# How Do Courts Treat the Use of Internal Models versus Third Party Quotes? ▴ Question

**Published:** 2025-07-30
**Categories:** Question

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## Concept

In the context of judicial review, the valuation of an asset represents a critical point of contention, where the methodologies employed are subjected to intense scrutiny. The core challenge for the court is to ascertain a valuation that is not only mathematically sound but also fundamentally fair and representative of economic reality. This process invariably leads to a close examination of the two primary sources of valuation data ▴ proprietary [internal models](https://prime.greeks.live/area/internal-models/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) and externally sourced [third-party quotes](https://prime.greeks.live/question/how-should-an-institutions-internal-compliance-framework-integrate-with-the-audit-trails-from-a-third-party-rfq-platform/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). The selection between these two approaches is a determination of how an institution chooses to articulate value, a decision with profound consequences within a legal framework that prizes objectivity and verifiable evidence above all else.

Internal models are sophisticated, often complex analytical engines built by an institution to price assets and manage risk. They are constructed from the institution’s own data, assumptions, and proprietary intellectual property. Their strength lies in their specificity; they can be tailored to the unique characteristics of an asset, particularly one that is illiquid or possesses features not easily captured by standard market instruments. This bespoke nature allows for a granular analysis that can, in theory, produce a more precise valuation.

The central issue for a court, however, is the inherent opacity of these models. Their proprietary nature makes them a “black box,” where the inputs and the logic connecting them to the output are not immediately transparent to an outside observer. This creates a significant evidentiary burden for the party presenting the model-based valuation.

> A court’s primary function in a valuation dispute is to validate the economic fairness and reliability of the evidence presented.

Third-party quotes, conversely, derive their power from their market-based origins. These are prices solicited from external, independent market participants, representing actionable bids or offers. Their evidentiary value is rooted in the concept of an arm’s-length transaction, which is the bedrock of “[fair market value](https://prime.greeks.live/area/fair-market-value/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite).” A quote from a credible third party is seen as a direct reflection of what the market is willing to pay, lending it an immediate air of objectivity. The challenge with third-party quotes arises from questions of their relevance and robustness.

A court must be convinced that the quotes are for the identical or a sufficiently similar asset, that they are recent, and that they come from a liquid and active market. A single, stale quote for a dissimilar asset holds little [evidentiary weight](https://prime.greeks.live/area/evidentiary-weight/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite).

The judicial treatment of these two valuation methodologies is therefore a study in the balance between precision and objectivity. An [internal model](https://prime.greeks.live/area/internal-model/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) offers the potential for a highly tailored and nuanced valuation, but it requires the court to undertake a deep, technical analysis to validate its assumptions and methodology. A third-party quote provides a clear, market-driven data point, but its applicability to the specific facts of the case must be rigorously established. The court’s task is to navigate this trade-off, guided by established legal principles of evidence, to arrive at a figure that is defensible, fair, and grounded in economic substance.

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## Strategy

The strategic decision to rely on an internal model versus third-party quotes in a legal dispute is governed by the prevailing standard for the admissibility of [expert testimony](https://prime.greeks.live/area/expert-testimony/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite). In United States federal courts, this standard is primarily defined by the principles established in Daubert v. Merrell Dow Pharmaceuticals, Inc. and its progeny.

This line of cases positions the judge as a “gatekeeper” responsible for ensuring that all expert testimony, including that of financial experts, is both relevant and reliable before it can be presented to a jury. Understanding the practical application of the [Daubert standard](https://prime.greeks.live/area/daubert-standard/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) is therefore central to formulating a winning litigation strategy.

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## The Daubert Gauntlet for Internal Models

An internal financial model, when presented as evidence, is the quintessential form of expert testimony that falls under the purview of Daubert. The proponent of the model must be prepared to defend its intellectual foundations against a rigorous challenge. The court will assess the model’s reliability based on a non-exhaustive list of factors.

- **Testability** Can the model’s underlying theory be tested or falsified? A model based on esoteric or purely theoretical assumptions that cannot be empirically validated is unlikely to pass muster. The discounted cash flow method, for instance, is a widely accepted valuation technique because its inputs can be tested against market data.

- **Peer Review and Publication** Has the methodology been subjected to peer review within the financial community? While not a prerequisite, publication in a reputable financial journal or acceptance by industry bodies lends significant credibility. A proprietary model that has never been exposed to outside scrutiny faces a higher barrier.

