Congressional Reforms and Privately-Held Companies

In the wake of numerous scandals involving the financial practices of publicly-traded corporations, Congress passed the Sarbanes-Oxley Act of 2002, regulating those practices and the financial markets that deal in publicly-traded securities. What owners of privately-held companies may not realize is that some of the provisions of that Act also apply to private companies and that there are other circumstances in which a private company is well-advised to comply with the Act’s requirements.

Provisions that expressly apply to private companies include sections imposing criminal liability for the destruction of documents done to impede a federal investigation or bankruptcy proceeding and making companies liable for any retaliation against whistleblowers who provide information about the commission, or possible commission, of a federal offense.

Many provisions of the act are also expressly applicable to companies with debt securities registered with the Securities and Exchange Commission.

There are also benefits to using the provisions of Sarbanes-Oxley as a guide for internal procedures. For one thing, voluntary compliance will reduce the risks of litigation against officers and directors. Moreover, private companies that are considering an initial public offering or preparing for a sale to a public company, would benefit substantially from establishing a compliance program well in advance. Compliance is necessary to complete an IPO and cannot be done quickly. A public company looking to purchase a private company will find a company that can show compliance much more attractive, because that public company will become responsible for the compliance of the purchased company.

Check with us to identify and establish practices in compliance with Sarbanes-Oxley for your company.

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In this issue:

Congressional Reforms and
Privately-held Companies

Websites Expand Legal Liability

Review of Moneyball (continued)

Advantages and Pitfalls of Joint Accounts

Your Taxes: Sale of Inherited or Gifted Property

Auto Insurance: Your Right to Sue

Mortgage Pay-off Recording

This is the 16th in a series of newsletters published by Langsam Stevens & Silver LLP and its predecessor firms for the information of their clients. The information contained herein is not intended to be, and should not be construed as, a substitute for professional legal advice. Please do not hesitate to call us for further information or assistance.

An out-of-state business or individual who engages in business in Pennsylvania can sometimes be sued in Pennsylvania. Occasional, fleeting, or minimal business contacts are not enough to justify making an out-of-state business or individual travel to Pennsylvania to face suit-both Pennsylvania and federal law require that some truly meaningful business contacts must take place before an out-of-state business or person can be bound by the decisions of a Pennsylvania court.

Recently, a Pennsylvania court decided that a Maryland business that buys and sells cars over the Internet can be sued in Pennsylvania. Through its Internet site, the Maryland business sold a Pennsylvania dealerís car to a Maryland couple. Even though the documents were signed in Maryland and both the Internet seller and the buyers were located in Maryland, the Pennsylvania car dealer was permitted to bring suit over the transaction in Pennsylvania because the Maryland company engaged in ìknowing and repeated transmissions of computer files over the Internetî into Pennsylvania.

A "passive" website that simply shares information does not give a state jurisdiction to entertain suits against the siteís operator. But where a website is interactively used to market and complete business transactions with consumers, the site itself may constitute sufficient "contact" with Pennsylvania to permit claimants to bring suit in Pennsylvania courts over transactions gone wrong.

Doing business over the Internet is quick and convenient but can be complicated. It may be difficult even to know where Internet companies are physically located. Before closing a transaction or purchase, be sure you know the identity of the company or individual on the other side.

Whether in California, Maryland, or even Alaska, if you are wronged in a consumer or business transaction completed online, you may be entitled to relief in the Pennsylvania courts.

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What is Moneyball Really About?

Moneyball: The Art of Winning an Unfair Game by Michael Lewis
A Book Review by Henry I. Langsam, Esquire, Stevens & Silver LLP

This is an excerpt from a longer article, the beginning of which was published in our last newsletter. The entire article is available on our website at www.langsamstevens.com/Moneyball.htm.

Billy Beane's 2002 Draft
When we think of intellectuals, scientists and thinkers, we might consider Albert Einstein or John Maynard Keynes, however, we surely do not think of baseball people as intellectuals. Bill James was baseball's version of the intellectual. The message Bill James whispered to Billy was: if you challenge conventional wisdom, you will find ways to do things much better than they are currently done in baseball. The A's not only adopted Bill James' thinking, they built on it and improved it. The whole point of James was: don't be an ape! Think for yourself along rational lines. Hypothesize, test against the evidence, never accept that a question has been answered as well as it ever will be. Do not believe a thing is true just because some famous baseball player says that it is true.

Before Billy Beane, the baseball field was a field of ignorance. As of June 4, 2002, the day of that year's amateur players draft, there were still big questions about baseball which needed answering:

• What was the most efficient way to use relief pitchers;
• Which part of defense was pitching and what part was fielding;
• How important was fielding;
• No one had solved the problem of fielding statistics;
• No one had figured out how to make the amateur draft more than a crap shoot.

