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December 18, 2013 Articles

United States v. Cuti and Lay/Fact Witness Opinion Testimony

Second Circuit rules on "what-if-you-had-known" questions posed to accountants called as fact witnesses but not as expert witnesses.

By Stanley A. Twardy Jr. and Daniel E. Wenner

After the decision by the U.S. Court of Appeals for the Second Circuit in United States v. Cuti, 720 F.3d 453 (2d Cir. 2013), there is a greater likelihood that today’s chief financial officer (CFO) or auditor may be tomorrow’s star witness in a criminal-fraud trial. In Cuti, the court held that accountants who had participated in preparing or auditing financials can be asked “what-if-you-had-known” questions because such testimony was permissible fact and lay-opinion testimony.

The Case
Cuti involved the prosecution in the Southern District of New York of defendants Anthony Cuti and William Tennant, both former executives of Duane Reade, a retail drugstore chain in New York City. Cuti and Tennant were tried and convicted for various securities-fraud offenses that stemmed from their alleged efforts to artificially inflate Duane Reade’s earnings.

The case centered around purportedly fraudulent real-estate transactions in which Duane Reade sold real-estate concessions and other rights that the store owned in its storefront leases. Cuti, Duane Reade’s former chairman and chief executive officer, and Tennant, its former CFO, were convicted of engaging in sham transactions with Winick Realty Group to artificially inflate the firm’s earnings.

The government charged that Duane Reade entered into transactions with Winick Realty to sell valueless concessions in leases. In return, Duane Reade entered into bogus consulting agreements with and padded brokerage fees to Winick Realty to return the money it had been paid for these sham concessions. At the heart of the scheme was the accounting treatment for the sales of the concessions, which the government alleged had been used to artificially inflate Duane Reade’s earnings.

The Accountants’ Testimony
At trial, the government elicited testimony from John Henry, who succeeded Tennant as Duane Reade’s CFO, and Kevin Hallinan, the lead outside auditor for Duane Read. The government asked both Henry and Hallinan how they accounted for proceeds from these transactions, how they would have accounted for them had they been aware of facts the government alleged were withheld from them, and how the material information that they were not shown led to misstatements in the financial statements. They also testified about the rules regarding accounting set forth under the generally accepted accounting principles (GAAP), including how to recognize income based on transactions to sell real-estate concessions. Both testified they booked the income from the sales according to the GAAP.

The government brought to both Henry’s and Hallinan’s attention various documents and information that they had not seen or known about and asked them several “what-if-you-had-known” questions to determine how knowledge of those facts would have altered their recognition of the revenue on Duane Reade’s financial statements. They testified that knowledge of those facts would have altered their approach in their accounting. Basically, they testified that had they known what the government was telling them, they would have eliminated recognizing the revenue that allowed Duane Reade to meet its earnings targets.

Cuti objected to this “what if” testimony, arguing that it was improper expert testimony masquerading as lay-opinion testimony. Both the trial and appellate courts disagreed.

Not Expert Opinion But Fact Testimony
The scope of a witness’s testimony is governed by Rules 602, 701, and 702 of the Federal Rules of Evidence. Rule 602 provides that “[a] witness may testify to a matter only if evidence is introduced sufficient to support a finding that the witness has personal knowledge of the matter.” Rule 701 states:

If a witness is not testifying as an expert, testimony in the form of an opinion is limited to one that is: (a) rationally based on the witness’s perception; (b) helpful to clearly understanding the witness’s testimony or to determining a fact in issue; and (c) not based on scientific, technical, or other specialized knowledge within the scope of Rule 702.

Rule 702 states:

A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if: (a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.

Cuti argued on appeal that the government elicited expert testimony from Henry and Hallinan without disclosing them as experts under Federal Rule of Criminal Procedure 16 and without properly qualifying them under Federal Rule of Evidence 702. The court of appeals rejected this argument.

