**Among lawyers, the old adage still applies: “iudex non calculat”. But a few days ago, an article1 appeared in the business section of the FAZ, which, due to the headline, did not reveal the explosive nature of the author’s comments on the subject of yields. In everyday life we often use terms about whose meaning we do not give much thought, because we believe to have already fully grasped the content. This is also the case for most business correspondents of major daily newspapers and journalists of well-known business magazines. This includes the presenters of popular TV shows when they talk about stock market developments and investment activities, and about the future financial targets of major DAX stocks which, as a return benchmark, aim to generate at least 25 percent of the company’s equity as a return in the coming year. Calculating the return for one year is still easy to understand, but what about when several years have to be linked together and, for example, a compact capital investment at the beginning generates five or ten different or equally high returns in the following five or ten years, before the capital investment is returned in the last return ? What is really meant when an investor is recommended a capital investment that promises a particularly high return? Does the recommender know exactly what he is talking about and can he count on the recipient of the message understanding the content in the same way as the sender delivers it? Not at all. The concept of return is used by anyone who has to proclaim that he is selling something that will bring the buyer more benefit (income) than the capital he invests in it! This brings us quite close to the basic question and its solution. But a close miss is not a hit. Those who rave about “return on investment” are generally unaware that they are also liable for their statements to the recipient. These include initiators of investment offers as well as banks, over whose counters the investments are offered to the clientele or which take over the share financing of the investment. This applies equally and in particular to rating agencies, sales groups, investment advisors and brokers, as well as tax advisors, whom the potential investor asks for advice; to auditors and prospectus auditors, who are entrusted with the meticulous verification of the facts by the initiator. In the end, lawyers in their various functions as judges, public prosecutors or lawyers have to decide whether the statements of various methods of return promise the plaintiff or client too much or too little in return from the outset, and whether a possible claim for damages is justified. Claim investor losses incurred as a result of inaccurate information.**

First, let’s keep the opening message in mind:

**Basic principle of dynamic return determination without reinvestment of reflows**

**IRR return method with or without reinvestment premise?**

**IRR reinvestment premise generates notional additional interest**

**Validity of IRR return also for consumers of recoveries?**

**Is the reinvestment decision made by the investor or by the IRR return method?**

Therefore, an investor and his lawyer should pay strict attention to whether, when concluding his capital investment, the return on the assumption of reinvestment at the internal rate of return was stated or even the IRR method was stated in the prospectus or only the return on the parent investment was referred to, which does not assume reinvestment of the returns. By applying the IRR, the IRR return method anticipates the reinvestment decision.

**Legal evaluation of the IRR method**

The IRR method implies factual assertions, with its application as a yield ratio:

(3) As a rule, products that advertise IRR returns do not include an option to reinvest the distributions in the same product in order to retain them and thus generate additional interest.(4) The fact that there are ongoing distributions forces the investor (who wants to achieve the IRR return) to take care of the reinvestment himself and to find investment opportunities that necessarily yield a return at the stated IRR interest rate.

(5) The use of the IRR misleads that it is an accumulating product and/or it misleads that the investor can necessarily invest his current distributions at the calculated IRR; in this product or in another investment product on the capital market. Generally, these reinvestment opportunities do not exist for the distributions at said IRR yield. The residual proceeds, on the other hand, will not be reinvested because they are usually returned as the final payment at the end of the investment, ending the investment period.

#### A. Damages as a claim for performance

**Example :**

#### B. Compensation for damages is also possible under the advertising liability provisions of the German Civil Code (BGB), according to which, for example, statements made in a brochure are deemed to be warranted characteristics.

#### C. In the event of damages arising from the reversal, the investor shall receive his equity instalments paid back in full, plus interest at the rate customary in the capital market from the beginning.

**Consumers of the distributions cannot reinvest anything**

^{2}

^{3}.

**What is the relationship between IRR and capital commitment method or effective interest rate?**

n

Σ R_{t} * (1+r)^{-t}

t=0

_{0}, at the beginning of the investment at time t

_{0}, gives the value zero. We take this condition from the IRR determination equation according to the following formula: n

NKW= Σ R

_{t}*

^{ }(1+r)

^{-t}-I

_{0}=0

t=0

Σ R

_{t}*(1+r)

^{-t}=I

_{0 }t=0

_{0}, we have also found the present value of the investment expenditure, which in this simple case consists of only a single value I

_{0}= -100.

_{0}using the IRR formula, we can calculate the values at the end of the investment. To do this, we compound interest R

_{t}and also I

_{0}on the investment end t

_{n}with compound interest = (1+r)

^{n}(mathematically, “we extend”):

Σ R

_{t}*(1+r)

^{-t}*(1+r)

^{n}=I

_{0}*(1+r)

^{n }t=0

Σ R

_{t}*(1+r)

^{n-t}= I

_{0}*(1+r)

^{n}

t=0

Σ R

_{t}*(1+r)

^{n-t}

t=0

^{n-t}and (1+0)

^{n-t}, respectively, will always equal 1, so the terminal value of the parent investment reduces to the simple sum of all recoveries. n n

Σ R

_{t}*(1+r)

^{n-t}= Σ R

_{t}*1

t=0 t=0

**From the point of view of liability, not only initiators, prospectus auditors, rating agencies, banks and distributors, auditors, tax advisors and investment advisors should be aware of the differences, but also lawyers should take note of the fact that incorrect statements on returns trigger liability claims. This is particularly true for all users of the IRR method.**

**Concluding remarks on the IRR yield**

**Authors**

Johannes Fiala, lawyer, Master of Mediation (MM), banker and business economist (MBA), certified financial and investment advisor, has been advising independent financial service providers, in particular insurance brokers and agents, capital investors and distributors on the subject of consulting and prospectus liability for years. For two decades he gained experience in the fiduciary handling or administration of corporate and estate assets, real estate and securities – also by court order.

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## About the author

PhD, MBA, MM

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.

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