- **Known or Potential Error Rate** All models have limitations and potential for error. The court will expect a transparent discussion of the model’s error rate and the sensitivity of its output to changes in key assumptions. An expert who presents a model as infallible is likely to lose credibility.

- **General Acceptance** Is the methodology generally accepted within the relevant field of finance? This factor, inherited from the older Frye standard, remains a powerful consideration. Using established and widely recognized valuation techniques as the foundation of an internal model is a sound strategic choice.

The case of Kumho Tire Co. v. Carmichael extended the Daubert standard explicitly to non-scientific experts, including accountants and valuation professionals. This means that any financial expert presenting a valuation based on an internal model must be prepared for a thorough cross-examination on these points. A successful strategy involves selecting an expert who can not only articulate the model’s conclusion but also defend its architectural soundness and the reasonableness of its inputs.

> Courts often view valuation reports prepared specifically for litigation with a degree of skepticism, favoring those created in the ordinary course of business.

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## The Corroboration Strategy for Third Party Quotes

Third-party quotes are generally treated as factual evidence rather than expert opinion, which means they are not typically subjected to a full Daubert analysis. The strategic challenge here shifts from defending a methodology to establishing relevance and authenticity. A court will need to be convinced of several points:

- **Authenticity** The quotes must be proven to be genuine communications from credible market participants.

- **Relevance** The quotes must be for the specific asset in question or a very close proxy. The timing of the quotes is also critical; stale quotes have diminished value.

- **Market Context** The quotes must come from a market with reasonable depth and liquidity. A handful of quotes from a thinly traded, opaque market may be deemed unreliable.

A significant legal consideration is the effect of disclaimers often included in valuation reports. In CBRE (V) Pty Ltd v City Pacific Ltd, a court found that a valuation could be considered misleading even if the party relying on it was not the original addressee, and that standard disclaimers did not automatically limit liability. This suggests that courts will look at the substance of a valuation over its contractual form.

The key strategic takeaway is that simply presenting a third-party quote is insufficient. It must be woven into a larger narrative that establishes its context, credibility, and direct applicability to the valuation dispute at hand.

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## Execution

The execution of a valuation argument in court requires a granular understanding of how judges weigh different forms of evidence. The theoretical strengths and weaknesses of internal models and third-party quotes translate into practical advantages and disadvantages in a courtroom setting. A successful litigant must anticipate how opposing counsel will attack their valuation and how the judge will apply the rules of evidence to each piece of information presented.

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## Comparative Analysis of Evidentiary Weight

The choice between relying on an internal model or third-party quotes is a tactical one, with each option presenting a distinct risk-reward profile. The following table outlines the key factors a court considers when evaluating these two sources of valuation.

| Factor | Internal Model | Third-Party Quote |
| --- | --- | --- |
| Objectivity | Viewed with initial skepticism due to its proprietary nature and potential for manipulation. The burden of proof is on the proponent to demonstrate its impartiality. | Presumed to be more objective as it originates from an external, arm’s-length source. This presumption can be rebutted by showing the market is illiquid or the quote is an accommodation. |
| Verifiability | Difficult to verify without extensive discovery into the model’s code, inputs, and assumptions. Subject to a rigorous Daubert challenge. | Easier to verify through documentation, communication records, and testimony from the quoting party. The focus is on authenticity and market context. |
| Specificity | Can be highly specific to the asset being valued, capturing unique features that market quotes might miss. This is its primary strength. | May lack specificity if the asset is unique or illiquid. The court must be convinced that the quoted asset is a valid comparable. |
| Legal Scrutiny | Focuses on the reliability and relevance of the expert’s methodology under the Daubert standard. The expert’s qualifications and independence are paramount. | Focuses on the factual foundation of the quote. Scrutiny is applied to the credibility of the source, the timing of the quote, and the nature of the market. |

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## How Do Courts Handle Valuation Disclaimers?

A common feature of [third-party valuation](https://prime.greeks.live/area/third-party-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) reports is the inclusion of disclaimers intended to limit the valuer’s liability and restrict the use of the report to the named recipient. However, courts do not always allow such disclaimers to shield a valuer from responsibility, particularly when the valuation is found to be misleading. In the case of CBRE (V) Pty Ltd v City Pacific Ltd, the court held that disclaimers do not alter the fact that providing a misleading valuation may breach statutory standards. This precedent indicates that courts are willing to look beyond the contractual language to the substance of the valuation and its impact.

