New South Wales Supreme Court CITATION : Idoport Pty Limited & Anor v National Australia Bank Limited & 8 Ors; Idoport Pty Limited & Market Holdings Pty Limited v Donald Robert Argus; Idoport Pty Limited "JMG" v National Australia Bank Limited & Ors. [42] [2001] NSWSC 939 FILE NUMBER(S) : SC 50113/98; 50026/99; 3991/00 HEARING DATE(S) : 22/10/01, 23/10/01 JUDGMENT DATE : 30 October 2001 Idoport Pty Limited (Plaintiff) PARTIES : National Australia Bank Limited (Defendant) Donald Robert Argus (Defendant) JUDGMENT OF : Einstein J COUNSEL : Mr R Titterton (Plaintiffs) Mr J Sackar QC, Mr J Halley (Defendants) SOLICITORS : Withnell Hetherington (Plaintiffs) Freehills (Defendants) CATCHWORDS : Opinion Evidence DECISION : Supplementary judgment on expertise relating to valuation opinions given. IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION – Commercial list Einstein J 30 October 2001 50113/98 Idoport Pty Limited & Anor v National Australia Bank Limited and 8 Ors 50026/99 Idoport Pty Limited & Market Holdings Pty Limited v Donald Robert Argus 3991/00 Idoport Pty Limited "JMG" v National Australia Bank Limited & Ors. Judgment on valuation issues 1 The judgment delivered on 21 March 2001 ([2001] NSWSC 123) dealt in paragraphs 245 - 251 with the question of Mr Maconochie's suggested expertise in relation to valuation issues and the like. A number of questions have now arisen as to the application of those reasons to particular paragraphs of Mr Maconochie statements. This judgment deals with those questions. 2 The burden of the defendant submission is that the court has held that Mr Maconochie has the specialised knowledge on the basis of which, whether wholly or substantially, to express opinions in relation to the potential or actual revenues and costs associated with the Ausmaq Service inasmuch as these relate to the commercial potential of Ausmaq in certain markets. The submission is that the court has held that Mr Maconochie does not have specialised knowledge on the basis of which, whether wholly or substantially, to press opinions that go to the issue of value of Ausmaq or JMG. 3 The defendants then take issue with Mr Maconochie's entitlement to express any opinions as to discount rates; the potential cost to income ratio of the Ausmaq Service; the likely value of the performance bonus payable to JMG and the appropriate price-earnings multiple for the valuation of the NMG and hence JMG. 4 The defendants' submissions deal closely with the true nature of a discount rate, a cost to income ratio, and a price - earnings multiple. In essence the submission is that selection of an appropriate discount rate is an exercise which, for the purposes of calculating damages by a court, requires to be undertaken only by accounting experts. Likewise in essence the submission is that calculation of a cost to income ratio is an exercise of accounting expertise. Likewise the submission is that price-earnings multiples are a method of calculating the value of a business based on its present day earnings and that use of this method is clearly a valuation exercise. As to the question of the performance bonus payable to JMG, the essence of the submission is that a close understanding of the Consulting Agreement throws up the fact that calculation of a performance bonus involves a number of parameters constituting a valuation exercise requiring accounting expertise. 5 The defendants detailed submissions in this regard were in the following terms: " Discount Rates A discount rate is the rate applied to a cash amount payable in the future in order to calculate the value of the amount in present day terms. It is used by Mr Maconochie to convert AUSMAQ's potential 2003 revenue to a 1999 amount for the purposes of valuing performance bonuses and/or buyout amounts allegedly payable to JMG. Selection of an appropriate discount rate is an exercise that, for the purposes of calculating damages for a court , should be undertaken only by accounting experts. Even where expert accountants do undertake such an exercise the correct rate is often the subject of debate (see for example P M Sulcs & Associates Pty Ltd v Daihatsu Australia Pty Ltd [2001] NSWSC 636 per Kirby J. at paragraphs 815-816 and 903-909. Note that Mr Maconochie addresses none of the points raised by the expert accountants in this case). The application of discount rates to revenue projections is clearly a valuation exercise going outside the field of "opinions going to market share of a particular product or Service including anticipated cash flow and cost projections ", the limit of matters on which His Honour found Mr Maconochie was entitled to express opinions. This is exercise is undertaken, and is the only exercise undertaken, in paragraph 9.64 of Mr Maconochie's Fifth Statement. On a correct application of His Honour's rulings, these opinions should be rejected. Cost to Income Ratio Mr Maconochie expresses opinions about the cost to income ratio of NMG in the contexts of calculation of the performance bonus and of valuation of the AUSMAQ business. Cost to Income Ratio is a term defined in the Consulting Agreement: "Cost to income ratio means operating costs for the relevant financial year divided by gross operating revenue for the relevant financial year" (Schedule 2). Operating costs are in turn defined as: "the total expenses of the relevant Operating Entity as calculated in the determination of net profit or loss in the accounts and excluding: a) any extraordinary items, income tax or losses on the sale of non-current assets; b) any financing charges (including, without limitation, interest expense); c) any administration charges which are not on arms length terms in the ordinary course; d) the amount of any Performance Bonus payable; e) any amount to which section 3 above applies; and f) any royalties payable to the Company in respect of the System IP Rights (except to the extent that such royalties are solely to reimburse the Company for third party license costs incurred by the Company in respect of the System IP Rights)." Gross operating revenue is further defined as: "sales revenue of the relevant Operating Entity derived in accordance with approved Australian accounting standards from time to time as set out in the profit and loss statement in the accounts and excluding any extraordinary items." Calculation of the cost to income ratio is an exercise of accounting expertise. As the above definitions show, it involves calculation of gross operating revenue and operating costs, which in turn require calculation of "total expenses" (including determination of net profit or loss) and sales revenue (according to approved Australian accounting standards) excluding extraordinary items . These are calculations which can only be carried out by an expert accountant. The exact definitions of many of the terms are a matter of dispute even between such experts. This forms the basis of expert evidence in this case, in the expert reports of: Mark Bryant, dated 28 March 2000; Phillip Cox, dated 6 July 2000; Geoffrey Kirk, dated 11 July 2000; Hugh McMullan, dated 11 July 2000; and Mark Bryant, dated 11 October 2000. Such an exercise falls within the meaning of "applying the underlying facts and assumptions requisite to be made in order to finally, as a bottom line as it were, express opinions, as for example in relation to the valuation of Ausmaq or the valuation of JMG by reference to the buyout provisions of the Consulting Agreement" (Maconochie Expertise Judgement, 251). Mr Maconochie was found not to have the requisite specialised knowledge to express opinions in this area. Nevertheless, he expresses opinions of this kind in the following paragraphs: Paragraphs 9.65, 9.66, 11.7 and 11.8 of his Fifth Statement dated 9 June 1999; and Paragraphs 46 and 47 (including subparagraphs) of his Statement in Reply to Mr Turner dated 11 September 2000. On a correct application of His Honour's rulings, these opinions should be rejected. Performance Bonuses In broad terms, the performance bonus payable to JMG is a percentage of the gross operating revenue of NMG. This percentage is determined by reference to the cost to income ratio of NMG, so that a full bonus is payable where the cost to income ratio is 0.45 or lower, no bonus is payable where it is 0.85 or more and a reduced bonus is payable on a sliding scale where the cost to income ratio is between 0.45 and 0.85. Because the performance bonus is a function of gross operating revenue, and because of the relevance of the cost to income ratio to it, calculation of the performance bonus is an exercise of accounting expertise. As set out above in the section headed "cost to income ratio", many of the values needed to complete these calculations are calculated by reference to definitions which must be interpreted by expert accountants. These include gross operating revenue, operating costs, total expenses, net profit or loss, sales revenue and extraordinary items. The correct method of interpreting these terms and thus calculating performance bonuses is an issue in dispute between the parties and is the subject of expert evidence as set out in paragraphs 16.1-16.5 above. Calculation of performance bonuses is therefore a valuation exercise of the kind Mr Maconochie is not permitted to conduct, involving as it does accounting expertise and relating, as it does, to the bottom line valuation of AUSMAQ . Mr Maconochie expresses opinions regarding the value of performance bonuses allegedly lost to JMG in the following places: Paragraph 6.3.1 of his Fourth Statement dated 24 May 1999; and Paragraphs 6.3.1, 6.3.3 (second time appearing), 9.65, 11.6 (last sentence) of his Fifth Statement dated 9 June 1999. On a correct application of His Honour's rulings, these opinions should be rejected. Price-Earnings Multiples Price-earnings (PE) multiples are a method of calculating the value of a business based on its present day earnings . The multiples method of valuation is not the only commonly used method of doing this. In P M Sulcs & Associates Pty Ltd v Daihatsu Australia Pty Ltd [2001] NSWSC 636 and [2001] NSWSC 