This month Roger Isaacs, Forensic Partner at Milsted Langdon gives his thoughts on one of the hardest tasks for a forensic accountant; valuing claims for compensation arising from damage to reputation.
There are a myriad of ways in which the reputation of a business can suffer. Recently one of the most high profile causes of loss has been cyber-crime. Talk Talk, Ashley Madison and even Mumsnet have all been victims hacking attacks that led to the loss of clients’ data.
“bespoke cyber-crime insurance policies”
The rise in the number of these types of data breach has led to an increase in the number of companies that have taken out bespoke cyber-crime insurance policies. Often these policies provide for compensation to be paid in the event that a cyber-attach results in damage to the policy-holder’s reputation. Demonstrating that there has been a loss is often relatively simple but quantifying the financial effect is far less straightforward.
One of the challenges that faces forensic accountants who are instructed to assess these types of loss is that they typically continue into the future. This means that comparing the actual financial position of the victim company with the position in which it would have been but for the cyber-attack is only the first step in the loss calculation. It is then necessary to estimate for how long the reputational damage is likely to continue to have an adverse effect on the business.
It may be relatively easy to demonstrate that, at the date of assessment or trial, the effect is ongoing but it would be extraordinary to suggest that losses would ever continue for all eternity. Common sense suggests that as each year goes by, the effect of the reputational damage will reduce as the victim companies rebuild their reputations and win back the trust of their customers.
“cheaper than an M&S prawn sandwich”
That said, in the most extreme cases, the damage can be so profound that the brand of the victim becomes inexorably linked with the event that tarnished its reputation. For example, few people old enough to remember the Ratner’s jewellery chain do not associate it with its eponymous founder’s public speech to the Institute of Directors in 1991 in which he famously described a cut-glass sherry decanter set sold in his shops as “total c**p” before adding that some earrings were “cheaper than an M&S prawn sandwich but probably wouldn’t last as long“. The damage to the chain’s reputation was so profound that it was brought to the brink of collapse and the term ‘Doing a Ratner’ has subsequently come into popular parlance.
“an appropriate half-life”
Few would disagree that Ratner’s was an exceptional case and most businesses that suffer damage to their reputations are able to recover within a few years. Putting a value on future losses for the purposes of assessing the quantum of damages claims is typically achieved by applying an appropriate discount factor to a stream of anticipated predicted losses that themselves diminish over time. In effect the losses are given an appropriate half-life and then discounted to the date of trial.
The choice of half-life will ultimately be a matter for the court but forensic accountants can assist by illustrating the financial effect of different half-lives and by providing opinions on relevant commercial considerations. They can also analyse how the performance of a claimant has suffered in the period leading up to trial so as to extrapolate likely future performance into the future.