EDWARD J. EMMONS, CLERK S/ □□□□□ U.S. BANKRUPTCY COURT 5 □□ 2 NORTHERN DISTRICT OF CALIFORNIA □□□ □□□□ Qnes 1 □□□□□ ORL 9 The following constitutes the Memorandum Decision|of the Court. Signed: August 10, 2022 3 4 LOD 6 7 RogerL.Efremsky = | | U.S. Bankruptcy Judge 8 9 10 1] 12 UNITED STATES BANKRUPTCY COURT NORTHERN DISTRICT OF CALIFORNIA, OAKLAND DIVISION 13 14 || In re Case No. 19-40193 15 || PACIFIC STEEL CASTING COMPANY LLC, Chapter 7 16 Debtor. 17} SARAH L. LITTLE, Chapter 7 Trustee, AP No. 19-4057 18 Plaintiff, 19 V. 20 SPEYSIDE FUND, LLC, a Delaware limited liability company, et al., 22 Defendants. 23 24 Memorandum Decision Granting Daubert Motions 25 The Speyside Defendants have filed a motion seeking to 26 || exclude certain parts of the reports of Plaintiff’s expert 27 || witness Austin Wade (the “Wade Reports”). Defendant UHY, LLP 28 Daubert -l1-
1 (“UHY”) has filed a motion seeking to exclude the same parts of 2 the Wade Reports. UHY also seeks to exclude certain parts of the 3 reports of Andrew Mintzer (the “Mintzer Reports”), Plaintiff’s 4 expert witness on auditing issues, because Mr. Mintzer relies on 5 the challenged assumptions and opinions expressed by Austin Wade 6 (collectively, the “Daubert Motions”). Docket Nos. 184-187 and 7 190-192. Plaintiff has filed Opposition. Docket Nos. 212-213. 8 Defendants have filed Replies. Docket Nos. 215 and 219. The 9 matter has been fully briefed. 10 The court assumes the parties’ familiarity with the 11 underlying facts, the procedural history, and the issues under 12 consideration. 13 I. Background 14 A. Factual Background 15 In 2014, chapter 11 debtor Pacific Steel Casting Company, 16 now known as Second Street, entered into a Bankruptcy Code §363 17 sale of substantially all of its steel foundry assets to Speyside 18 Fund or its assignee, referred to here as Pacific Steel or the 19 Debtor. The sale was documented with an asset purchase agreement 20 (the “APA”) and approved by the court. In connection with the 21 sale, Pacific Steel assumed Second Street’s collective bargaining 22 agreement with its union and agreed to contribute to the 23 associated multiemployer pension plan (the “MEP”). 24 Under controlling ERISA law, an asset sale of this type 25 would have been deemed a withdrawal by Second Street from the MEP 26 creating an immediate obligation for it to pay the approximately 27 $27 million withdrawal liability owed at that time unless certain 28 Daubert -2- 1 conditions were met. 2 In order to forestall that immediate obligation, the sale 3 was structured to comply with the provisions of ERISA that permit 4 postponing or entirely avoiding this withdrawal liability under 5 certain conditions (the “Contingent Withdrawal Liability”). 6 More than a year following the closing of the sale, Second 7 Street confirmed its chapter 11 plan. The plan was also 8 structured to conform to the ERISA requirements regarding 9 avoiding the Contingent Withdrawal Liability. 10 In order to avoid Second Street’s immediate obligation to 11 pay the Contingent Withdrawal Liability, Pacific Steel had to 12 remain in compliance with certain provisions of ERISA for a 13 period of five years following the sale. One of these provisions 14 was to post a bond payable to the union’s pension trust if 15 Pacific Steel defaulted in its performance of these requirements. 16 In December 2017, the bond provided for the pension trust was 17 canceled by its issuer. This made Second Street’s withdrawal 18 liability no longer contingent. Pacific Steel continued to 19 contribute to the MEP for another year and then ceased operating 20 and filed this chapter 7 case. 21 B. Procedural Background 22 1. First Amended Complaint 23 In the first amended complaint (the “FAC”), Plaintiff 24 alleges that the Speyside Defendants damaged Pacific Steel and 25 its creditors by their improper accounting practices, by making 26 impermissible distributions to its owners, and by breaching their 27 fiduciary duties. Docket No. 70, FAC. Plaintiff also alleges that 28 Daubert -3- 1 UHY knowingly aided and abetted the Speyside Defendants’ breach 2 of their fiduciary duties when it failed to properly audit 3 Pacific Steel’s financial statements. 4 When the sale closed, Pacific Steel accounted for its 5 purchase of the business from Second Street as a “bargain 6 purchase gain.” Plaintiff alleges that this accounting for the 7 transaction was improper and Pacific Steel’s financial statements 8 were thereafter misleading. Plaintiff alleges that there was no 9 bargain purchase gain and Pacific Steel failed to properly 10 account for the Contingent Withdrawal Liability. Docket No. 70, 11 FAC, ¶¶ 11, 61-62. This theoretical construct fuels the 12 allegations that Pacific Steel was insolvent at inception and 13 continuously thereafter, and management’s decisions ensured the 14 company would fail before the five-year period elapsed. She 15 alleges damages of some $40 million. 