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## Navigating a Daubert Challenge

For a party relying on an internal model, surviving a [Daubert challenge](https://prime.greeks.live/question/can-a-firm-legally-challenge-a-close-out-amount-that-it-believes-was-not-calculated-in-a-commercially-reasonable-manner/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) is the most critical phase of the execution. The process is adversarial, with each side presenting expert testimony on the validity of the financial model.

| Phase of Challenge | Proponent’s Argument (Defending the Model) | Opponent’s Argument (Attacking the Model) |
| --- | --- | --- |
| Methodology | The model is based on widely accepted financial principles (e.g. discounted cash flow, Black-Scholes) that have been peer-reviewed and are standard in the industry. | The model uses a novel or untested methodology. It is “junk science” designed to produce a predetermined result. |
| Inputs and Assumptions | The inputs (e.g. growth rates, discount rates) are derived from reliable market data and are consistent with historical trends and reasonable future expectations. | The inputs are speculative and lack sufficient factual basis. The expert has “cherry-picked” data to support their conclusion. |
| Error and Sensitivity | A sensitivity analysis has been performed, showing the model’s output is robust across a range of reasonable assumptions. The potential for error is understood and quantified. | The model is excessively sensitive to minor changes in a single input, making its output unreliable. The expert has not accounted for the potential rate of error. |
| Application | The expert has correctly applied the reliable methodology to the specific facts of the case. | The expert’s opinion is not sufficiently tied to the facts of the case. The model, even if theoretically sound, is irrelevant as applied here. |

Ultimately, the court’s decision will rest on a holistic assessment of the evidence. A valuation based on a well-documented internal model, validated by an independent and credible expert, can be very persuasive. Similarly, a collection of recent, relevant, and verifiable third-party quotes from an active market can provide a powerful benchmark of value.

The most effective legal strategy often involves a hybrid approach, using third-party quotes to corroborate and anchor the reasonableness of the outputs generated by an internal model. This creates a layered, defensible argument that appeals to the court’s need for both analytical rigor and objective, market-based evidence.

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## References

- Banton Group. “Can a third party rely on a valuation not addressed to it?.” Banton Group, 27 Apr. 2022.

- McDaniel, Peter. “Court Rejects Litigation Value Reports as Unreliable.” The Business Divorce Law Report, 6 Sept. 2024.

- New Square Chambers. “Share Valuation in Shareholder Disputes.” 4 New Square Chambers, 10 July 2019.

- Legal Information Institute. “Daubert Standard.” Wex, Cornell Law School.

- MJCPA. “Will your business valuation expert survive a Daubert challenge?.” mjcpa.com, 28 Nov. 2022.

- The Center for Forensic Economic Studies. “Daubert and Economics.” The Center for Forensic Economic Studies, 2 Dec. 2013.

- Expert Institute. “The Daubert Standard ▴ A Guide To Motions, Hearings, and Rulings.” Expert Institute, 9 May 2024.

- “Financial expert’s ‘market efficiency’ analysis survives Daubert attack.” Business Valuation Resources, 13 May 2015.

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## Reflection

The examination of how courts treat internal models versus third-party quotes reveals a fundamental tension within the legal system’s search for financial truth. It compels a deeper reflection on an institution’s own valuation architecture. How robust are your internal models to external scrutiny? Is your reliance on third-party data systematic and well-documented, or is it a matter of convenience?

The principles applied by courts ▴ objectivity, verifiability, relevance ▴ are not merely legal hurdles; they are the essential components of a sound and defensible valuation framework. The knowledge gained here should serve as a diagnostic tool, prompting an introspective analysis of your own systems and processes. A superior operational framework is one that not only generates accurate valuations but can also withstand the most rigorous and adversarial examination.

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## Glossary

<a href="https://prime.greeks.live/question/how-should-an-institutions-internal-compliance-framework-integrate-with-the-audit-trails-from-a-third-party-rfq-platform/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Third-Party Quotes

Integrating RFQ audit trails transforms compliance from a reactive task into a proactive, data-driven institutional capability. </a><a href="https://prime.greeks.live/area/internal-models/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Internal Models

Meaning ▴ Internal Models constitute a sophisticated computational framework utilized by financial institutions to quantify and manage various risk exposures, including market, credit, and operational risk, often serving as the foundation for regulatory capital calculations and strategic business decisions. </a><a href="https://prime.greeks.live/area/fair-market-value/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Fair Market Value

Meaning ▴ Fair Market Value quantifies the objective price equilibrium for an asset, representing the notional transaction point where a willing, uncoerced buyer and seller, each possessing comprehensive information, would execute a trade in an open and competitive market environment. </a><a href="https://prime.greeks.live/area/evidentiary-weight/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Evidentiary Weight

