Opinion ID: 159203
Heading Depth: 2
Heading Rank: 2

Heading: Accounting Claims

Text: 62 During discovery, the Plaintiffs obtained, for the first time, a document entitled Extraordinary Items 1982, a list of company expenses and other accounting items from 1982 prepared by KII's controller, Milton Hall. After discovering the existence of Hall's list, the Plaintiffs were granted leave of court to amend their complaint, adding allegations about KII's accounting treatment of the items on Hall's list. They contended the Defendants' 1982 financial statements, upon which the Plaintiffs relied when valuing KII stock for the SPA, failed to identify the items on Hall's list as non-recurring. Because these expenses were, according the Plaintiffs, actually non-recurring in nature, the Plaintiffs undervalued the company by approximately $283 million. 63 The Plaintiffs sought recovery for these alleged mischaracterizations as a violation of both the Full Disclosure and the Generally Accepted Accounting Principles (GAAP) warranties contained in the SPA, as well as the Defendants' fiduciary duty of full disclosure. With respect to these accounting claims, the Plaintiffs raise three issues on appeal: (1) whether the district court improperly required the Plaintiffs to prove, as a predicate for all of their accounting claims, that these expenses were unusual or infrequently occurring as defined by GAAP; (2) whether the district court abused its discretion by failing to amend the 1998 Pretrial Order 9 to make clear that the accounting claims did not hinge on the jury's finding the items were unusual or infrequently occurring as defined by GAAP; and (3) whether the district court erroneously denied the Plaintiffs an opportunity to present certain rebuttal testimony to the defense theory on these claims. 64
65 In the 1998 Pretrial Order, the Plaintiffs set forth the following claims: 66 KII employed accounting methods that were designed intentionally to understate KII's earnings and assets in the financial statements. . . . 67 To diminish its apparent earnings, KII therefore employed the following accounting practice which violated GAAP and constituted breaches of both warranties in the Stock Purchase and Sale Agreement (quoted above): KII failed to disclose its unusual and/or infrequently occurring losses. KII categorized these losses as recurring expenses or depreciation, thereby artificially reducing what appeared to be KII's ordinarily recurring income. 68 (emphasis added) 69 Later that year, in ruling on a defense motion in limine seeking to exclude some of the Plaintiffs' expert testimony on the accounting claims, the district court responded to the parties' arguments about the parameters of these claims: If the plaintiffs intend to pursue an allegation that the defendants failed to disclose information on items that are neither unusual or infrequently occurring under GAAP, then the court rules that such an allegation or theory is outside the plaintiffs' accounting claim as pleaded in the pretrial order . . . . The district court looked to the 1998 Pretrial Order, which articulated only one factual basis for the Plaintiffs' accounting claim regarding these expenses: KII failed to disclose its unusual and/or infrequently occurring losses. Additionally, the district court noted the Plaintiffs chose to define these losses with accounting parlance borrowed from GAAP. Thus, the district court concluded the Plaintiffs must prove the Defendants failed to disclose unusual or infrequently occurring items, as defined by GAAP, to prevail on their accounting claims and therefore excluded any expert testimony on disclosure requirements for losses that were not unusual and/or infrequently occurring. 70 At trial, Alfred Eckert, a former Goldman Sachs investment banker who led the team hired by William Koch to value KII for purposes of the SPA, explained that when valuing a company's stock, he would add back into the company's earnings certain non-recurring losses. He further testified that his decision to add back these items depended not on generally-accepted accounting principles, but simply on whether, in his opinion, the losses likely would recur. On the Defendants' motion and over the Plaintiffs' objection, the district court then instructed the jury that the plaintiffs' accounting claim is limited to the defendants' failure to disclose items that are unusual and/or infrequently occurring as those terms are defined by [GAAP] and to disregard Eckert's testimony addressing the treatment of non-recurring items that do not fall within these definitions. The district court also issued an order (the May 12, 1998 Order) consistent with these instructions resolving that the accounting claims were predicated on the Plaintiffs' ability to prove the losses at issue were unusual or infrequently occurring under GAAP. Finally, both the instructions which the court gave the jury at the close of the trial and the jury's verdict form all indicated that to prevail on their accounting claim, under any legal theory, the Plaintiffs were required to prove the Defendants failed to disclose infrequently occurring losses as defined by GAAP. 71 On appeal, the Plaintiffs challenge the district court's orders and actions hinging their accounting claims on proof that the items at issue were unusual or infrequently occurring as defined by GAAP. This court reviews for abuse of discretion a district court's exclusion of evidence or issues from trial on the basis of a properly-drawn, detailed pretrial order. See Grant v. Brandt, 796 F.2d 351, 355 (10th Cir. 1986). 