16 2. Pending Motions for Partial Summary Judgment 17 Plaintiff, joined by Second Street, has filed a motion for 18 summary judgment in which she contends, inter alia, that (1) the 19 doctrines of judicial and equitable estoppel preclude the 20 Speyside Defendants from taking the position that they are not 21 responsible for paying the Contingent Withdrawal Liability; (2) 22 applying rules of contract interpretation to the APA shows that 23 the Speyside Defendants assumed the Contingent Withdrawal 24 Liability (§2.03(b)), or agreed to indemnify Second Street for it 25 (§7.10(a)); (3) if the APA is deemed ambiguous and the court 26 considers extrinsic evidence, it will show that Plaintiff’s 27 interpretation of the APA is correct; (4) the “equities” require 28 Daubert -4- 1 Plaintiff to prevail. Docket No. 172. 2 The Speyside Defendants have moved for partial summary 3 judgment as to the fact of their liability for the Contingent 4 Withdrawal Liability. Docket Nos. 176, 180-183. Plaintiff, joined 5 by Second Street, has filed opposition. Docket Nos. 195-199. The 6 Speyside Defendants have also moved for partial summary judgment 7 as to the amount of that liability if the court finds it exists. 8 Docket No. 178. These motions have been fully briefed. 9 UHY has filed a motion for summary judgment in which it 10 contends that it may not be held liable for knowingly aiding and 11 abetting the breach of fiduciary duty allegedly committed by the 12 Speyside Defendants. Docket Nos. 148-150. The matter is under 13 submission. Docket Nos. 158-159. 14 3. Plaintiff’s Experts 15 Plaintiff has retained two expert witnesses. Austin Wade is 16 identified as her witness for (1) analysis of New Pacific Steel’s 17 “accounting books and records;” (2) opining on the solvency of 18 Pacific Steel from 2014 to the 2019 petition date; and (3) the 19 “harm caused to the Debtor’s business as a result of management 20 decisions.” Docket No. 187, Toral Dec., Ex. 1, Wade Report at 1; 21 Ex. 2, Wade Rebuttal Report. Andrew Mintzer is identified as 22 Plaintiff’s expert witness regarding whether Pacific Steel’s 23 audited financial statements were prepared in accordance with 24 generally accepted accounting principles (“GAAP”) and whether UHY 25 performed its audits in accordance with generally accepted 26 auditing standards (“GAAS”). Docket No. 186, Toral Dec., Ex. 5, 27 Mintzer Report at 1. 28 Daubert -5- 1 II. Legal Standard 2 Rule 702 of the Federal Rules of Evidence
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EDWARD J. EMMONS, CLERK S/ □□□□□ U.S. BANKRUPTCY COURT 5 □□ 2 NORTHERN DISTRICT OF CALIFORNIA □□□ □□□□ Qnes 1 □□□□□ ORL 9 The following constitutes the Memorandum Decision|of the Court. Signed: August 10, 2022 3 4 LOD 6 7 RogerL.Efremsky = | | U.S. Bankruptcy Judge 8 9 10 1] 12 UNITED STATES BANKRUPTCY COURT NORTHERN DISTRICT OF CALIFORNIA, OAKLAND DIVISION 13 14 || In re Case No. 19-40193 15 || PACIFIC STEEL CASTING COMPANY LLC, Chapter 7 16 Debtor. 17} SARAH L. LITTLE, Chapter 7 Trustee, AP No. 19-4057 18 Plaintiff, 19 V. 20 SPEYSIDE FUND, LLC, a Delaware limited liability company, et al., 22 Defendants. 23 24 Memorandum Decision Granting Daubert Motions 25 The Speyside Defendants have filed a motion seeking to 26 || exclude certain parts of the reports of Plaintiff’s expert 27 || witness Austin Wade (the “Wade Reports”). Defendant UHY, LLP 28 Daubert -l1-
1 (“UHY”) has filed a motion seeking to exclude the same parts of 2 the Wade Reports. UHY also seeks to exclude certain parts of the 3 reports of Andrew Mintzer (the “Mintzer Reports”), Plaintiff’s 4 expert witness on auditing issues, because Mr. Mintzer relies on 5 the challenged assumptions and opinions expressed by Austin Wade 6 (collectively, the “Daubert Motions”). Docket Nos. 184-187 and 7 190-192. Plaintiff has filed Opposition. Docket Nos. 212-213. 8 Defendants have filed Replies. Docket Nos. 215 and 219. The 9 matter has been fully briefed. 10 The court assumes the parties’ familiarity with the 11 underlying facts, the procedural history, and the issues under 12 consideration. 13 I. Background 14 A. Factual Background 15 In 2014, chapter 11 debtor Pacific Steel Casting Company, 16 now known as Second Street, entered into a Bankruptcy Code §363 17 sale of substantially all of its steel foundry assets to Speyside 18 Fund or its assignee, referred to here as Pacific Steel or the 19 Debtor. The sale was documented with an asset purchase agreement 20 (the “APA”) and approved by the court. In connection with the 21 sale, Pacific Steel assumed Second Street’s collective bargaining 22 agreement with its union and agreed to contribute to the 23 associated multiemployer pension plan (the “MEP”). 