798, neither party's valuation expert selected this method (see judgements of Kirby J dated 1 August 2001 at paragraphs 811-815 and dated 13 September 2001 at paragraph 4). Mr Maconochie's use of such multiples therefore involves two exercises of opinion. The first is the choice of the appropriate valuation methodology. The second is the selection of an appropriate multiple. Both are most clearly valuation exercises outside those which His Honour permitted Mr Maconochie to conduct. They are the final step in the valuation process and involve assessment of "the different modes of or approaches to valuing the rights to the subject product or Service and as to why one mode or approach is correct or preferable to another mode or approach" and a "bottom line" valuation of AUSMAQ. Mr Maconochie expresses opinions in relation to the choice of PE multiples and the application of such multiples to revenue projections in the following paragraphs: Paragraphs 6.3.2 of his Fourth Statement dated 24 May 1999; and Paragraphs 6.3.4, 6.3.3 (second time appearing), 9.67-9.69 and 11.9-11.17 of his Fifth Statement dated 9 June 1999. On a correct application of His Honour's rulings, these opinions should be rejected." [emphasis added] 6 The plaintiffs on the other hand, draw attention to so much of paragraph 251 of the Maconochie expertise judgment as included the following: "Mr Maconochie has not satisfied the section 79 criteria in that he has simply not been shown to have acquired the necessary specialised knowledge to express the opinions which he seeks to express on the ultimate valuation type issue. This is not however to say that he is not perfectly capable of expressing expert opinions in relation to matters such as anticipated cash flow and costs projections and market penetration and the viability of the Ausmaq System within the particular markets in respect of which on my holdings, he has been shown to be in a position to express expert opinions as to viability . Only at that level is he shown to have the specialised knowledge permitting him to analyse cash flow and cost projectio ns impact of a project on the target market and like concepts". [emphasis added] 7 The plaintiffs also draw attention to paragraphs 155, 211, 241 and 247 of the judgment which were in the following terms: '[155] ' Mr Maconochie's professional training, study and experience have given him an appreciation of and an ability to analyse and assess complex systems and situations and to identify and define objectives and to assess alternative modes of implementing engineering or commercial solutions to meet particular objectives. He has had very considerable experience in relation to computer services and programs. That experience has regularly been focused by reference to the financial services industry and his studies and analysis of parameters of that industry and of the possibilities with respect to utilising computer and computerised functionality have been shown to be extensive and long-standing . He has had a detailed involvement with and formed an ability to assess customer needs in target markets and target customer segments in financial services industry . He has had extensive experience in the exercise of having to describe, assess classify and carry out analyses of financial services in terms of a range of reference points including purpose, business objectives, service facilities, features, products and to a certain extent, regulatory requirements. He has had intensive and extensive involvement in the analysis of documents describing e-commerce financial services and in relation to determination of functionality, objectives and strategy of e-commerce financial services. [211] The evidence establishes that his professional experience has included computer-based analysis and research involving complex mathematical models of physical and commercial systems, and applying that experience in the conception, analysis, design and realisation of new projects and services. The evidence establishes that he has had a considerable exposure over an extended period of time to financial products and services and a special interest in relation to new and innovative approaches to improving modes of access to and dealings in relation to financial products and services and markets. Clearly the evidence establishes that he has had considerable occasion to carefully contemplate matters of this type. The evidence establishes considerable reading by him on matters of this type and establishes research and enquiries by him at a number of levels at different points in time generally in relation to both financial products and services and in relation to new and innovative approaches to improving modes of access to and dealings in relation to financial products and services and markets. [241] I return to the simple fact that the clear burden of a very great deal of the opinions which Mr Maconochie seeks to express on the markets/valuation issues relate in one way or another to the prospects for success of what both parties appear to accept