The court noted that determining whether testimony constituted fact or opinion was more art than science, noting Judge Richard Posner’s observation that “[a]ll knowledge is inferential, and the combined effect of Rules 602 and 701 is to recognize this epistemological verity but at the same time to prevent the piling of inference upon inference to the point where testimony ceases to be reliable.” United States v. Giovannetti, 919 F.2d 1223, 1226 (7th Cir. 1990). The court went on to describe Henry’s and Hallinan’s testimony when answering hypotheticals to be based on their observations while working on behalf of Duane Reade and to fall on the fact side of the fact-opinion spectrum. The court also found that “since the applicable accounting rules were explained in detail, the reasoning process that the witnesses employed in answering the hypotheticals was straightforward and transparent to the jurors, who could readily discern whether the responses given were reliable.” Cuti, 720 F.3d at 458. As a result, the court held “that the challenged testimony was properly admitted as factual testimony.”

The Testimony Was Appropriate Lay Testimony under Rule 701
The court of appeals also held (alternatively) that the testimony was properly admitted as lay opinion under Rule 701. The court reasoned that the testimony did not run afoul of Rule 701(a) because “the witnesses were not testifying to the existence of facts, but simply acknowledging that knowledge of such facts, already admitted into evidence, would have caused them to alter their accounting treatment.”

The court found their testimony to be consistent with Rule 701(c), which requires the opinions to be those that “result[] from a process of reasoning familiar in everyday life.” Rule 701 advisory committee’s note, 2000 amend. The court acknowledged that it might appear that the accounting rules involved in the case are technical and unfamiliar in everyday life. But the court noted that those rules and their application were not actually at issue in the case. Instead, the issue was simply whether the undisclosed facts would have altered the application of those rules. As a result, the witnesses were not giving any expert opinion about accounting rules, but were simply giving their opinions about whether they would have acted differently if they had been aware of additional information, which the court concluded was a process that is familiar in everyday life.

What Does Cuti Portend?
Prosecutors’ application of the twin holdings of Cuti—that testimony from the accountants was properly admitted as factual testimony and was properly admitted as lay-opinion testimony—will likely be widespread. The court took pains to describe the testimony from witnesses who were involved in the events underlying the litigation to be fact testimony, even though the witnesses had a particular expertise that was the subject matter of their testimony. Even though these witnesses were accountants who were asked to interpret accounting rules, the court did not consider them to be experts. Certainly, the result would have been different had the witnesses been uninvolved in the underlying events. But the impact will undoubtedly be applied to more disciplines than accounting.

Prosecutors in fraud cases will take advantage of the expertise of certain fact witnesses who have played a part in the events at issue. Accountants and other professionals will be turned from simple fact witnesses—discussing the mundane, “who, what, when, where, and how”—into pseudo-experts who will walk the jury through the purported fraud and explain to them why they should convict. CFOs, auditors, and others will no longer be simply pieces of the government’s puzzle; instead, they will likely be called on to be the experts who piece the puzzle together.

Defense counsel should make clear or ask the trial court to make clear to the jury that the government’s witnesses are not experts. If left unsaid, the jury may consider the accounting witnesses as having an expertise, which may be true but is irrelevant under Cuti. Perhaps they can even convince the court to give an instruction to that effect.

Finally, what’s good for the goose is good for the gander. Defense counsel should take advantage of Cuti to avoid having to designate experts if possible. If the government can ask accountants and auditors “what-if-you-had-known” questions, then defense counsel should be entitled to as well. While that might not always be doable, Cuti opens the possibility that defense counsel can use the government’s witnesses to provide opinion testimony on their client’s behalf, by using “what if” questions that show the defendant’s lack of scienter.

Keywords: criminal litigation, lay opinion testimony, "what-if-you-had-known" questions, lay/fact-witness testimony, expert testimony, United States v. Cuti, 720 F.3d 453 (2d Cir. 2013)

Stanley A. Twardy Jr., is the managing partner of Day Pitney in the Stamford, Connecticut, office, and Daniel E. Wenner is counsel to the firm in the Hartford, Connecticut, office.

Copyright © 2013, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).