72 It is first important to note that the failure to disclose unusual and/or infrequently occurring losses constitutes the sole factual basis pleaded by the Plaintiffs in the 1998 Pretrial Order to support their claims regarding the Defendants' accounting treatment of KII expenses. Because a pretrial order defines the scope of an action for trial, the Plaintiffs were thus obligated to prove this one specific factual contention to prevail on their accounting claims. See Fed. R. Civ. P. 16(e) (A pretrial order entered after a pretrial conference shall control the subsequent course of the action unless modified by a subsequent order.); Trujillo v. Uniroyal Corp., 608 F.2d 815, 817 (10th Cir. 1979) (When issues are defined by the pretrial order, they ought to be adhered to in the absence of some good and sufficient reason.) (citation and internal quotation marks omitted). The question then is whether the district court properly determined the Plaintiffs needed to prove the losses were unusual or infrequently occurring as defined by GAAP, or whether infrequent occurrence under some other standard would have sufficed. 73 As the Plaintiffs point out, this court has recognized that a pretrial order should be 'liberally construed to cover any of the legal or factual theories that might be embraced by [its] language.' Trujillo, 608 F.2d at 818 (quoting Rodriguez v. Ripley Indus., Inc., 507 F.2d 782, 787 (1st Cir. 1974)). A careful reading of this court's cases reviewing trial courts' construction of pretrial orders, however, reveals that a district court may more strictly construe a pretrial order when that order has been refined over time, properly drawn, and drafted with substantial specificity. See, e.g., Cleverock Energy Corp. v. Trepel, 609 F.2d 1358, 1361-62 (10th Cir. 1979) (affirming trial court's exclusion of breach of fiduciary duty issue as beyond the scope of the pretrial order when the objecting party failed to take timely advantage of an opportunity to enlarge upon the general terms used in the order); Rigby v. Beech Aircraft Co., 548 F.2d 288, 291-92 (10th Cir. 1976) (affirming trial court's exclusion of evidence of defects in 40-gallon fuel cells of airplane when the plaintiffs' answers to interrogatories and the pretrial order consistently alleged defects only in the plane's 31-gallon fuel cells). On the other hand, this court has more liberally construed pretrial orders when the orders are not drafted with substantial care and specificity. See, e.g., Whalley v. Sakura, 804 F.2d 580, 582-83 (10th Cir. 1986) (liberally construing pretrial order when pretrial order . . . stated the claims of the plaintiff in general terms); Trujillo, 608 F.2d at 817-19 (broadly construing a pretrial order that was not properly drawn, [was] not definitive, specific, complete or detailed). 74 In Cleverock Energy this court elaborated on the reasons for allowing two divergent approaches to construing pretrial orders: 75 This court is acutely aware of the evils of the inflexible application of a pretrial order. These evils are aggravated when the pretrial order is unrefined. We recently held [in Trujillo] that a coarse pretrial order could not be narrowly applied to exclude one of three subtheories fairly encompassed within its general terms. However, we should not lose sight of the important policies behind the pretrial order mechanism, i.e., the narrowing of issues to facilitate an efficient trial and to avoid surprise. 76 Cleverock Energy, 609 F.2d at 1361-62 (citations omitted). Ultimately, the court held, We cannot in these circumstances conclude that the trial judge, who presided over the pretrial conferences of this extensive litigation and had before him the pleadings, motions and various pretrial statements of the parties, abused his discretion in striking the . . . issue as beyond the scope of the litigation. Id. at 1362. In sum, while pretrial orders generally should be construed liberally, a district court may more strictly construe such an order when the party favoring a liberal construction has had ample opportunity to refine the order and when the final order is properly drawn and substantially specific. 