as being the 'novel' Ausmaq proposition in the established financial markets around the world. To my mind in the very unusual circumstances of the issue as raised in these proceedings, Mr Maconochie's training, study or experience in the terms in which he has expressed it does demonstrate that he has acquired sufficient knowledge of the United States relevant markets as to be in a position to express expert class "d" opinions by way of an assessment of the detailed prospects for success of the introduction of the Ausmaq service into the United States markets . [Without being exhaustive I intend this finding to extend to cover expression of opinions as to the ascertainment of United States addressable markets and their extent, likely market penetration and prediction of market success] In reaching this view I have taken into account the extent to which Mr Maconochie is entitled to rely upon the full extent as sworn to, of his own study and analysis (weighed in the light of his further inquiries and obtaining of information in relation to particular research and in light of the background of his antecedent adjectival knowledge, such as it was in relation to the United States markets) of books and materials on a number of areas as having furthered his store of knowledge upon which to lay claim to having acquired the necessary 'specialised knowledge' . It particularly takes into account his earlier identified training and experience in relation to computer-based analysis and research involving complex mathematical models of physical and commercial systems and applying that experience in the conception, analysis, design and realisation of new projects and services . He has carried on research into the funds management industry in the United States including the structure of that industry. He examined and thought about the books and materials he read. He discussed aspects of the information with the persons identified. In investigating aspects relating to fee issues qua the Country fund proposition, he had the benefit of a volume showing all of the managed funds and investment companies in the United States showing the fees and the nature of the investment management operations. The holding does not however extend to suggest that he has been shown to have acquired specialised knowledge on which to be in a position to wholly or substantially base opinions as to relevant United States regulatory requirements. [247] Hence amongst other areas Mr Maconochie seeks to provide market share estimates for the United States market; purports to undertake an analysis of the United States Mutual Fund markets; purports to set out revenue estimates based on this analysis; purports to express opinions in relation to a number of markets relying upon Cerulli data for market size and for determining addressable markets; estimates Ausmaq market share using a United Kingdom estimate as proxy; endeavours to calculate and to express opinions as to the revenue which NMG would have earned from Ausmaq had it followed the business path set out in JMG business plans; uses more than one method to endeavour to state revenue calculations including using an expected market share; seeks to give evidence in relation to new approaches to the nature of the Ausmaq offering; Ausmaq pricing structure to investors and advisers; Ausmaq superannuation and equities offerings; 'Ausmaq strategic alignment'; comparison between Ausmaq and Master Trusts; NMG cost to income ratio; and purports to express opinions as to the calculation of revenue which NMG would have allegedly earned from the New Zealand market had the business path set out in JMG business plans been followed.' [emphasis added] 8 The proposition for which the plaintiffs contend is that the court has either found and held, or alternatively, it is consistent with courts judgment, that Mr Maconochie possesses specialised knowledge on the basis of which, whether wholly or substantially, to be in a position: · To know [and presumably therefore to be in a position to express an opinion as to] the nature and proper use of and to calculate discount rates · To know [and presumably therefore to be in a position to express an opinion as to] the nature of and the proper use of cost to income ratios in respect of e-commerce financial services, including the Ausmaq Service; · To know [and presumably therefore to be in a position to express an opinion as to] how to calculate by reference to an assumed discount rates and/or cost to income ratio, the present value of the Performance Bonus payable to JMG 9 The plaintiffs' essential submission is these are not matters of valuation, but of financial and business expertise and specialised knowledge. 10 The plaintiffs quite simply take issue with this submission as contrary to the reasons expressed in paragraph 251 of the judgment. Holding 11 Neither party appears to have a particular problem with the underlying distinction the subject of the court holding generally expressed in the defendants' submissions set out in paragraph 2 of this judgment. 