24 Under controlling ERISA law, an asset sale of this type 25 would have been deemed a withdrawal by Second Street from the MEP 26 creating an immediate obligation for it to pay the approximately 27 $27 million withdrawal liability owed at that time unless certain 28 Daubert -2- 1 conditions were met. 2 In order to forestall that immediate obligation, the sale 3 was structured to comply with the provisions of ERISA that permit 4 postponing or entirely avoiding this withdrawal liability under 5 certain conditions (the “Contingent Withdrawal Liability”). 6 More than a year following the closing of the sale, Second 7 Street confirmed its chapter 11 plan. The plan was also 8 structured to conform to the ERISA requirements regarding 9 avoiding the Contingent Withdrawal Liability. 10 In order to avoid Second Street’s immediate obligation to 11 pay the Contingent Withdrawal Liability, Pacific Steel had to 12 remain in compliance with certain provisions of ERISA for a 13 period of five years following the sale. One of these provisions 14 was to post a bond payable to the union’s pension trust if 15 Pacific Steel defaulted in its performance of these requirements. 16 In December 2017, the bond provided for the pension trust was 17 canceled by its issuer. This made Second Street’s withdrawal 18 liability no longer contingent. Pacific Steel continued to 19 contribute to the MEP for another year and then ceased operating 20 and filed this chapter 7 case. 21 B. Procedural Background 22 1. First Amended Complaint 23 In the first amended complaint (the “FAC”), Plaintiff 24 alleges that the Speyside Defendants damaged Pacific Steel and 25 its creditors by their improper accounting practices, by making 26 impermissible distributions to its owners, and by breaching their 27 fiduciary duties. Docket No. 70, FAC. Plaintiff also alleges that 28 Daubert -3- 1 UHY knowingly aided and abetted the Speyside Defendants’ breach 2 of their fiduciary duties when it failed to properly audit 3 Pacific Steel’s financial statements. 4 When the sale closed, Pacific Steel accounted for its 5 purchase of the business from Second Street as a “bargain 6 purchase gain.” Plaintiff alleges that this accounting for the 7 transaction was improper and Pacific Steel’s financial statements 8 were thereafter misleading. Plaintiff alleges that there was no 9 bargain purchase gain and Pacific Steel failed to properly 10 account for the Contingent Withdrawal Liability. Docket No. 70, 11 FAC, ¶¶ 11, 61-62. This theoretical construct fuels the 12 allegations that Pacific Steel was insolvent at inception and 13 continuously thereafter, and management’s decisions ensured the 14 company would fail before the five-year period elapsed. She 15 alleges damages of some $40 million. 16 2. Pending Motions for Partial Summary Judgment 17 Plaintiff, joined by Second Street, has filed a motion for 18 summary judgment in which she contends, inter alia, that (1) the 19 doctrines of judicial and equitable estoppel preclude the 20 Speyside Defendants from taking the position that they are not 21 responsible for paying the Contingent Withdrawal Liability; (2) 22 applying rules of contract interpretation to the APA shows that 23 the Speyside Defendants assumed the Contingent Withdrawal 24 Liability (§2.03(b)), or agreed to indemnify Second Street for it 25 (§7.10(a)); (3) if the APA is deemed ambiguous and the court 26 considers extrinsic evidence, it will show that Plaintiff’s 27 interpretation of the APA is correct; (4) the “equities” require 28 Daubert -4- 1 Plaintiff to prevail. Docket No. 172. 2 The Speyside Defendants have moved for partial summary 3 judgment as to the fact of their liability for the Contingent 4 Withdrawal Liability. Docket Nos. 176, 180-183. Plaintiff, joined 5 by Second Street, has filed opposition. Docket Nos. 195-199. The 6 Speyside Defendants have also moved for partial summary judgment 7 as to the amount of that liability if the court finds it exists. 8 Docket No. 178. These motions have been fully briefed. 9 UHY has filed a motion for summary judgment in which it 10 contends that it may not be held liable for knowingly aiding and 11 abetting the breach of fiduciary duty allegedly committed by the 12 Speyside Defendants. Docket Nos. 148-150. The matter is under 13 submission. Docket Nos. 158-159. 