77 The Plaintiffs do not allege that the 1998 Pretrial Order was improperly drawn. Indeed, a pretrial conference was held on August 25, 1997, after which a proposed order was drafted. See Fed. R. Civ. P. 16(d). The district court signed the 1998 Pretrial Order on February 6, 1998. See Fed. R. Civ. P. 16(e). Further, this court has noted a proper pretrial order is definitive, sharpen[s] and simplifie[s] the issues to be tried, and represents a complete statement of all the contentions of the parties. Trujillo, 608 F.2d at 817 (citations and internal quotations omitted). The 1998 Pretrial Order in this case fits that bill, as many years of draft pretrial orders, district court orders, and discovery served to focus the legal and factual contentions of the parties and culminated in this final pretrial order. Additionally, because numerous draft pretrial orders were produced over the many years of this litigation, the Plaintiffs cannot claim that they lacked opportunities to draft the order to clearly encompass their claims. Because the 1998 Pretrial Order was properly drawn, with relative specificity and definitiveness, and because the Plaintiffs had ample opportunity to refine the order, the district court was not required to afford the Plaintiffs overly-generous leeway in its construction of their accounting claims. 78 Indeed, a contextual reading of the 1998 Pretrial Order leads this court to conclude that the district court did not abuse its discretion in determining that the Plaintiffs' accounting claims predicated recovery on their ability to prove the losses at issue were unusual or infrequently occurring as defined by GAAP. Again, the 1998 Pretrial Order frames this accounting claim in the following terms: To diminish its apparent earnings, KII therefore employed the following accounting practice which violated GAAP and constituted breaches of both warranties in the Stock Purchase and Sale Agreement (quoted above): KII failed to disclose its unusual and/or infrequently occurring losses. (emphasis added). As the district court noted in its May 12, 1998 order, the words unusual and/or infrequently occurring are terms of art used in GAAP literature, which the Plaintiffs earlier referenced at the summary judgment stage. Furthermore, this lone factual allegation mentioning unusual and infrequently occurring losses immediately follows a portion of the sentence which asserts a GAAP violation. 79 To support their reading of the 1998 Pretrial Order, the Plaintiffs point to the conjunction and between the asserted GAAP violation and the alleged breaches of two warranties, as well as the reference to both warranties. This language, however, bolsters, rather than subverts, the district court's construction of the pretrial order. The first of the two referenced warranties (the GAAP Warranty) warranted that the financial statements disclosed to the Plaintiffs as of December 31, 1981 and December 31, 1982 fairly present the . . . financial condition . . . of . . . [KII] . . . in accordance with generally accepted accounting principles . . . . The second warranty (the Full Disclosure Warranty) stated that since December 31, 1982, the Defendants had provided all information which if fully disclosed might materially affect the valuation of the stock of [KII] . . . . Although only the first of these warranties explicitly required GAAP compliance, by pleading that the Defendants' accounting practices violated GAAP and both warranties, the Plaintiffs appear to assert that because these practices violated GAAP they necessarily violated the Full Disclosure Warranty as well as the GAAP Warranty. Otherwise, the initial reference to the GAAP violation which precedes the word and would be superfluous, given the factual allegation using GAAP terminology which follows. Thus, the claim ties GAAP requirements to both warranties, as well as to the words unusual and infrequently occurring. 80 Similarly, this court rejects the Plaintiffs' argument that because they separately pleaded breach of fiduciary duty, along with breach of these two warranties, the court should not read the words unusual and infrequently occurring as GAAP terms of art when applied to their breach of fiduciary duty claim. In its May 12, 1998 order, the district court responded to this argument: There is no reasonable construction of this pretrial order that is so liberal as to permit a court to read terms of art in the same sentence as having two different meanings simply because the party subsequently asserts an alternative legal theory. This court concurs with that assessment. Further, as the district court noted in that May 12 order, the Plaintiffs failed to exercise their drafting prerogative to include a different, alternative, or additional definition in the Pretrial Order. Instead, they effectively expressed their satisfaction to be bound by the GAAP definition. 81 Finally, in analyzing the 1998 Pretrial Order, the district court properly considered the parties' motions, briefs, and arguments regarding the accounting claims that came before it throughout the thirteen years in which that court presided over this litigation. The district court stated, [T]he plaintiffs did not allude during the summary judgment proceedings to any position that their two legal theories on the accounting claim were based on alternative meanings to 'unusual and/or infrequently occurring losses.' The record bears out the accuracy of this statement. For example, in its Memorandum in Opposition to the Defendant's Motion for Summary Judgment, the Plaintiffs assert, Thus, Koch . . . failed contrary to GAAP to disclose its 1982 writeoffs as unusual, non-recurring expenses. (emphasis added). 82 In conclusion, this court holds that the district court, with its thirteen years of reading and listening to the parties' assertions and arguments concerning these accounting claims, did not abuse its discretion when it construed a properly drawn, refined, and specific pretrial order as excluding any accounting claims not predicated on proof that the losses at issue were unusual or infrequently occurring by GAAP definitions. 83