12 The central problem concerns the application of that distinction. 13 Towards the end of paragraph 251 of the earlier judgment the following passage appears: "It is one thing to be shown by one's training, study or experience to have acquired the specialised knowledge on which wholly or substantially to be in a position to express opinions going to market share of a particular product or Service including anticipated cash flow and cost projections. It is quite another to be shown by one's training, study or experience to have acquired the specialised knowledge on which wholly or substantially to be in a position to express opinions as to the different modes of or approaches to valuing the rights to the subject product or Service and as to why one mode or approach is correct or preferable to another mode or approach. Mr Maconochie has been shown to have acquired specialised knowledge in relation to the first mentioned area but not in relation to the second mentioned area . And this notwithstanding that some of the formulae, parameters and processes/calculations utilised by experts in both fields may be, nor may be based upon some other underlying theoretical bases " 14 The passage emphasised in the above extract serves to underline the difficulty under which the parties now labour in their respective submissions. 15 There is a very narrow line indeed between: (1) permitting Mr Maconochie to express expert opinions utilising particular formulae, parameters and processes/calculations, where those opinions relate to anticipated cash flow and cost projections and market penetration and the viability of the Ausmaq System within particular markets and (2) rejecting any attempt by Mr Maconochie to express expert opinions utilising all or parts of the same formulae, parameters and processes/calculations, where those opinions trespass into the valuation discipline and are given for the purpose of valuing Ausmaq or JMG, the earlier judgment having expressly held that Mr Maconochie does not have the specialised knowledge on which wholly or substantially to be in a position to express opinions as to: "the different modes of or approaches to valuing the rights to the subject product or Service and as to why one mode or approach is correct or preferable to another mode or approach". 16 The present approach taken by the defendants in submissions principally identifies particular processes (or to use the defendant's term, 'tools'), and suggest that use of these processes/tools is a valuation exercise and/or involves an exercise of accounting expertise. The proposition which follows is that Mr Maconochie has not been held to have the requisite specialised knowledge on the basis of which, whether wholly or substantially, to be in a position to express opinions which necessarily use these processes/tools. The proposition is of substance in that Mr Maconochie has not been held to have acquired the specialised knowledge on the basis of which, whether wholly or substantially, to be in a position to express opinions as to: · what is the appropriate discount rate and its use; · what is the appropriate cost to income ratio and its use; · what is the appropriate price and earnings multiple and its use; · calculation of performance bonuses. 17 The defendants' submissions in endeavouring to point up in relation to certain sections of Mr Maconochie's statements, what is suggested to have been the precise purpose for which the subject processes/tools were sought to be utilised by him are also of substance: · the submission that discount rates are used by Mr Maconochie to convert Ausmaq's potential 2003 revenue to a 1999 amount for the purposes of valuing performance bonuses and/or buyout amounts allegedly payable to JMG and that the only exercise undertaken in paragraph 9.64 of Mr Maconochie's fifth statement is to apply discount rates to revenue projections. · the suggestion that Mr Maconochie[in paragraphs 9.65, 9.66, 11.7 and 11.8 of his fifth statement and paragraphs 46 and 47 (including sub paragraphs) of his statement in reply to Mr Turner of 11 September 2000] uses cost to income ratios for the purpose of applying the underlying facts and assumptions requisite to be made in order to express opinions as for example in relation to the valuation of Ausmaq or the valuation of JMG by reference to the buyout provisions of the Consulting Agreement. · the suggestion that Mr Maconochie [in Paragraph 6.3.2 of his Fourth Statement dated 24 May 1999; and Paragraphs 6.3.4, 6.3.3 (second time appearing), 9.67-9.69 and 11.9-11.17 of his Fifth Statement dated 9 June 1999] uses price-earnings multiples and the application of such multiples to revenue projections as a method of calculating the value of a business based on its present day earnings. · the suggestion that calculations of performance bonuses is a valuation exercise engaged in by Mr Maconochie to assess the bottom line valuation of Ausmaq/JMG's interest in Ausmaq. 