However, Bill James had written in his newsletters persuasively that:

• College players are better investments than high school players by a huge margin;
• The conventional wisdom of baseball insiders that high school players were more likely to become superstars was demonstrably false.

Though James never showed how the statistics of high school or college player might be used to make judgments about his professional future, privately, Paul DePodesta, the head of research and development for the Aí's, had made his own studies. In their draft, the A's were going to put their radical new ideas to the test: despite the shrieks of ultimate baseball insiders, their scouts. Billy Beane's version of the draft using Sabermetrics, as compared with the rest of baseball, was the equivalent of investment house analysts using statistics to pick stocks versus amateur investors going on their gut call or perhaps the Ouija board. Lewis said:

Billy Beane was a human arsenal built, inadvertently, by professional baseball, to attack its customs and rituals. He thought himself to be fighting a war against subjective judgments, but was doing something else too....Billy Beane had gone looking for, and found, his antithesis. Young men who failed the first test of looking good in a uniform. Young men who could hit play anything but baseball. Young men who had gone to college.

How Billy Beane Applies Science to Win an Unfair Game: Drafting, Trading and Fielding a Team.
The Oakland A's had a problem. The Aís had $40 million to spend on 25 baseball players. Their competition, the Yankees, had $126 million available for their first 25 players and held perhaps another $100 million more in reserve. What could Billy do to solve this problem of financial imbalance?

A poor team could not afford to go shopping for big league stars in the prime of their careers. It could not even afford to get average priced players. The average big league salary in 2002 was $2.3 million. The average A's opening day salary was a bit less than $1.5 million. The poor team had to go find bargains: young players, older guys the market undervalued, people who did not look attractive to the rest of the teams. If the market was close to rational, all the good ball players had been bought up by the rich teams and the A's would not have had a chance. However, they did have a chance. They won their division three years in a row. How?

Major League Baseball created a blue ribbon panel on baseball's economics in 1999 to analyze the plight of smaller market teams with a view towards analyzing the dominance of the larger markets versus the smaller markets. Most of the members of the panel felt that parity or some kind of salary control would be the only way to have smaller market teams compete. However, one dissenting voice, former Federal Reserve chairman Paul Volcker, the only panel member with a financial background, asking two provocative questions:

1. If poor teams were in such dire financial condition, why do rich guys keep paying higher prices to buy them?
2. If poor teams had no hope, how did the Oakland Aís, with the second lowest payroll in all of baseball, win so many games

In 1998, Billy's first year on the job, the A's went 74-88. In 1999, the A's finished 87-75. Volcker wanted to know how the A's did it. Paul DePodesta wrote Billy Beane's presentation before the panel. Billy testified to the blue ribbon panel that the Oakland A's lack of funds meant signing no famous stars no matter how well the team performed and that kept the fans away. However, all the A's marketing studies showed that the main thing fans cared about was winning. They did not care if it was with nobodies. Win and the fans come, lose and they stay home. "Assembling nobodies into a ruthlessly efficient machine for winning baseball games, and watching them become stars, was one of the pleasures of running a poor baseball team." Billy also suggested that his inability to pay the going rate for baseball players let alone stars meant that his success was likely to be short-lived. But perhaps Billy did not really believe what he said. Perhaps he felt that the baseball market was so inefficient that superior management could still run circles around taller piles of cash. The A's won 91 games in 2000 and 102 games in 2001 and made the playoffs in both of those years. The A's were getter better over time: not worse. Maybe the A's were lucky: or maybe the Aís were more efficient. The Oakland A's, by winning so many games with so little talent and payroll were something of an embarrassment to Bud Selig and his blue ribbon commission. Selig called them an "aberration."

Before the 2002 season began, Paul DePodesta had reduced the coming baseball season to a math problem. He asked how many wins would it take to make the playoffs? He concluded 95. He then calculated how many more runs the A's would need to score than they allowed to win 95 games: 135 (This analysis derives from Bill James). Then, using the A's players' past performance as his guide, he analyzed how many runs they would actually score and allow. He concluded that if he did not suffer a huge number of injuries, the team would score between 800-820 runs and give up between 650-670 runs. From that, he predicted that the team would win between 93-97 games. Because the A's entered the 2002 season without three players widely regarded by the market to be among their best, the expected result was a net loss of 7 wins: 102-95. How could that be when you lose three stars? Beane and his staff analyzed that established closers were systematically overpriced so the loss of Isringhausen largely meant that the A's lost Isringhausen's saves. Well how important are saves? Saves often occurred with a ninth inning that starts with the bases empty and the home team leading. Billy felt that you could take a slightly above average pitcher and drop him into a closer's role and let him accumulate a gaudy number of saves and then sell him off. Translated to Wall Street thoughts, that meant you could buy a stock, pump it up with false statistics and sell it off for more than you paid for it.