84 The Plaintiffs further argue the district court erred by failing to amend the pretrial order to permit the trial of accounting claims not predicated on proof of unusual or infrequently occurring losses as defined by GAAP. Although the Plaintiffs never formally moved for an amendment of the pretrial order, this court interpret[s] the assertion of an issue not listed in the pretrial order as the equivalent of a formal motion to amend the order . . . . Trierweiler, 90 F.3d at 1543. Thus, by opposing the Defendants' in limine motion, eliciting Eckert's testimony, and opposing the Defendant's motion to strike that testimony as beyond the scope of the pretrial order, the Plaintiffs effectively moved for an amendment of the pretrial order. 85 This court reviews a district court's failure to amend a final pretrial order for an abuse of discretion. See id. Federal Rule of Civil Procedure 16(e) provides, The order following a final pretrial conference shall be modified only to prevent manifest injustice. Fed. R. Civ. P. 16(e). Furthermore, the burden of demonstrating manifest injustice falls upon the party moving for modification. See R.L. Clark Drilling Contractors, Inc. v. Schramm, Inc., 835 F.2d 1306, 1308 (10th Cir. 1987). This court considers the following factors when faced with a challenge to a district court's exclusion of an issue by failing to amend a pretrial order: (1) prejudice or surprise to the party opposing trial of the issue; (2) the ability of that party to cure any prejudice; (3) disruption to the orderly and efficient trial of the case by inclusion of the new issue; and (4) bad faith by the party seeking to modify the order. 10 Cf. Roberts v. Roadway Express, Inc., 149 F.3d 1098, 1108 (10th Cir. 1998); Smith v. Ford Motor Co., 626 F.2d 784, 797 (10th Cir. 1980). This court should also consider whether the party favoring amendment of the pretrial order formally and timely moved for such modification in the trial court. When a party fails to formally move for modification, it neglects to focus the trial court's attention on the factors informing on the amendment determination and generally prevents the creation of an adequate record as to the other four factors, thus limiting our effectiveness in reviewing the trial court's decision. Cf. Hullman v. Board of Trustees of Pratt Community College, 950 F.2d 665, 667-68 (10th Cir. 1991). The failure to formally move to amend the pretrial order in this case resulted in exactly those consequences. This court must therefore independently surmise the import of amending the pretrial order to allow the trial of accounting claims not theretofore made. 86 Allowing the Plaintiffs to pursue any accounting claims without having to prove the expenses at issue were unusual or infrequently occurring as defined by GAAP would have significantly prejudiced and surprised the Defendants. When the district court issued its March 1998 in limine order, it fully apprised all parties of its understanding of the pretrial order and the parameters of the accounting claims for trial. The Defendants undoubtedly relied upon that ruling to prepare their own presentation of evidence as well as anticipate the Plaintiffs' case. As a consequence, the Plaintiffs' sudden attempt to inject into the trial evidence which the in limine order had precluded necessarily surprised the Defendants. Additionally, a proper defense of these essentially new accounting claims would have justified a mid-trial reopening of discovery, the addition of new witnesses, and further motions and briefings. 11 After spending thirteen years honing their defenses, this sudden amendment of the pretrial order would have significantly prejudiced the Defendants. Cf. Joseph Mfg. Co., Inc. v. Olympic Fire Corp., 986 F.2d 416, 420 (10th Cir. 1993) (stating that defendant's failure to raise specific defense at an earlier possible juncture cuts deeply against his claim of manifest injustice). Although the court could have allowed the Defendants to undertake this additional work in order to cure the prejudice of injecting new issues into the trial, to do so might have so severely disrupted the orderly and efficient course of an ongoing trial that we cannot say the district court's refusal was an abuse of discretion. Finally, the Plaintiffs' neglect in not formally moving for amendment of the pretrial order weighs against overturning the district court's decision. An analysis of the applicable factors leads this court to conclude the Plaintiffs have not demonstrated that manifest injustice resulted from the district court's failure to amend the pretrial order and correspondingly they have failed to demonstrate the district court abused its discretion in not amending the pretrial order.