18 In the result the defendant submissions' are of substance and should be accepted: · The application of discount rates to revenue projections is clearly a valuation exercise and clearly goes outside the field of "opinions going to market share of a particular product or Service including anticipated cash flow and cost projections". · Calculation of a cost to income ratio is clearly an exercise of accounting expertise since it involves calculation of gross operating revenue and operating costs, which in turn, as the defendants point out, require calculation of "total expenses" (including determination of net profit or loss) and sales revenue (according to approved Australian accounting standards) excluding extraordinary items. · Because performance bonus is a function of gross operating revenue, and because of the relevance of the cost to income ratio to it, calculation of the performance bonus is also an exercise of accounting expertise. · Both of the exercises identified by the defendants in relation to use of price-earnings multiples are clearly valuation exercises outside those in respect of which Mr Maconochie has been held to have specialised knowledge. They are the final step in the valuation process and quintessentially involve assessment of the different modes of or approaches to valuing the rights to the subject product or Service and as to why one mode or approach is correct or preferable to another mode or approach and involve a 'bottom line' valuation of Ausmaq. 19 The plaintiffs put forward a set of alternative submissions. The first is that the matters referred to in paragraph 8 above are not "pure valuation matters" such as valuing land or likely rents, but are matters which on the courts earlier judgment, Mr Maconochie, as an experienced businessman, can provide evidence, opinion or otherwise. In my view the submission is not of substance and should be rejected. I reject the submission that: · calculations performed by Mr Maconochie involving the use of discount rates should be accepted as an expression of Mr Maconochie's financial and business expertise and specialised knowledge. · calculations performed by Mr Maconochie involving the use of potential cost to income ratios should be accepted by the court as an expression of Mr Maconochie's financial and business expertise and specialised knowledge. · calculations performed by Mr Maconochie using price-earnings multiples should be accepted by the Court as an expression of Mr Maconochie's financial and business expertise and specialised knowledge. · opinions as to the likely value of the performance bonus payable to JMG may be given by Mr Maconochie. 20 The second of the alternative submissions was that any calculations of Mr Maconochie should be accepted by the court as a matter of calculation so that his respective opinions may be utilised as matters of assumption for the first plaintiff to prove aliunde the evidence to be given by Mr Maconochie, presumably to be assumptions which other witnesses are asked to make. This submission seems unexceptional if the precise calculations are clearly set out and one is not left to speculate as to these – section 136 orders may then be made accordingly – the calculations then being permitted as "Subj/Op/Calc". Other Opinions are affected by valuation 21 Finally I accept as of substance the defendants' submissions in the following terms: "Additionally, paragraphs 11.12-11.17 and the accompanying Exhibits 56 and 57 of Mr Maconochie's Fifth Statement dated 9 June 1999, where they do not directly involve valuation calculations, include figures that have been calculated using discounted cash flow figures, cost to income ratios and PE multiples, a process Mr Maconochie was not permitted to engage in and should therefore be rejected. Paragraphs 7.1 to 7.13 of Mr Maconochie's Fourth Statement dated 24 May 1999 and paragraph 7 of Mr Maconochie's Fifth Statement dated 9 June 1999 set out Mr Maconochie's opinions as to the correct methodology for the valuation of NMG and JMG, an exercise he is not permitted to engage in. Accordingly, they should also be rejected." Orders 22 The above reasons should make claim to the parties what are the orders as to admissibility which are appropriate. Against the event that this may not be the case I should make clear that as to MFI P 246, the paragraphs and documents referred to in the left-hand column on pages 52, 53, 54, 55, 56, and 57 are rejected. As to page 58 the first sentence of paragraph 9.2.1 (c) is allowed as Subj/Op, all paragraphs of paragraphs 9.2.4 are allowed as Subj/Op, and paragraph 9.5 is allowed as Subj/Op. The other paragraphs referred to in the left-hand column of page 58 are rejected. As to page 59 the last paragraph of paragraph 9.6 is allowed only insofar as relating to North America, Australia and New Zealand and the balance of that paragraphs is rejected. I certify that paragraphs 1 - 22 are a true copy of the reasons for judgment herein of the Hon. Justice Einstein given on 30 October 2001 ___________________ Susan Piggott Associate 30 October 2001 Last Modified: 06/13/2002 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.