The blue ribbon commission may have asked the wrong question: it was not whether a baseball team could keep its stars even after they finished with their first six years as indentured servants and became free agents: the questions was how did a baseball team find stars in the first place. Could it find new talent to replace the old ones lost? Talent was a lot more fungible than baseball teams believed. Isringhausen could be pretty easily replaced.

Well how about the loss of Johnny Damon, the A's centerfielder? Before becoming Billy's assistant, DePodesta had analyzed baseball's statistics. He found only two statistics that correlated most closely with winning percentage: on-base percentage and slugging percentage. Everything else was far less important. "On-base percentage" is actually on-base per thousand at-bats. If a batter gets on base 4 out of 10 times, he has an on-base percentage of four hundred (.400). Slugging percentage is actually based on "per four thousand." A perfect slugging percentage achieving a home run every time is four thousand (four bases every plate appearance). The majority of big league players have on-base percentages between .300-.400 and slugging percentages between .350-.550. On-base plus slugging was the simple addition of on-base and slugging percentages. This was a much better indicator than any other offensive statistic of the number of runs a team would score. Simply adding the two statistics suggest that they are of equal importance but as it turns out, on-base percentage is more valuable than slugging percentage point for point. An extra point of on-base percentage was worth more than three times an extra point of slugging percentage according to DePodesta's calculations. This analysis tells a baseball professional the most important thing a player can do is get on base. It does not matter how. There were underpriced baseball players able to get on base. Oaklandís on-base percentage was .324 or roughly ten points below the league average. The offense that the A's lost in losing Damon was fairly easily replaceable. But the team could not analyze the loss of Damon's defense as no such statistic then existed.

A method to analyze loss of defense arose from financial market analysis in the early 1980s: the advent of the options and futures market. Options and futures were fragments of stocks and bonds; they became known as derivatives. They had a certain precise quantifiable value. Stock and bond valuation was a matter of opinion: the market told us what they were worth. But fragments of a stock or bond, when you glue them back together, must be worth exactly what the stock or bond was worth. If they were worth more or less than the original article, the market was thought inefficient. A trader could profit from such inefficiencies.

A couple of option professionals, Ken Mauriello and Jack Armbruster, decided to solve the issue of evaluating defense by quantifying every event that occurs on the baseball field. They sought to determine how much the players should involved be held responsible and therefore debited and credited. These baseball students/analysts decided to base their accounting on runs: runs were the money of baseball. They collected ten years of data from Major League Baseball: every ball that was put into play. Every event that followed a ball being put into play was compared by the system to what had typically happened during the previous ten years. Thus, the performance of the player would be judged against the average. Mauriello and Armbruster began by turning every major league diamond into a mathematical matrix of location points. Each point was marked with a number. Then they reclassified every ball that was hit. There was no such thing in their record as a double: that was too inexact. There were no such things as pop flies, line drives and grounders: the baseball was hit with a certain velocity and trajectory to a certain grid on the field. In the Mauriello/Armbruster form of analysis, a line drive double hit to the gap became a ball hit with a certain force that landed on point number 643. Then the system carved up every baseball play into countless, meaningful fragments: derivatives. For example, take a single being hit to right field with a runner on first. If Raul Mondesi is the right fielder, that runner stops at second base instead of dashing to third because Mondesi threw a lot of people out. It is worth something. Mauriello and Armbruster took James and his co-hort's analysis one step further. They recorded events on a baseball field without any reference to traditional statistics. They not only ignored RBIs and saves, they ignored all conventional baseball statistics. When Paul DePodesta saw the system in operation, he immediately understood its significance: the system extracts the element of luck. DePodesta liked the system so much, he encouraged Billy to hire these unconventional baseball statisticians. Now, the A's had a way of valuing Damon's defense. Let us assume for a moment that a line drive hit at X trajectory and Y speed to point number 965 had 8600 identical hits in the system history. Let us further acknowledge that 92 percent of the time that hit went for a double, 4 percent for a single and 4 percent of the time it was caught. Let us further suppose that the average value of that event is .50 of a run. The system then credits the hitter having generated .50 of a run and the pitcher with having given up .50 of a run. If Johnny Damon happens to get one of his trademark catches on such a hit, he is credited with saving his team .50 of a run. Using this analysis, the A's were able to estimate how many runs Damonís likely replacement would cost the team. The cost of losing Damon to his expected replacement was 15 runs or about a run every ten games. The Mauriello/Armbruster system was not perfect. It still could not make perfectly definitive statements about fielding under this system because the system did not measure where a defensive player started from. It does not tell you how far a player had to go to catch a ball. Bill James had rated defense no more than five percent of baseball. Superior defense might have been brilliant defense positioning by the bench coach rather than the talents of the ballplayer. The Aís concluded from this information they could not replace Johnny Damon's defensive ability: the cost would be too great. Accordingly, to offset the loss of Damonís defense, they added more offense.