87 During the Defendants' case, three defense witnesses testified that KII was by nature a risk-taking company and the losses at issue resulted from risky ventures. With this testimony, the Defendants sought to demonstrate that these losses did not constitute unusual or infrequently occurring losses under GAAP definitions. Because those definitions account for the the environment in which the entity operates, the Defendants presented testimony that KII operated within a business environment in which it routinely took risks and suffered resulting losses. In addition, according to the Plaintiffs, one of these defense witnesses, Lynn Markel, on cross-examination disputed the testimony of Milton Hall, KII's controller, about some of the facts underlying the items on Hall's list of Extraordinary Items, which had triggered the Plaintiffs' accounting claims. 88 The Plaintiffs then sought to recall one of their accounting witnesses, Gary Gibbs, on rebuttal. The Plaintiffs proffered that this witness would testify the Defendants' interpretation of the GAAP definitions was incorrect and Markel's testimony disputing Hall was contradicted by the underlying documents and financial statements. The district court precluded this rebuttal testimony, concluding the Plaintiffs reasonably could have anticipated this defense theory and evidence in their case-in-chief. 89 The Plaintiffs now challenge that decision, arguing that prior to the testimony of these defense witnesses, the Defendants' theory had always focused on the likely recurrence of a type of event or write-down. With the introduction of this testimony, the Plaintiffs assert, the Defendants' theory suddenly twisted into whether [KII] was a type of company that had to report its non-recurring losses the same way as other companies. Thus, the Plaintiffs contend they were entitled to present rebuttal testimony to this new defense theory and the district court erred by denying them the opportunity to do so. 90 This court reviews for an abuse of discretion a district court's refusal to allow rebuttal testimony. See Marsee v. United States Tobacco Co., 866 F.2d 319, 324 (10th Cir. 1989). [W]here the evidence rebuts new evidence or theories proffered in the defendant's case-in-chief, that the evidence may have been offered in the plaintiff's case-in-chief does not preclude its admission in rebuttal. Bell v. AT&T, 946 F.2d 1507, 1512 (10th Cir. 1991). When plaintiffs, however, seek to rebut defense theories which they knew about or reasonably could have anticipated, the district court is within its discretion in disallowing rebuttal testimony. See Comcoa, Inc. v. NEC Telephones, Inc., 931 F.2d 655, 664 (10th Cir. 1991) (Because plaintiffs were warned that rebuttal evidence would be restricted and because they reasonably could have anticipated defendants' evidence . . . [i]t was within the district court's discretion to disallow plaintiffs' rebuttal evidence.); Fashauer v. New Jersey Transit Rail Operations Inc., 57 F.3d 1269, 1287 (3d Cir. 1995) (holding that district court acted within its discretion by precluding rebuttal testimony to that which reasonably could have been anticipated). This court in fact endows the district court with broad discretion in deciding whether to admit or exclude rebuttal evidence. United States v. Olivo, 80 F.3d 1466, 1470 (10th Cir. 1996); see also Geders v. United States, 425 U.S. 80, 86 (1976) (discussing trial court's broad powers to manage a trial, including rebuttal testimony). 91 The GAAP definitions for unusual and infrequently occurring should have alerted the Plaintiffs to the likelihood that the Defendants would argue the nature of KII's business endeavors rendered the expenses at issue usual and frequently occurring. The Accounting Principles Board Opinion No. 30, an opinion at the heart of these accounting claims, refers to the following GAAP definitions for unusual nature and infrequency of occurrence: 92 Unusual nature the underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates. 93 Infrequency of occurrence the underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates. 94 Reporting the Results of Operation Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions, APB Opinion No. 30 (June 1973) (emphasis added). These definitions explicitly underscore the need to consider accounting items within the environment in which the entity operates when determining whether to classify such items as unusual or infrequently occurring by GAAP standards. Indeed, in opposing the Defendants' motion for summary judgment, the Plaintiffs themselves referenced the language found in APB Opinion No. 30 and pointed out the significance of this language. The Plaintiffs should not have been surprised, therefore, when the defense witnesses discussed the risk-taking business environment in which KII operates and the effect of this environment upon the accounting treatment of expenses. 