's report has led the IRS to fruitful analyses and inquiries that it then introduces through its own expert witness. Accordingly, the lesson in HCA is that excluding such an expert's report can probably be accomplished, but Bell teaches that it is best to anticipate and deal with the issue on the front end. Of course, in fairness, that was impossible in HCA because of the nature of the transactions and the public disclosures that were required; it should be quite achievable when the expert is engaged in anticipation of taking a return position or upon an audit or resulting litigation.