14 3. Plaintiff’s Experts 15 Plaintiff has retained two expert witnesses. Austin Wade is 16 identified as her witness for (1) analysis of New Pacific Steel’s 17 “accounting books and records;” (2) opining on the solvency of 18 Pacific Steel from 2014 to the 2019 petition date; and (3) the 19 “harm caused to the Debtor’s business as a result of management 20 decisions.” Docket No. 187, Toral Dec., Ex. 1, Wade Report at 1; 21 Ex. 2, Wade Rebuttal Report. Andrew Mintzer is identified as 22 Plaintiff’s expert witness regarding whether Pacific Steel’s 23 audited financial statements were prepared in accordance with 24 generally accepted accounting principles (“GAAP”) and whether UHY 25 performed its audits in accordance with generally accepted 26 auditing standards (“GAAS”). Docket No. 186, Toral Dec., Ex. 5, 27 Mintzer Report at 1. 28 Daubert -5- 1 II. Legal Standard 2 Rule 702 of the Federal Rules of Evidence provides: 3 A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form 4 of an opinion or otherwise if: 5 (a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the 6 evidence or to determine a fact in issue; 7 (b) the testimony is based on sufficient facts or data;
8 (c) the testimony is the product of reliable principles and methods; and 9 (d) the expert has reliably applied the principles and 10 methods to the facts of the case. 11 Plaintiff has the burden of establishing that her experts’ 12 testimony is relevant, reliable, and admissible. Lust ex rel. 13 Lust v. Merrell Dow Pharms., Inc., 89 F.3d 594, 598 (9th Cir. 14 1996); Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579, 597 15 (1993); Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999). 16 The court acts as a gatekeeper in this context and must 17 determine that the expert used proper methods, and adequately 18 explained them. United States v. Hermanek, 289 F.3d 1076, 1093 19 (9th Cir. 2002) (court considers whether methodology underlying 20 expert’s testimony is valid and can be applied to facts in issue; 21 bare qualification alone does not establish admissibility); In re 22 Countrywide Fin. Corp. Mortg.-Backed Sec. Litig., 984 F.Supp.2d 23 1021, 1026 (C.D. Cal. 2013) (court must assure expert used 24 sufficient data, employed reliable methods, applied them to data 25 in reliable way). The court exercises its discretion here with a 26 degree of flexibility in applying Rule 702 and must consider 27 whether vigorous cross-examination is a preferable way to deal 28 Daubert -6- 1 with “shaky but admissible” expert testimony. Daubert, 509 U.S. 2 at 598. However, if there is too great an “analytical gap” 3 between the expert’s data and the offered opinion, the court may 4 exclude the opinion. General Elec. Co. v. Joiner, 522 U.S. 136, 5 146 (1997). 6 III. Discussion 7 The Speyside Defendants have moved to exclude (1) certain of 8 Mr. Wade’s opinions because he and Plaintiff’s counsel 9 acknowledged at his deposition that they were beyond his 10 expertise; (2) Mr. Wade’s “probability of failure” determinations 11 because they are not based on any discernible methodology and 12 thus are not reliable; (3) Mr. Wade’s factual narrative because 13 this sort of “story” - not based on first hand knowledge of any 14 events but on his weighing of the evidence - is not the province 15 of an expert, and he may not opine on the motives or subjective 16 belief of the Defendants. The Speyside Defendants argue that 17 these opinions in the Wade Reports must be excluded as violative 18 of Rule 702 and the Daubert standard. UHY argues that the court 19 should exclude these aspects of the Wade Reports and should also 20 exclude the opinions in the Mintzer Reports that rely on Mr. 21 Wade’s probability of failure analysis. Docket No. 191, Quadrozzi 22 Dec., Ex. D, Mintzer Report, inter alia, ¶¶ 86-93, 113. 23 In response, Plaintiff contends that both Wade Reports 24 comply with the Daubert standard in every respect and Mr. Wade 25 may be challenged on cross-examination to deal with any weakness 26 in his work. Plaintiff also argues that UHY has waived any 27 Daubert objection because it failed to do so before its motion 28 Daubert -7- 1 for summary judgment was fully briefed. (This argument lacks 2 merit and the court dismisses it without further discussion.) 3 The court will address each challenged category of the Wade 4 Reports in turn. 5 A. Opinions Disclaimed at Deposition 6 An expert may not testify on topics that the expert and his 7 counsel concede are beyond his expertise. Pension Comm. of Univ. 8 of Montreal Pension Plan v. Banc of Am. Sec. LLC, 691 F.Supp.2d 9 448, 461 n.65 (S.D.N.Y. 2010) (expert may not testify on matters 10 on which expert is not offered); Madison v. Courtney, No. 18-cv- 11 00671, 2019 WL 8263428, at *5 (N.D. Tex., Jan. 26, 2011) (expert 12 may not testify on matters disclaimed by counsel). This sensible 13 - and unassailable - rule applies here and limits both the Wade 14 Reports. 