Experts — Method of Gatekeeping Is Discretionary But Court Must Apply Daubert – Inadmissibility of Certain Hedonic and Credit Expectancy Damages

Smith v. Dorchester Real Estate, Inc., 2013 U.S. App. LEXIS 20785 (1st Cir. Oct. 15, 2013):

This case arises out of a fraudulent real estate mortgage scheme that involved inducing a schizophrenic trash collector into acting as a straw buyer for two overvalued residential properties in Massachusetts. That person, Robert Smith, sued various entities and individuals involved in the transactions, including the mortgage lenders, mortgage brokers, real estate brokers, and closing agents. A jury returned a verdict largely favorable to Smith on his claims of fraud and breach of fiduciary duty, and  the district court doubled and trebled certain damages pursuant to the Massachusetts Consumer Protection Statute. Two of the defendants, real estate brokerage firm Century 21 Dorchester Real Estate, Inc. ("Century 21") and mortgage broker New England Merchants Corporation ("NEMCO") appeal the unfavorable verdict on multiple grounds. Smith cross-appeals the dismissal of several claims. We affirm in part and reverse or vacate other rulings.***

Evidence was introduced from which the jury could have concluded that Smith, who was in his mid-forties during the relevant time period, suffers from schizophrenia, depression, posttraumatic stress disorder, and mild mental retardation. He is functionally illiterate. In January 2005, a woman who introduced herself as Laurice Taylor approached Smith while he was working as a trash collector for the Waste Management Corporation in Dorchester, Massachusetts. Taylor told Smith that she worked at a nearby RE/MAX real estate office and invited him to participate in a "special investment program" through RE/MAX. So long  as he had good credit, Smith would receive $10,000 per investment without contributing any capital. Taylor reassured him that "RE/MAX would take care of everything," and Smith agreed to participate.

Unbeknownst to Smith, the investment opportunity was an illicit scheme developed by Dwight Jenkins, a convicted bank fraudster. In the words of the district court,

   Jenkins trolled the margins of society for the gullible (like Smith) and the greedy . . . whom he recruited as straw "investors" in shady real estate deals. With the help of louche mortgage brokers and a complicit attorney, the "investors" were inveigled into taking out "liar loans" for the purchase of overvalued residential properties. The "investors" received a small fee, while Jenkins and his cohorts (including the brokers) skimmed fees and commissions from the grossly inflated purchase prices.

Smith v. Jenkins, 818 F. Supp. 2d 336, 340 (D. Mass. 2011). The basics of the scheme may be briefly described. With the assistance of real estate agents, Jenkins would find a residential property for sale and enter into a purchase and sale agreement with the seller for the listing price. He would then assign the right to purchase the property   to a straw buyer for a significantly higher price. At the closing, the straw buyer would borrow the amount of the higher purchase price, the seller would receive the lower listing price, and Jenkins would take the difference as a "contract release fee." Jenkins characterized this arrangement to the straw buyers as an "investment," promising to maintain the property, collect rent, pay operating bills, mortgages, and other expenses, and eventually sell the property at a profit in which the straw buyer would share. ***

The jury found Century 21 liable to Smith for fraud and breach of fiduciary duty and awarded $50,000 in damages for those claims. The district court denied Century 21's post-trial motions challenging the verdict on sufficiency-of-the-evidence grounds and assigning error to the court's decision to allow Smith's damages expert to testify at trial.

2. Admission of Expert Testimony on Damages 

Century 21 also challenges the district court's denial of its pre-trial motion to preclude the testimony of Smith's damages expert, forensic economist Stan V. Smith, Ph.D., and the subsequent denial of its motion to strike Dr. Smith's testimony. We agree that portions of Dr. Smith's testimony should have been precluded.

Federal Rule of Evidence 702 assigns to the district court "the task of ensuring that an expert's testimony both rests on a reliable foundation and is relevant to the task at hand." Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 597 (1993). To determine whether an expert's testimony is sufficiently reliable, the district court considers whether "the testimony is based on sufficient facts or data"; whether "the testimony is the product of reliable principles and methods"; and whether "the expert has reliably applied the principles and methods to the facts of the case." Fed. R. Evid. 702; see Daubert, 509 U.S. 592-94. As to the relevancy criterion, the court must determine whether the testimony "will assist the trier of fact to understand or determine a fact in issue." Daubert, 509 U.S. at 592.

