Corporate Governance, Sarbanes - Oxley Act and Case Law

IFRS3 and FRS10 in the UK allows acquired intangibles to be valued FAS.141 in the US requires a purchase price to be allocated to acquired assets including intangibles and FAS.142 demands intangible impairment reviews.

Goodwill and other intangible assets are no longer subject to amortisation, they must be tested at least annually for impairment or on an interim basis when there is reason to suspect that values have diminished. Testing is done through the application of commonly used valuation methodology. Non-goodwill indefinite lived assets are to be tested first.

There is a lot more emphasis on pre-acquisition analysis with valuers asked to look at transactions prior to consummation of the deal.

International Accounting Standards will be commonplace soon and concerning intellectual property they are mostly similar (e.g. legal right but but not economic right) to the new US standards.

In addition, the developing International Financial Reporting Standards (IFRS) being promulgated by the IASB (International Accounting Standards Board) may afford further, new opportunities.

For instance, the requirements (IFRS2) that companies expense stock-based compensation - such as stock options - will require the valuation of the stock/options. In the USA, this is also emerging as a requirement (SFAS123, Amended). 

We understand the auditor perspective, for example PwC in respect of our work for Prudential over the years as that of the SEC in many other appraisals.

Auditors are particularly interested in scruitinising purchase price methodology.

For example they look at what kind of internal rate of return has been used to make forecasts of earnings in relation to the purchase price.

We advise clients to use as many valuation methods as allowed to give them flexibility, typically market and comparability study, discounted cashflow and market capitalisation.

If only one method is chosen, there is a danger of having an impairment charge, even though there has been no real change to the underlying business.

The Purchase Cost Allocation summary at our NewsDesk contains more detail.

There is developing case law which will compel Boards of directors in the US and Europe to accept that they must undertake and lead IP decisions rather than leave them to management without Board oversight. Companies may be subject to potential litigation and liability. Directors may experience significant personal exposure.

True to form the SEC's policy is that any settlement involving individuals be paid for by the individual and as part of the settlement the person must agree to waive any right to seek reimbursement from his or her company or an insurance policy.

Therefore if Board members recognise that IP is a potential high risk area that can no longer be delegated solely to management without sufficient oversight, they will increasingly recommend that valuation and how IP is exploited is a key determinate to those fiduciary duties. In the process advice from experts in the valuation and exploitation of intellectual property and intangibles may be a key ingredient.

"IP valuation is an important but complex undertaking - not a box-ticking exercise and companies need to be aware of the pressures that this may impose on their own management teams (the US standard setters have already said they expect that most companies will require expert assistance in this area)" - PwC 2005.

“Sarbanes – Oxley is turning into the Y2K of accountancy” The Times May 12, 2004. In the US the provisions of valuation services for external audit clients is prohibited under this legislation. The UK's Auditing Practices Board has issued new Ethical Standards effective after 15 December amounting to the same (our News Desk contains more information).

This accounting regulation is a boon for independent valuation expertise. Compliance with the new corporate governance rules will impose new requirements on chief executives and financial officers in the signing of accounts. It prohibits the use of auditors as consultants. On the other hand it has been observed as a boon for the accountancy profession who hope to lift the squeeze on audit fees.

With just four firms dominating the global audit business, the requirement of rotation removes one competitor from the beauty parade. If the independent expert, offering equivalent expertise is put into the frame, the likelihood of another firm being excluded on the ‘no consultancy’ rule will not be a problem. Appointing Valuation Consulting would leave a choice of three firms rather than one – not quite 'buggins’s turn'.

The Act has also highlighted IPR in necessary public reporting and disclosure requirements (for example R&D spends and litigation). There is a conflict with competitive advantage through confidentiality. Beware; a $5million fine and 20 years incarceration (willful contraventions) or $1million and 10 years incarceration (knowing contraventions). Fear not, valuation is relative not absolute.

The Delaware judgment in the landmark case of re Caremark International Inc Derivative Litigation (698A2d 959 Del.Ch 1996) served notice. That decision imposed on directors the duty to ensure that adequate monitoring systems exist in respect of financial reporting.

Later cases that underline directors exposure concerning a Board's oversight of intellectual property include, re Walt Disney Co Deriv Litig 825 A2d275 Del CR 2003 and the judgment in respect of Research in Motion - an infringement matter regarding the Blackberry and use of NTP's patents which case establishes the potential liability of directors in respect of IP infringement (NTP Inc v Research in Motion Ltd 2004 US App LEXIS 25767 Fed Cir December 2004). 

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