The blue ribbon panel report believed that a poor team could not survive the loss of its proven stars. But the business was more complicated than that as proven by the Aís. But the Aís still had to account for the loss of Giambi.

(To be continued)

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People use joint financial accounts for a variety of purposes, not necessarily just when real joint ownership of the assets is intended. One reason to set up a joint account is simple convenience: having a family member or friend as a signatory on an account can make life easier for an elderly or disabled person, or for anyone who, for whatever reason, cannot easily take care of their banking matters for themselves. In such a case, all of the funds in the account come from only one of the named "owners," and there is no intention to give ownership of any of the money to the other signatories. But what happens if one of these non-contributing signatories gets into financial trouble? Can their creditor take the money in the joint account?

Under Pennsylvania law, the answer is no; at least if you can establish that the account was a convenience account. The Pennsylvania Multiple Party Account Act, 20 Pa.C.S. ß 6301 et seq. which defines the interests of joint owners is financial accounts, specifies that, during the lifetimes of the account owners, each owner has an interest in the account only in proportion to their actual deposits into the account. The only exceptions are where there is clear proof that the depositor intended to make a gift to the other owners; or where the joint owners are minor children, in which case the account belongs to the minors - not to the adult who holds the account in trust.

Recently, the Pennsylvania Supreme Court held that the Multiple Party Account Act applies, not just to accounts in regular banks, but to any financial accounts, including brokerage accounts. Deutsch, Larrimore & Farnish, P.C. v. Johnson, 577 Pa. 637; 848 A.2d 137 (2004)

Another consideration for these joint accounts for convenience, though, is that, upon the death of one of the account owners, the money in the account immediately becomes the property of the other account owners, regardless of whether they contributed anything to the account. This can be very useful for estate planning, when the co-owners are intended to eventually receive the money, since the money in the account is not subject to probate, but instead passes immediately to the surviving account owners. (Note that the money is still ordinarily subject to estate and inheritance taxes.)

In any case, any person who wants to be sure to be able to establish their sole right to the money in a joint account has to be careful to maintain control over the account records and all deposits into the account and to report all interest income on their own tax returns. Otherwise, someone elseís creditor may be able to seize money that you thought was yours alone.

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When we receive property as an inheritance or a gift, we donít often think about what will happen if we decide to sell that property in the future. What are the tax consequences? Since the person receiving the property didn't pay anything for it, it might seem that the entire amount of the sale price would be taxable, however, that's usually not the case.

Inherited Property
The taxable amount of the income from a sale of property depends upon the taxpayer's "basis" in the property. Only the amount of the sale price that is above the basis amount is taxed. In the normal case where the taxpayer is the same person who bought the property they are selling, the basis is the amount that the taxpayer paid for the property. But the rules are different when the property was not purchased by the taxpayer.

In the case of an inheritance, the taxpayer's basis in the property is usually the fair market value of the property on the date of death of the person from whom the property was inherited. For instance, if a wealthy relative leaves you some shares of stock that are worth $100,000 at the date of death, you could turn around and sell the stock for $100,000 and not have any taxable gain. Your basis in the stock is $100,000. This is true even if the decedent only paid $1,000 for the stock in the first place.

Gifted Property
The rules are a little more complicated for property that is received as a gift. The tax basis of the property depends upon whether the sale price is above or below the donor's basis in the property.

If property received by gift is sold at a price higher than the donor's original basis in the property, then the recipient's basis is considered to be the same as the donor's basis. To return to the example above, if the same wealthy relative gave you the stock that they paid $1,000 for, and you turned around and sold it for $100,000, you would pay taxes on $99,000 — the difference between the $100,000 purchase price and the $1,000 your relative originally paid for the stock.

If you sell property you have received by gift at a price that is lower than and property's value at the time of the gift and is also lower than the donor's basis in the property, so that there is a clear loss on the sale, then the recipient's basis is either the donor's basis or the value at the time of the gift, whichever is lower.