"[T]here is no particular procedure that the trial court is required to follow in executing its gatekeeping function under Daubert." United States v. Diaz, 300 F.3d 66, 73 (1st Cir. 2002). However, the gatekeeper function must be performed. Id. (citing Daubert, 509 U.S. at 592); see also Kumho Tire Co. v. Carmichael, 526 U.S. 137, 158-59 (Scalia, J., concurring) (observing that "trial court discretion in choosing the manner of testing expert reliability is not discretion to abandon the gatekeeping function"). Although the court need not make explicit findings on the admissibility criteria sua sponte, Hoult v. Hoult, 57 F.3d 1, 5 (1st Cir. 1995), "[w]ithout specific findings or discussion on the record, it is impossible on appeal to determine whether the district court carefully and meticulously reviewed the proffered . . . evidence or simply made an off-the-cuff decision to admit the expert testimony." Goebel v. Denver & Rio Grande W. R.R. Co., 215 F.3d 1083, 1088 (10th Cir. 2000) (internal quotation marks omitted) (brackets omitted) (emphasis added). The question of whether the district court actually performed its gatekeeping function in the first place is subject to de novo review. United States v. Avitia-Guillen, 680 F.3d 1254, 1256 (10th Cir.), cert. denied, 133 S. Ct. 466 (2012); Naeem v. McKesson Drug Co., 444 F.3d 593, 607 (7th Cir. 2006). If we are satisfied that the court did not altogether abdicate its role under Daubert, we review for abuse of discretion its decision to admit or exclude expert testimony. Kumho, 526 U.S. at 152; Crowe v. Marchand, 506 F.3d 13, 16 (1st Cir. 2007). If we determine that the court abused its discretion, we then must determine whether the error was harmless. Gay v. Stonebridge Life Ins. Co., 660 F.3d 58, 62 (1st Cir. 2011). From the evidence in the record, we are unable to conclude that the district court sufficiently evaluated the admissibility of Dr. Smith's testimony. There are no statements on the record indicating that the court conducted a Daubert analysis. The judge denied without comment the defendants' motion to preclude Dr. Smith's testimony as unreliable and unhelpful to the jury. In denying the motion to strike the trial testimony on the same  grounds, the court stated only that "[a]ny infirmities in the witness's testimony were exposed during cross-examination. Whether these undermine the creditability of the witness's ultimate opinion(s) are for the jury to determine." But a court cannot rely on the jury to determine the relevance and reliability of the proffered testimony in the first instance; Daubert and its progeny place this responsibility in the hands of the district court.

We, of course, are not suggesting that the experienced trial judge ignored Daubert. Still, given the record-based limitations under which we are required to operate, the absence of any findings or discussion on the record leaves us hard-pressed to conclude that the district court adequately fulfilled its gatekeeping role in admitting Dr. Smith's testimony.

Alternatively, however, even if the district court conducted a sub silentio review, the admission of much of Dr. Smith's testimony cannot be upheld as an exercise of the district court's discretion. Dr. Smith testified that the plaintiff suffered three types of damages: (1) the loss of enjoyment of life (so-called "hedonic damages");(2) the loss of credit expectancy as a result of two foreclosures   on his record; and (3) the loss of time expended dealing with the consequences of the fraud scheme. We find that the first two categories fell short of admissibility in any event and leave the third to the district court to consider on remand after performing a Daubert analysis.

a. Hedonic Damages

We begin with the contentious issue of hedonic damages. Dr. Smith opined that Smith is entitled to $219,900 for his loss of enjoyment of life. To arrive at that figure, Dr. Smith employed a method for valuing life known as the "willingness-to-pay" model. This model measures the monetary worth of life by calculating the amounts that individuals, government agencies, and businesses are willing to pay for reductions in health and safety risks.   The model relies on labor market studies reflecting wage risk premiums, studies reflecting consumer purchases of safety equipment, questionnaires regarding consumers' willingness to pay for safety measures, and studies of government regulations requiring expenditures for certain safety devices. Dr. Smith testified that the resulting figure is between $5 and $6 million for the value of a "statistically average" person's life, defined as a 31-year-old with  a 45-year additional life expectancy.

To be "conservative," Dr. Smith instead used $4.2 million as the value of life in calculating Smith's damages, without offering any rationale for the chosen figure. This figure, according to Dr. Smith, averages out to approximately $130,000 as the monetary worth of one year of life. Next, Dr. Smith took into account that Smith had reported losing 90% of his enjoyment of life as a consequence of the defendants' conduct. But instead of using that percentage, at the behest of Smith's counsel Dr. Smith used "arbitrarily conservative" figures of 25% loss of enjoyment in the early years and 12.5% loss in the later years. Multiplying these percentages by the per-year value of life yielded the $219,900 figure for Smith's hedonic damages.