15 The Wade Report starts with the premise that Pacific Steel 16 “assumed via indemnification” the Contingent Withdrawal 17 Liability. The Report says, in the APA “Pacific Steel agreed to 18 indemnify and hold [Second Street] harmless (assume) from any 19 liability of [Second Street] caused by [Pacific Steel’s] 20 withdrawal from the pension plans.” Docket No. 186, Toral Dec., 21 Ex. 1, Wade Report at 10. This statement is obviously an 22 interpretation of the APA. At his deposition, Mr. Wade and 23 Plaintiff’s counsel agreed he was not offered to interpret the 24 APA, acknowledging that it was inappropriate to do so. Docket No. 25 212, Bagdanov Dec., Ex. 1, Wade Deposition Transcript 17:24-18:1 26 (hereafter, Wade Tr.). 27 At his deposition Mr. Wade also backtracked on whether this 28 Daubert -8- 1 was, in fact, an opinion. He stated it was merely his 2 “understanding” that Pacific Steel “assumed [Second Street’s] 3 contingent withdrawal liability via indemnification.” Wade Tr. 4 18:15-19:2. He also said “[i]t was his “general understanding” 5 that “they are on the hook for it.” Wade Tr. 20:10-13. 6 Plaintiff’s attorney confirmed this as well, interjecting: “his 7 assumptions are that there is an indemnification ... he is not 8 going to opine on the interpretation of the APA.” Wade Tr. 18:9- 9 16. 10 Despite this disclaimer, the Wade Report starts with the 11 opinion that Pacific Steel assumed the Contingent Withdrawal 12 Liability by agreeing to indemnify Second Street for it under the 13 APA. Wade Report at 10-13. The Report then proceeds to criticize 14 Pacific Steel’s financial statements because they do not conform 15 to his premise: “I could find no reference to this 16 indemnification obligation, either by means of disclosure or 17 valuation, nor could I find any justification for the Debtor’s 18 failure to identify and quantify this obligation.” Wade Report at 19 11. He states the “contingent indemnification obligation” should 20 have been booked “consistent with GAAP requirements.” Id. At his 21 deposition, however, he admitted he was not an expert on the 22 relevant GAAP requirements and stated he deferred to Plaintiff’s 23 other expert on this issue. Wade Tr. 246:7-23 (“I probably 24 wouldn’t represent myself as an expert in GAAP standards”); 25 208:3-24 (“I never argued in my report that the Debtor needed to 26 book that liability...that’s a GAAP issue. That’s in Andy’s 27 report.”). 28 Daubert -9- 1 The Wade Report also offers an opinion on the operation of 2 ERISA §4204: “Pacific Steel’s indemnification obligation and pre- 3 acquisition contingent withdrawal liabilities were liabilities 4 assumed by [Pacific Steel] in the asset sale; when the bond was 5 canceled the contingent withdrawal liability became actual.” Wade 6 Report at 40-41. The Wade Report also criticizes the Speyside 7 Defendants’ expert: “Defendants’ expert does not adequately 8 examine the probability that the withdrawal liability assumed via 9 indemnification would be triggered.” Docket No. 186, Toral Dec., 10 Ex. 2, Wade Rebuttal Report at 2. 11 At his deposition, Mr. Wade and Plaintiff’s counsel again 12 backtracked and admitted that Mr. Wade was not offered as an 13 ERISA expert and had no relevant expertise in this area. However, 14 Mr. Wade claimed it was his “understanding and my opinion that 15 when the pension bond was terminated that the contingent 16 liability is going to become real.” Wade Tr. 69:16-21. This is 17 not sufficient - his understanding of this legal issue is not the 18 proper subject of an expert’s opinion and he has admitted he has 19 no expertise to support this opinion. 20 Mr. Wade also criticizes the fact that Pacific Steel 21 accounted for its purchase from Second Street as a “bargain 22 purchase gain” and accuses Pacific Steel of, inter alia, using 23 this accounting to conceal its “balance sheet insolvency.” Wade 24 Report at 1, 10-13. “Had the debtor properly accounted for and 25 disclosed the contingent indemnification obligation ... then it 26 would not have been possible to book the ... bargain purchase 27 gain.” Wade Report at 13. This opinion is necessarily premised on 28 Daubert -10- 1 the application of GAAP standards. Because Mr. Wade disclaimed 2 expertise on application of GAAP standards this opinion does not 3 comport with Rule 702 or Daubert. Nonetheless, at his deposition, 4 he persisted: “in my opinion, if it was disclosed properly, it 5 wouldn’t have been possible to book the bargain purchase gain.” 6 Wade Tr. 208:17-24. This opinion fails to pass the test required 7 for its admissibility. Because he disclaimed expertise on GAAP 8 standards, he may not opine on whether it was “disclosed 9 properly.” 