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United States v. Cuti

United States Court of Appeals, Second Circuit

June 26, 2013

UNITED STATES OF AMERICA, Appellee,
v.
ANTHONY CUTI, WILLIAM TENNANT, Defendants-Appellants.

Argued: October 25, 2012

Defendants-Appellants Anthony Cuti and William Tennant, former executives of the retail drugstore chain Duane Reade, appeal their convictions for securities fraud in the District Court for the Southern District of New York (Batts, J.). Cuti and Tennant arranged fraudulent transactions to inflate Duane Reade's reported earnings in SEC filings. Among the issues raised on appeal by Cuti is the admission of non-expert witness testimony as to what the accounting treatment of the transactions would have been absent the fraud. Tennant asserts primarily that the jury lacked sufficient evidence to convict him and that the district court had no basis to give a conscious avoidance instruction. We conclude that the district court did not abuse its discretion in admitting the lay witness testimony and that Tennant's claims are without merit. Affirmed.

BRIAN C. BROOK, Clinton Brook & Peed (Matthew J. Peed, Clinton Brook & Peed, and Brian D. Waller, Simon & Partners, LLP, on the brief), New York, NY, for Defendant-Appellant Anthony Cuti.

JOHN J. KENNEY (Laura B. Hoguet, Tai-Heng Cheng, Caitlin N. Bush, Damian R. Cavaleri, on the brief), Hoguet Newman Regal & Kenney, LLP, New York, NY, for Defendant-Appellant William Tennant.

SARAH E. MCCALLUM (Rebecca Monck Ricigliano, Katherine Polk Failla, on the brief), Assistant United States Attorneys, for Preet Bharara, United States Attorney for the Southern District of New York, New York, NY, for Appellee.

Before: JACOBS, Chief Judge, WALKER, Circuit Judge, and O'CONNOR, Associate Justice (retired).[*]

JOHN M. WALKER, JR., Circuit Judge

Defendants-Appellants Anthony Cuti and William Tennant appeal from judgments of conviction following a jury trial in the District Court for the Southern District of New York (Deborah A. Batts, Judge).[1] This opinion addresses Cuti's claim that the district court erred in admitting testimony from two lay witnesses as to what the accounting treatment of certain fraudulent transactions would have been absent the fraud, and Tennant's claims that his conviction should be overturned for insufficient evidence to prove his knowledge of the fraud and that it was error for the district court to give a conscious avoidance jury instruction. We conclude that the district court did not abuse its discretion in admitting the testimony of the non-expert witnesses and that Tennant's claims are without merit.[2] AFFIRMED.

BACKGROUND

Cuti was the former president, chief executive officer, and board chairman of Duane Reade, a retail drugstore chain in the New York City metropolitan area. Tennant was Duane Reade's former chief financial officer or CFO and senior vice-president, who continued to consult for the company on real estate matters after his formal retirement.

The trial evidence, which we take as credited by the jury, showed that from 2000 to 2004, Cuti and Tennant (collectively, "defendants") executed a number of schemes to inflate the company's earnings in quarterly and annual financial statements filed with the Securities and Exchange Commission ("SEC").

The principal scheme consisted of the fraudulent sale of real estate concessions and other rights that Duane Reade held in its storefront leases. When Duane Reade vacated a storefront with an unexpired lease, the right to the remainder of the lease term could have residual value and be sold back to the landlord or to a broker, especially when rental rates had risen. Cuti and Tennant, however, inflated earnings by fraudulently selling real estate concessions that were virtually worthless and surreptitiously repaying the purchasers through payments disguised as expenses.

Cuti and Tennant's primary counterparty to the transactions in this scheme was the Winick Realty Group ("Winick Realty"), a commercial real estate brokerage firm and its subsidiaries (collectively, the "WRG entities"). At trial, Cory Zelnik, a partner at Winick Realty, testified that in 2000, the WRG entities paid $806, 000 for concessions in eight leases that Duane Reade had already sold, assigned away or planned to abandon and another $890, 000 for options to buy out Duane Reade from three leases that were of minimal value to Winick Realty. The defendants repaid the WRG entities for these outlays using a sham consulting agreement and padded brokerage fees. The revenue immediately recognized from these transactions helped Duane Reade bridge a gap between its true earnings and analysts' expectations for the fourth quarter of 2000. In subsequent quarters, the defendants continued to arrange other sham transactions to inflate company earnings and to repay the counter parties.

Because Duane Reade recognized such significant income from these activities, its external auditor, PricewaterhouseCoopers ("PwC"), required the company to include in its financial statements filed with the SEC, a note stating that the company had no side agreements with or other obligations to the transaction counterparties. At trial, the government produced evidence of side agreements and demonstrated, through witness testimony and voluminous documentation, how the defendants executed and concealed their fraudulent conduct from the company's internal accountants, PwC, the SEC, and the investing public.

As part of its case, the government called Kevin Hallinan, the PwC partner who was Duane Reade's lead outside auditor, and John Henry, Tennant's successor as CFO and the company's chief in-house accountant, to testify as to how they had accounted for the proceeds from the fraudulent transactions; how they would have accounted for the transactions had they been aware of the full facts; and how the material information that was withheld from them led to misstatements in the company's financial statements.

The rules governing the accounting of real estate concession transactions, as Hallinan and Henry explained, are set forth under generally accepted accounting principles ("GAAP") including Financial Accounting Standards Board Statement No. 13 and SEC Staff Accounting Bulletin No. 104. In order for revenue generated from such a transaction to be recognized immediately, (1) Duane Reade had to have negotiated with the counterparty at arms' length, (2) the transaction must have had value, (3) to the extent the transaction relieved Duane Reade of its obligations under a lease agreement, the company could not be committed to enter into another lease with the same landlord, and (4) the transaction could not create any further obligations for Duane Reade to perform. If any of the foregoing criteria were not satisfied, immediate revenue recognition would have been inappropriate. Both the company's internal accountants and outside auditors adhered to these rules in booking revenue from real estate concession transactions. At trial, the defendants did not dispute that these rules were appropriately and consistently applied.

To demonstrate the impact of the defendants' deception on the preparation and review of the company's financial statements, the government presented Hallinan and Henry with information that Cuti and Tennant had withheld, such as side letters to the transactions, and asked how the withheld information would have affected their accounting. In each instance, Hallinan and Henry replied that if they had been aware of the withheld information, they would not have recognized the full amount of the transaction proceeds as immediate revenue. Defense counsel objected to the use of "what- if-you-had-known" questions as eliciting inadmissible expert opinion testimony from fact witnesses.

In his defense, Tennant asserted that, like Hallinan and Henry, he too was deceived by Cuti's fraudulent scheme and signed transaction documents without knowing that fraud was afoot so there was insufficient evidence of his criminal intent to support a conviction. He also objected to the district court's inclusion of a conscious ...


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