95 Furthermore, testimony which the Defendants elicited on cross-examination early in the Plaintiffs' case-in-chief also should have put the Plaintiffs on notice of the Defendants' risk-taking environment theory. In cross-examining Milton Hall about his list of Extraordinary Items, defense counsel took Hall through his list item-by-item, having Hall explain the particular business context in which each of the losses was sustained. Hall thus provided a broad overview of KII's various business enterprises, describing how each of these enterprises both sought to make money and yet routinely suffered losses. One particularly relevant example of this testimony occurred when Hall described KII's practice of trading in futures markets, which resulted both in occasional profits and losses; Hall analogized KII's involvement in the futures market to an individual who trades in the stock market. The effect of this testimony should not have been lost on the Plaintiffs. Even at this early stage of the Plaintiffs' case-in-chief, the Defendants sought to establish the significance of KII's specific and unique business practices to their accounting treatment of particular expenses. Having listened to Hall's testimony, the Plaintiffs reasonably should have anticipated the Defendants' further elaboration on this theory during their own case. Indeed, the Plaintiffs could easily have countered this testimony prior to closing their case-in-chief. 12 96 Finally, it is significant that the Plaintiffs never objected to the testimony elicited by the defense as outside the scope of the defenses articulated in the pretrial order. Had the Plaintiffs raised such an objection, the district court might have limited the controversial testimony and thus obviated the Plaintiffs' asserted need to call a rebuttal witness. Because the Plaintiffs should reasonably have anticipated the evidence they sought to rebut and then failed to object to the evidence as supportive of a new theory beyond the Pretrial Order, the district court did not abuse its broad discretion in precluding the rebuttal witness. 97 Regarding the Plaintiffs' contention that this rebuttal witness was necessary to counter defense witness Lynn Markel, who allegedly contradicted the factual testimony of Milton Hall, the record both undermines the Plaintiffs' characterization of Markel's testimony and reveals that plaintiffs' counsel himself elicited the disputed testimony on cross-examination. Markel initially disagreed with facts and conclusions testified to by a different plaintiffs' witness, Gary Gibbs, even stating, I don't know where Mr. Gibbs got his information. The Plaintiffs' attorney then asked, Did you know that, in fact, Mr. Gibbs had gotten that information from Milton Hall? Markel replied, No. The Plaintiffs' attorney then made a final attempt to draw out Markel's disagreement with Hall, eliciting testimony which the Plaintiffs now claim demanded a rebuttal witness: Q: You told the jury last week that Mr. Gibbs had his facts wrong. And in truth, you disagree with Milton Hall, don't you? A: Mr. Gibbs had his facts wrong, sir. Contrary to the Plaintiffs' assertion in support of their argument for a rebuttal witness, Markel did not dispute Hall's testimony, but rather disagreed with the testimony of Gibbs. Further, even if Markel had disputed Hall's testimony, the Plaintiffs' attorney intentionally elicited such testimony. The record makes clear that Markel was not an out-of-control or unresponsive witness, or one aggressively attempting to advocate on cross-examination. When an attorney conducting cross-examination affirmatively draws out specific testimony, as occurred here, the district court does not abuse its discretion by disallowing rebuttal to that testimony.