10 In defense of Mr. Wade’s opinion regarding the propriety of 11 booking this bargain purchase gain, despite his stated lack of 12 expertise regarding GAAP, Plaintiff argues that “his conclusion 13 on that issue is not being offered as an opinion per se but as 14 part of his critical analysis of key Debtor documents he 15 considered in performing his insolvency analysis.” Docket No. 16 212, Oppo. at 25. This is singularly unhelpful, it clarifies 17 nothing, and it fails to rebut Defendants’ arguments. 18 The Wade Reports also offer the opinion that UHY’s audits 19 were inadequate and the disclosures regarding the Contingent 20 Withdrawal Liability in Pacific Steel financial statements were 21 inadequate or materially misleading as a result of UHY’s alleged 22 failings as an auditor. Wade Report at 33-37. Mr. Wade claims 23 UHY’s disclosures “related solely to going forward liabilities 24 ... but did not include any disclosure or valuation of [Pacific 25 Steel’s] agreement to indemnify [Second Street] for [Second 26 Street’s] pre-acquisition withdrawal liabilities or [Pacific 27 Steel’s] obligation to post a bond.” Wade Report at 12-13. He 28 Daubert -11- 1 also opines that “the UHY audit work papers indicate that the UHY 2 audit was grossly inadequate.” Wade Report at 45-46. 3 At his deposition, Mr. Wade admitted he was not an expert on 4 auditing issues and Plaintiff’s counsel confirmed that 5 Plaintiff’s other expert, Andrew Mintzer, was designated for 6 auditing issues. Wade Tr. 234:11-19 (typically wouldn’t opine on 7 audit standards); 235:11-13 (will stipulate Wade not an audit 8 expert); 238:15-16 (we will not proffer him as an UHY audit 9 expert). 10 In opposition to this motion, Plaintiff again tries to 11 disavow her disavowal. She now contends that Mr. Wade’s opinions 12 on “potential defects” in the UHY audits are admissible because 13 these are not opinions on “complex audit issues” and Defendants 14 “overlook the nuance involved in Mr. Wade’s analysis.” Oppo. at 15 27. Mr. Wade “observed” that the auditors “did not adequately 16 test inventory or adequately disclose a large contingent 17 liability,” and because he is a certified fraud examiner, it is 18 “perfectly reasonable” for him to opine on how Pacific Steel’s 19 financial statements “were manipulated despite being audited.” 20 Oppo. at 27. Plaintiff digs herself deeper into this unfortunate 21 hole by claiming that Mr. Wade’s opinions on UHY’s audit work are 22 merely offered to support his insolvency analysis and are not 23 offered as an “ultimate opinion on the robustness of an audit” 24 and he is not offering a “formal opinion” on UHY. Id. 25 Mr. Wade stated he was not an expert on auditing standards. 26 Plaintiff’s counsel stated Mr. Wade would not testify regarding 27 UHY’s auditing. It is not “perfectly reasonable” to backtrack in 28 Daubert -12- 1 this fashion; it is not “perfectly reasonable” for Mr. Wade to 2 opine on whether the audits involved “adequate testing” or 3 “adequate disclosure” which then permitted “manipulated” 4 financial statements. 5 The court agrees with Defendants that Mr. Wade may not offer 6 opinions on UHY’s audits - whether they are described as ultimate 7 or formal - he has disclaimed his expertise on this topic and may 8 not now reverse that. The Wade Reports’ opinions on auditing 9 issues are inadmissible. 10 Plaintiff also claims Mr. Wade may offer his opinions as an 11 “experiential expert” citing United States v. Wilson, 484 F.3d 12 267 (4th Cir. 2007). This simply does not work here in light of 13 the fact that Andrew Mintzer is Plaintiff’s expert on auditing 14 issues and Mr. Wade’s experience as an accountant - in and of 15 itself - does not make his statements relevant or reliable. 16 The court finds inadmissible the opinions Mr. Wade and 17 Plaintiff’s counsel stated were beyond his expertise. These 18 include (1) the application of GAAP standards, including the 19 propriety of accounting for the purchase as a bargain purchase 20 gain, and the GAAP rules for accounting for contingent 21 liabilities; (2) applicable auditing standards, their performance 22 or the failure of performance; (3) the interpretation or meaning 23 of any provisions of the APA; and (4) the operation of ERISA as 24 it pertains to the APA. 25 B. Probability Determinations 26 The Speyside Defendants describe a key issue in this case as 27 follows: “Assuming Pacific Steel bore the Second Street seller 28 Daubert -13- 1 withdrawal liability, the particular likelihood of it becoming 2 non-contingent at key measurement dates in 2014, 2015, and 2016.” 3 Docket No. 184, Motion at 14. 