Before considering whether Dr. Smith's testimony was admissible under Daubert, we delineate the limits of our review. Century 21 only argues that Dr. Smith's opinion about Smith's hedonic damages failed to satisfy the requirements of Rule 702. It makes no argument that hedonic damages are not recoverable at all in this type of suit, and therefore we do not decide that issue. 

Footnote 4.   We note, however, that it is not clear whether  Smith is entitled to hedonic damages under the circumstances of this case.   In re Griffith, 800 N.E. 2d 259 (Mass. 2003) discusses hedonic damages, although we have found no Massachusetts case addressing the scope of such damages. A number of decisions in other jurisdictions indicate that hedonic damages are recoverable, if at all, only for permanent injuries.   See Golden Eagle Archery, Inc. v. Jackson, 116 S.W.3d 757, 771-72 n.62 (Tex. 2003) (collecting cases).

Assuming that hedonic damages are compensable in this case, Dr. Smith's testimony nonetheless should have been excluded under Rule 702. Dr. Smith has been the subject of numerous decisions regarding the admissibility of his expert opinions on this very issue. The overwhelming majority of courts have concluded that his "willingness-to-pay" methodology is either unreliable or not likely to assist the jury in valuing hedonic damages, or both.    See, e.g., Allen v. Bank of Am., N.A., CIV. CCB-11-33, 2013 WL 1164898, at *12 (D. Md. Mar. 19, 2013); Richman v. Burgeson, No. 98 C 7350, 2008 WL 2567132, at *2-*4 (N.D. Ill. June 24, 2008); Davis v. ROCOR Int'l, 226 F. Supp. 2d 839, 842 (S.D. Miss. 2002); Saia v. Sears Roebuck & Co., 47 F. Supp. 2d 141, 148-50 (D. Mass. 1999);  Brereton v. United States, 973 F. Supp. 752, 758 (E.D. Mich. 1997); Kurncz v. Honda N. Am., Inc., 166 F.R.D. 386, 388-90 (W.D. Mich. 1996); Ayers v. Robinson, 887 F. Supp. 1049, 1059-64 (N.D. Ill. 1995); Sullivan v. U.S. Gypsum Co., 862 F. Supp. 317, 321 (D. Kan. 1994); Mercado v. Ahmed, 756 F. Supp. 1097, 1103 (N.D. Ill. 1991), aff'd, 974 F.2d 863, 868-71 (7th Cir. 1992); see also Dorn v. Burlington N. Santa Fe R.R. Co., 397 F.3d 1183, 1195 n.5 (9th Cir. 2005) (collecting state cases where Dr. Smith's testimony was excluded). But see Sherrod v. Berry, 629 F. Supp. 159, 162-64 (N.D. Ill. 1985), aff'd, 827 F.2d 195, 205-06 (7th Cir. 1987), vacated and remanded on other grounds, 856 F.2d 802 (7th Cir. 1988). Indeed, "[t]roubled by the disparity of results reached in published value-of-life studies and skeptical of their underlying methodology, the federal courts which have considered expert testimony on hedonic damages in the wake of Daubert have unanimously held quantifications of such damages inadmissable." Smith v. Ingersoll--Rand Co., 214 F.3d 1235, 1245 (10th Cir. 2000).

We share the concerns of those courts that have excluded expert testimony based on the "willingness-to-pay" methodology   as lacking in reliability. Like the Seventh Circuit, we have serious doubts that the underlying studies actually measure the value of life. Mercado, 974 F.2d at 871. In terms of consumer purchases,

   spending on items like air bags and smoke detectors is probably influenced as much by advertising and marketing decisions made by profit-seeking manufacturers and by government-mandated safety requirements as it is by any consideration by consumers of how much life is worth. Also, many people may be interested in a whole range of safety devices and believe they are worthwhile, but are unable to afford them. More fundamentally, spending on safety items reflects a consumer's willingness to pay to reduce risk, perhaps more a measure of how cautious a person is than how much he or she values life. Few of us, when confronted with the threat, "Your money or your life!" would, like Jack Benny, pause and respond, "I'm thinking, I'm thinking." Most of us would empty our wallets.   

Id. And as for the wage-risk premiums that Dr. Smith purportedly took into account, "[t]o say that the salary paid to those who hold risky jobs tells us something significant about how much we value life ignores the fact that humans are moved by more than monetary incentives." Id.; see Wilt v. Buracker, 443 S.E.2d 196, 205 (W. Va. 1993) ("Anyone who is familiar with the wages of coal miners, policemen, and firefighters would scoff at the assertion that these high risk jobs have any meaningful extra wage component for the risks undertaken by workers in those professions."). Finally, the cost of government health and safety regulations per life saved "may suggest a collective policy judgment the government has made, or may represent a policy selected for reasons other than the cost-benefit analysis 'hedonic analysis' implies, or even a mistaken policy." Dorn, 397 F.3d at 1195; see Mercado, 974 F.2d at 871 (identifying a host of issues other than the value of life that prompt government health and safety measures). In short, Dr. Smith's method for valuing life is based on assumptions "that appear to controvert logic and good sense." Wilt, 443 S.E.2d at 205.