If your relative gives you the stock at a time when it is worth $1,500 and you later end up selling the stock for only $500, your loss is calculated using the $1,000 that your relative paid for it. If the value of the stock at the time of transfer is $750 and you sell the stock for $500, your loss is calculated using the lower, $750 value as the basis.

The final, unusual, situation is when property is sold at a price that is lower than the donor's basis, but greater than the value at the time of the gift. This would be the case if your relative gave you the stock when it was worth $500 and you later sold the stock for $750. The stock was sold for more than its value at the time of the gift, but less than the price your relative paid for it. In this case, there are no tax consequences of the sale.

One thing that is clear is that a donor should consider the consequences carefully before making a gift of property as opposed to holding on to the property until their death. The difference in tax consequences to the recipient, particularly if the property has appreciated substantially in value, can be significant.

There are, of course, other important reasons for deciding to make a transfer by gift. But whatever, the situation it is always advisable to get professional advice about the tax consequences and alternative strategies before making a decision.

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Whether or not you remember doing it, when you purchased or renewed your automobile policy, you chose either a "full tort" or a "limited tort" option on your automobile policy. A "tort" is a legal wrong ñ something that we would describe in everyday language as negligence. Negligent driving is a tort.

Full Tort. If you chose the "full tort" option, you retained the option to sue a negligent driver who has injured you, not only for reimbursement for any medical bills or other economic losses not covered by your own automobile insurance or other insurance, but also for compensation for your pain and suffering and for the permanent or continuing limitations on your activities and income that may result from your injuries.

Limited Tort. If you chose the "limited tort" option and you prevail against a negligent driver, you will only be entitled to reimbursement for any medical bills or other economic losses not covered by your own automobile insurance or other insurance. You will not be able to recover anything for your pain and suffering or for future limitations unless your injuries result in your death, serious impairment of a body function, or permanent serious disfigurement. These standards are very difficult to meet. Limited tort consumers may sue for pain and suffering if the negligent driver was drunk, was driving an out-of-state vehicle, acted intentionally, or was uninsured. They can also bring a lawsuit for injuries suffered in a vehicle that is not a passenger car, and they can sue a business to recover damages for an injury caused by a motor vehicle defect.

In selecting your tort coverage, consider the purpose of the insurance. Most people want to be compensated by their insurance in the event of an accident, thus "full tort" should be selected. Others merely want the cheapest possible insurance to comply with the laws against driving without insurance. "Limited tort" coverage is approximately 18% cheaper on average.

Generally speaking, if you do not have your own policy of automobile insurance, you are bound by the tort option selected by your spouse or any insured relative with whom you live. Also, when you select a tort option for yourself, you may bind your children, your spouse, and relatives in your household, unless they have their own policies of automobile insurance.

Exception to the Rule
Recently, the Pennsylvania Supreme Court recognized another exception to the limited tort status. The court found that a young adult woman who was injured while a passenger in her mother's van was entitled to full tort status even though she had chosen the limited tort option when buying her own policy. Hoffman v. Troncelliti, 576 Pa. 504; 839 A.2d 1013 (2003).

The injured woman lived in her motherís household and her mother had a full tort policy that identified the mother's car as the insured vehicle and both the mother and her daughter as insured drivers. The daughter had a separate, limited tort policy on her own vehicle.

All automobile insurance policies issued in Pennsylvania identify the people and the vehicles covered by the policy. If you are injured, do not assume that you are limited to the automobile insurance coverage you have purchased for yourself. Instead, check to see if you are named on any other policies in your household.

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With the rapid expansion of national residential mortgage lenders and the frequency with which mortgages are sold on the secondary market, getting a residential mortgage ìsatisfiedî on the record when it is paid off or refinanced has become far more complicated than it was when residential mortgages were the province of local banks. Title insurance companies and property owners often must struggle to clear record title to properties. Mortgages that have been long paid off may remain on record, creating problems for home buyers, home sellers, and lenders alike.

A Pennsylvania law requires mortgage lenders to cooperate promptly in the recording of mortgage satisfaction documents. The Pennsylvania Mortgage Satisfaction Act provides for penalties for lenders who fail to satisfy mortgages that have been paid off. A mortgage lender that has been fully paid has 60 days to satisfy the mortgage of record. The penalty for failure to respond is a payment to the mortgage borrower in an amount "not to exceed the original loan amount."

In any successful action to recover penalties, the lender is required to reimburse the borrower for the costs of the suit, including attorneysí fees. The Act also allows a settlement officer to satisfy a residential mortgage of record if a lender has been fully paid but does not respond to a request to record the satisfaction documents.