4 This question is relevant for two issues: the accuracy of 5 Pacific Steel’s financial statements and its solvency at 6 different measurement dates. Painting with an extremely broad 7 brush, under GAAP, contingent liabilities must be disclosed on 8 financial statements if they are reasonably possible and their 9 fair value must be booked if they are probable. Plaintiff’s other 10 expert Andrew Mintzer and Defendants’ expert Jimmy Pappas agreed 11 that in this context, probable means 70%. See Mintzer Report at 12 19 n.94. 13 For accounting purposes, the fair value of a contingent 14 liability is determined by reducing its gross amount according to 15 its probability. Matter of Xonics Photochemical, Inc., 841 F.2d 16 198, 200 (7th Cir. 1988). For solvency analysis purposes, the 17 fair value of a contingent liability is determined in the same 18 way. In re Imagine Fulfillment Servs., LLC, No. Adv. 12-1514, 19 2014 WL 3867531, *5 (9th Cir. BAP Aug. 6, 2014) (amount of 20 contingent claim is determined by probability contingency will 21 occur; final state court judgment was noncontingent debt for 22 purposes of assessing solvency). 23 In his Reports, Mr. Wade opines on this probability question 24 in his analysis of Pacific Steel’s solvency. He starts by 25 assuming that Pacific Steel “took on” a $26.7 million contingent 26 withdrawal liability through the APA and the contingency period 27 was five years. Wade Report 40-42. (The Wade Reports describe 28 Daubert -14- 1 this as a 70-month period. ERISA §4204(a)(1)(B) and (C) refer to 2 “five plan years.” The court understands this contingency period 3 to have run to June 30, 2022.) “For solvency analysis balance 4 sheet test purposes, I added a contingent liability to the 5 balance sheet with fair value calculated at the estimated 6 contingent liability gross amount multiplied by the estimated 7 chance of business failure within the first 70 months.” Wade 8 Report at 41. He then posits a probability range for the 9 likelihood of business failure - from 50% at inception in 2014 to 10 100% by the end of 2017 - to calculate the fair value of the 11 alleged contingent indemnification obligation. Wade Report at 41 12 (50% in 8/14, 60% by 12/14, 70% by 4/15, 80% by 12/15, 90% by 13 2016, 100% by end of 2017). He claims this probability range of 14 50% to 100% is appropriate because “approximately 50% of 15 businesses fail with the first five years” and “most importantly, 16 the business did in fact fail within 70 months.” Wade Report at 17 41, 42 n.2 (listing 12 factors he used to calculate “the fair 18 value of this indemnification obligation”). 19 The Speyside Defendants and UHY contend this opinion is 20 inadmissible under Rule 702 because Mr. Wade applied no 21 discernable methodology for his probability analysis. NetFuel, 22 Inc. v. Cisco Sys., Inc., No. 18-cv-02352, 2020 WL 1274985, at *7 23 (N.D. Cal. Mar. 17, 2020 (noting experts must follow some 24 discernable methodology and courts’ condemnation of percentages 25 plucked out of thin air); Rondor Music Int’l Inc. v. TVT Recs. 26 LLC, No. CV 05-2902, 2006 WL 5105272, at *3-5 (C.D. Cal. Aug. 21, 27 2006) (excluding opinion where methodology difficult to 28 Daubert -15- 1 ascertain); Castagna v. Newmar Corp., No. 15-cv-249, 2020 WL 2 525936, at *3-4 (N.D.Ind. Feb.3, 2020 (report excluded where 3 opinion formed in black box without explanation of how factors 4 were evaluated). 5 In fact, Mr. Wade admitted his probability determinations 6 were arrived at “shooting from the cuff” and were based on common 7 knowledge and his years of experience as a forensic accountant 8 rather than any testable criteria. Wade Tr. 36:5-25 (common 9 knowledge, general understanding new businesses fail); 47:20- 10 48:15 (shooting from the cuff). The Report identifies a number of 11 factors that contributed to this increasing likelihood-of-failure 12 analysis but Mr. Wade could not identify how each factor 13 contributed to each of the incremental increases he applied. Wade 14 Tr. 53:10-16 (confirms used no testable criteria). Mr. Wade also 15 admitted he did not do - and could not do - the industry- 16 recognized tests employed by the Speyside Defendants’ expert. See 17 Report of the Speyside Defendants’ expert Jimmy Pappas employing 18 industry-standard methodologies known as synthetic credit score 19 test and Altman Z Score analysis. Docket No. 187, Pappas Report. 20 UHY also contends that the opinions in the Mintzer Reports 21 that adopt Wade’s unreliable opinions regarding probability of 22 failure must also be excluded. Pavo Sols., LLC v. Kingston Tech. 23 Co., Inc., 2019 WL 8138163, at *3 (C.D. Cal. Nov. 20, 2019). At 24 his deposition, Mr. Mintzer admitted he relied on these opinions 25 - business failure 50% likely at inception in 2014 and increasing 26 incrementally until it reached 100% likely in 2017 and did then 27 fail - with no testing and such testing would have been beyond 28 Daubert -16- 1 his expertise. Docket No. 191, Quadrozzi Dec., Ex. E, Mintzer 2 Deposition Tr. 51:3-5, 63-65, 149. 