Meaning ▴ The term Evidentiary Weight quantifies the calibrated influence or reliability assigned to a specific data point, signal, or analytical output within a computational decision-making framework. </a><a href="https://prime.greeks.live/area/internal-model/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Internal Model

Meaning ▴ An Internal Model is a proprietary computational construct within an institutional system designed to quantify specific market dynamics, risk exposures, or counterparty behaviors based on an organization's unique data, assumptions, and strategic objectives. </a><a href="https://prime.greeks.live/area/expert-testimony/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Expert Testimony

Meaning ▴ Expert testimony refers to the presentation of specialized knowledge, analysis, or opinion by a qualified individual within legal, regulatory, or arbitral proceedings. </a><a href="https://prime.greeks.live/area/daubert-standard/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Daubert Standard

Meaning ▴ The Daubert Standard defines the criteria for the admissibility of expert witness testimony in U.S. </a><a href="https://prime.greeks.live/area/third-party-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Third-Party Valuation

Meaning ▴ Third-party valuation refers to the independent assessment of an asset's fair market value performed by an unbiased external entity, distinct from the transacting parties or the asset holder. </a><a href="https://prime.greeks.live/question/can-a-firm-legally-challenge-a-close-out-amount-that-it-believes-was-not-calculated-in-a-commercially-reasonable-manner/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Daubert Challenge

A firm can legally challenge a close-out amount by demonstrating the calculation failed the objective standard of commercial reasonableness. </a>

**Tags:** [Litigation Value](https://options.greeks.live/area/litigation-value/), [Evidentiary Weight](https://options.greeks.live/area/evidentiary-weight/), [Shareholder Disputes](https://options.greeks.live/area/shareholder-disputes/), [Business Valuation](https://options.greeks.live/area/business-valuation/), [Financial Model Validation](https://options.greeks.live/area/financial-model-validation/), [Internal Model](https://options.greeks.live/area/internal-model/)	

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- 
### [How Does a Court Distinguish between the Weight and Admissibility of Expert Testimony?](https://options.greeks.live/question/how-does-a-court-distinguish-between-the-weight-and-admissibility-of-expert-testimony/)
![A slender metallic probe extends between two curved surfaces. This abstractly illustrates high-fidelity execution for institutional digital asset derivatives, driving price discovery within market microstructure. It represents Prime RFQ protocol precision navigating dark liquidity for best execution and capital efficiency.](https://options.greeks.live/wp-content/uploads/2025/07/precision-instrument-navigating-institutional-digital-asset-derivatives-rfq-protocols-for-optimal-price-discovery-and-high-fidelity-execution.jpg)

A court first acts as a gatekeeper, assessing admissibility based on reliability, then lets the jury assign weight based on credibility.

- 
### [Can a Party Use Internal Models to Determine the Close out Amount under the 2002 ISDA?](https://options.greeks.live/question/can-a-party-use-internal-models-to-determine-the-close-out-amount-under-the-2002-isda/)
![Internal components of a Prime RFQ execution engine, with modular beige units, precise metallic mechanisms, and complex data wiring. This infrastructure supports high-fidelity execution for institutional digital asset derivatives, facilitating advanced RFQ protocols, optimal liquidity aggregation, multi-leg spread trading, and efficient price discovery.](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-core-rfq-engine-for-institutional-digital-asset-options.jpg)

A party can use internal models for the 2002 ISDA Close-Out Amount if external data is unavailable or unreasonable.

- 
### [How Does the Basel Framework Influence the Choice between Different Risk Models?](https://options.greeks.live/question/how-does-the-basel-framework-influence-the-choice-between-different-risk-models/)
![Interlocking transparent and opaque geometric planes on a dark surface. This abstract form visually articulates the intricate Market Microstructure of Institutional Digital Asset Derivatives, embodying High-Fidelity Execution through advanced RFQ protocols. It symbolizes Aggregated Inquiry, optimal Liquidity Pool access, and Atomic Settlement within a Principal OS.](https://options.greeks.live/wp-content/uploads/2025/07/geometric-abstraction-of-institutional-digital-asset-derivatives-market-microstructure-driving-high-fidelity-execution-via-principal-rfq-protocols-and-optimal-liquidity-aggregation.jpg)

The Basel Framework dictates risk model choice by defining the methodologies for regulatory capital calculation.

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---

**Original URL:** https://options.greeks.live/question/how-do-courts-treat-the-use-of-internal-models-versus-third-party-quotes/