But even assuming that Dr. Smith's formula is a reliable measure of the value of life, it was of no assistance to the jury in calculating Smith's loss of enjoyment of life. As other courts have recognized, "[t]he willingness-to-pay studies do not relate  in any way to the actual component of damages, the enjoyment of life."    Id. at 205 n.15; see Sullivan, 862 F. Supp. at 321 ("The studies relied on by Mr. Smith do not use methodology designed to calculate the loss of enjoyment of life, yet are nonetheless extrapolated by Mr. Smith into what he claims to be valid data for calculating damages for . . . loss of enjoyment of life."). Dr. Smith equated the value of life with the value of enjoyment of life, though it is readily apparent that the two are not the same. A plaintiff who loses enjoyment of life but is alive is not in the same shoes as a plaintiff who lost his life. As the court observed in Sullivan: "Mr. and Mrs. Sullivan suffered totally distinct and different damages (Mrs. Sullivan died, Mr. Sullivan faces living without the support and companionship of his wife), yet, under Mr. Smith's analysis their damages are identical, save only an adjustment for differing the expectancy."    862 F. Supp. at 321. That Dr. Smith may equate the value of enjoyment of life with the value of life itself is not enough to bridge the gap. See Gen. Elec. Co. v. Joiner, 522 U.S. 136, 146 (1997) ("[N]othing in either Daubert or the Federal Rules of Evidence  requires a district court to admit opinion evidence that is connected to existing data only by the ipse dixit of the expert.").

b. Loss of Credit Expectancy  

Dr. Smith also testified that Smith suffered "the loss of credit expectancy" in the amount of $87,850 as a result of the foreclosures. According to Dr. Smith, a person with a good credit rating has the ability to borrow twice his annual income at a 12% rate of interest. This "credit expectancy" represents a "safety net"--even though a person will "rarely" have to borrow the maximum available credit, it is valuable, according to Dr. Smith, because it gives the person "flexibility, an option in life." On the other hand, someone with a bad credit rating has an increased cost of using this available credit because the rate of interest jumps to at least 25%. The increased cost lasts for seven years, the length of time that a delinquency remains on a credit report. According to Dr. Smith, this increased cost of borrowing twice one's income is the amount of lost credit expectancy. Because Smith had a good credit rating prior to the foreclosures, which derailed it, Dr. Smith doubled Smith's reported income of $41,000 and multiplied it by  13% per year for seven years to arrive at the $87,850 figure for Smith's loss of credit expectancy.

This testimony was inadmissible under Rule 702. By the time this case went to trial, more than five years had passed since Smith's credit troubles began. Even assuming that Smith actually had the capacity to borrow twice his income at the suggested rates, a proposition for which Dr. Smith cited no authority but himself, there was no evidence that Smith tried to or had the intention to borrow anything close to that amount during those five years.

Footnote 5. Smith only testified that he "applied for credit cards, and they wouldn't give it to me."

The conclusion that Smith should nonetheless be compensated as if he had borrowed the maximum amount of "available" credit in year one at the high cost of 25% per year is unsupportable. The disconnect between Dr. Smith's methodology and the facts of the case rendered the testimony unhelpful to the jury in determining Smith's actual damages.

Similarly, there was no evidence of the likelihood of Smith borrowing the stated sum in the remaining two years before the foreclosures would disappear from his credit report. Nor was there any evidence of his income at  the time, a crucial variable in Dr. Smith's formula. "With respect to future damages, a plaintiff is entitled to compensation for all damages that reasonably are to be expected to follow, but not to those that possibly may follow, the injury which he has suffered." Donovan v. Philip Morris USA, Inc., 914 N.E.2d 891, 899 (Mass. 2009) (internal quotation marks omitted) (brackets omitted). Absent evidence to the contrary, Smith's loss of future credit expectancy at the rate calculated by Dr. Smith was merely in the realm of possible harm. As such, it was speculative and should have been excluded.

None of this is to suggest that the damage to Smith's credit rating is not compensable. See United States v. Burke, 504 U.S. 229, 239 (1992) (listing "a ruined credit rating" as an example of consequential damages). Dr. Smith's methodology was simply not a useful measure, and his testimony should not have been admitted.

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