3 In response to the Defendants’ arguments, Plaintiff insists 4 Mr. Wade may opine as he has done because he identifies all the 5 facts he considered and he uses Pacific Steel’s business records 6 to “tell a story of what actually happened.” Oppo. at 13. 7 Plaintiff claims that the Speyside Defendants unfairly forced Mr. 8 Wade to try to assign percentages to each of the factors he 9 identified in his analysis but he explained this was impossible 10 to do. Oppo. at 16. 11 Plaintiff’s response is not convincing. Mr. Wade’s 12 probability-of-failure determinations may have been based on his 13 review of thousands of documents but they were not based on any 14 reliable principles or discernable methods. They do appear to 15 emerge from a black box which means they are too unreliable and 16 subjective to be of any assistance to the court. Accordingly, 17 they must be excluded. The Mintzer Report opinions that adopt and 18 rely on the Wade Report’s probability of failure opinions are 19 also excluded. 20 C. Factual Narrative and Interpretations 21 The Speyside Defendants and UHY also object to the parts of 22 the Wade Reports that they contend are factual characterizations 23 presented in the guise of independent expertise. Highland Cap. 24 Mgmt., L.P. v. Schneider, 379 F.Supp.2d 461, 469 (S.D.N.Y. 2005) 25 (excluding factual narrative covering lay matters); In re 26 Lyondell Chem. Co., 558 B.R. 661, 668-69 (Bankr. S.D.N.Y. 2016) 27 (excluding chronology and editorialized excerpts from emails). 28 Daubert -17- 1 They also object to the Wade Reports’ use of a factual narrative 2 to opine on the subjective belief of the Defendants or their 3 motivations or intent. Aya Healthcare Servs., Inc. v. AMN 4 Healthcare, Inc., No.17-cv-205, 2020 WL 2553181, at *6 (S.D. Cal. 5 May 20, 2020), (expert testimony regarding intent impermissible), 6 aff’d, 9 F.4th 1102 (9th Cir. 2021); Lippe v. Bairnco. Corp., 288 7 B.R. 678, 687 (Bankr. S.D.N.Y. 2003) (expert may not offer 8 personal evaluation of testimony or credibility of others), 9 aff’d, 99 F.App’x 274 (2d Cir. 2004). 10 The Speyside Defendants cite several places in the Wade 11 Reports that they claim offend these principles. Examples include 12 the factual characterizations in the “Timeline of Significant 13 Events” (Wade Report at 6-7, Rebuttal Report at 9); his statement 14 that “overstatement [of inventory value] was intentional” and 15 “designed to mislead” (Wade Report at 22); his statement that the 16 insiders damaged the Debtor because the Debtor materially 17 misrepresented its financials (Id. 44); his analysis of 18 deposition testimony to opine on the reasons for Debtor’s 19 ownership structure (Id. 14). The Speyside Defendants argue that 20 this is not the province of an expert and Mr. Wade may not opine 21 on or offer his interpretation of the motivations or state of 22 mind of the Speyside Defendants. 23 In opposition, Plaintiff argues Mr. Wade is just “telling a 24 story of what actually happened” based on his review of Debtor’s 25 books and records and publicly available sources. Oppo. at 17. 26 “What actually happened” will be determined at trial. This sort 27 of recitation is not appropriate for expert testimony. The Wade 28 Daubert -18- 1 Reports will be limited to exclude this sort of impermissible 2 content which is not limited to the illustrative examples cited. 3 IV. Conclusion 4 The court has carefully considered whether any arguable 5 flaws in the Wade Reports should be dealt with by cross- 6 examination rather than exclusion but finds this is not 7 appropriate on this record. Accordingly, the parts of both Wade 8 Reports opining on GAAP standards, auditing standards under GAAS, 9 the interpretation of the APA, including indemnification issues 10 and contingent withdrawal liability issues, and the operation of 11 ERISA are excluded. The Wade Reports’ analysis and opinions 12 regarding the probability of failure is also unreliable and 13 therefore excluded. To the extent the Mintzer Reports are based 14 on these excluded aspects of the Wade Reports, they are also 15 excluded. Finally, the inappropriate factual narratives and 16 opinions regarding Defendants’ motivations or intentions in the 17 Wade Reports are also excluded. 18 The court requests that Defendants submit orders granting 19 their respective Daubert Motions. 20 21 22 * * * * * * End of Memorandum Decision * * * * * * 23 24 25 26 27 28 Daubert -19- 1 Court Service List 2 None required. 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Daubert -20-