Simplifying with Cutti and Rule 701

November 11, 2014

Last month, the Supreme Court decided not to review a decision involving lay witness opinion testimony. The case – Cuti v. United States, 720 F.3d 453 (2nd Cir. 2013) – may be valuable for anyone who is involved in complex business litigation. It is worth a closer look.

The Cuti case involved a securities fraud prosecution against former executives from Duane Reade, the drugstore chain. The Government alleged that the executives used phantom internal transactions to create the illusion that the Company had sold off some expiring retail leases at above-market prices, creating illusory income on the Company’s financial statements. The key question was whether the transactions were proper under the revenue recognition rules from Generally Accepted Accounting Principles (“GAAP”).

At trial, the Government offered testimony from two witnesses – the Company’s outside auditor and its newly-appointed CFO – who both testified that they were familiar with the revenue recognition rules from GAAP (which were not in dispute). Both witnesses testified that, if they had known the true facts, they would have decided that the Company could not report so much revenue from selling the leases (id. at 456-57). The Defendants objected that this was improper opinion testimony from non-experts, but the judge admitted the testimony (id. at 457). The Government then argued that the scheme had artificially inflated the Company’s publicly-reported earnings, which misled investors. The jury convicted the Defendants.

On appeal, the Defendants renewed their attack on the testimony. The Court of Appeals ruled that the testimony was admissible under the fact witness provisions of the Federal Rules of Evidence, because the witnesses were testifying about their own lack of knowledge about the improper transactions, and why that was significant to their work (id. at 458-59). The Court of Appeals also held that the testimony was admissible under Rule 701, which provides:

Opinion Testimony by Lay Witnesses

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;
helpful to clearly understanding the witness’s testimony or to determining a fact in issue; and
not based on scientific, technical, or other specialized knowledge within the scope of Rule 702.

The Court of Appeals held that Rules 701(a) and 701(b) were met because the witnesses were simply acknowledging how certain facts, if known, would have caused them to alter their accounting treatment of the lease sales, and that was plainly helpful to the jury (720 F.3d at 459). Rule 701(c) was met because, while the GAAP rules were technical, those rules were not in dispute, and the testimony focused on how the concealed facts would have changed the application of the GAAP rules (id. at 459-60). Thus, the lay witnesses could give opinion testimony, and the Court of Appeals upheld the convictions. A few weeks ago, the Supreme Court decided not to review the case, leaving the convictions in place. Tennant v. United States, 83 U.S.L.W. 3234, 2014 U.S. LEXIS 7118 (U.S. Oct. 20, 2014).

In civil litigation, Cuti means that many plaintiffs may be able to give opinions – even on subjects that are not generally-known – if the requirements of Rule 701 can be met. For example, a small business owner may be able to offer opinions about how a customer rebate would be paid, based on a hypothetical set of facts. Or a commodities trader may be able to explain how a hypothetical bonus would be calculated, using the compensation system at his company.

In many cases, Cuti and Rule 701 may provide a simpler way to prove something, saving everyone from unnecessary expense and complexity.



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