by T. GormanPosted on Posted in SECActions

The former Chairman of the Board and CEO of Duane Reade, Inc., Anthony Cuti, was sentenced to serve a prison term of three years for financial fraud. He was also ordered to pay a $5 million fine. Mr. Cuti was convicted following a jury trial on one count of conspiracy to make false statements in annual and quarterly SEC reports and to auditors, one count of securities fraud and three counts of making false statements in SEC reports. U.S. v. Cuti, No. 08-cr-00972 (S.D.N.Y.).

The charges are based on a scheme implemented by Mr. Cutri and William Tennant, the former CFO of the company, to inflate the financial results of Duane Reade from November 2000 through June 2005. The scheme involved increasing the income of the company using fraudulent real estate transactions while reducing expenses through the use of fictitious vendor credits.

The real estate transactions involved the sale of interests in leases and options on retail locations that were largely worthless or which had already been sold by Duane Reade. To induce brokers and developers to participate in these transactions Mr. Cutie executed side agreements under which the purchasers were suppose to be reimbursed. Messrs. Cuti and Tennant then devised other fraudulent schemes to funnel the money back to the brokers and developers. Mr. Cutie mislead the outside auditors of Duane Reade about the true nature of these transactions. He also failed to inform them that the purchasers were reimbursed.

To reduce expenses and further inflate income Mr. Cutie arranged to obtain false credits from vendors of the company. To induce the vendors to issue the credits he and another company employee told the vendors they could bill the Duane Reade for the amount of the credits in a latter accounting period without doing any additional work.

Together both facets of the scheme artificially and materially inflated the income of the company. This defrauded its public shareholders and the private equity firm Oak Hill Capital Partners, L.P. which took the company private in 2004.

Mr. Tennant, who was convicted on one count of securities fraud at the same time Mr. Cutie was convicted is scheduled to be sentenced August 29, 2011.

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by T. GormanPosted on Posted in SECActions

Periodically executives and regulators become concerned about short selling. During the recent market crisis, for example, the SEC placed limitations on selling the shares of financial institutions short. Although the directive was controversial, regulators in other country followed suit. As the current European bank crisis has unfolded, a ban on selling the shares of those institutions short has been imposed in local markets. No doubt the move is controversial with some arguing it is ineffective and others claiming it will prevent the share price of covered financial institutions from spiraling down as a result of short selling.

While the debate over short selling continues, the SEC settled with two defendants earlier this month who were charged with manipulative short selling. SEC v. Andreas Badian, Civil Action No. 06 CV 2621 (S.D.N.Y. Filed Apr. 4, 2006) is an action against Andreas Badian, an employee of unregistered investment adviser Rhino Advisors; three registered representatives then employed by now defunct Refco Securities, Jacob Spinner, Mottes Drillman, and Jeffrey Graham; and Pond Securities Corp., a registered broker dealer, along with two of its employees, Ezra Birnbaum and Shaye Hirsch. The complaint centers on a fraudulent short selling scheme alleged to have been conducted in violation of the antifraud provisions of the securities laws as well as other provisions.

Mr. Badian, acting for Rhino, directed the scheme to manipulate down the share price of Sedona Corporation, a Pennsylvania software company, according to the Commission. Under an agreement with Sedona, Amro International, S.A., a Rhino client, loaned Sedona $2.5 million. Three months later Amro was to be paid $3 million by Sedona. The agreement permitted Amro to convert Sedona’s debenture debt to shares of Sedona stock on certain specified dates. The lower the share price, the more shares Amro would receive.

To preclude Amro from manipulating Sedona’s share price, the agreement prohibited the company from selling Sedona’s shares short. Nevertheless, Mr. Badian directed defendants Spinner, Drillman and Graham to sell large amounts of Sedona stock to drive the price down. From March 1, 2001 through March 29, 2001 the defendants’ short selling of Sedona shares was responsible for over 40% of the total reported trading volume. As a result by March 23 the share price had deteriorated from an average closing price of about $1.43 per share in early 2001 to about $0.75 per share by March 23, 2001. Subsequently, Amro exercised its conversion rights and received over 1.6 million shares of Sedona stock in repayment of $1.1 million due under the Agreement.

Defendants Mottes Drillman and Jacob Spinner settled with the Commission. Each consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and Securities Act Section 17(a) and from aiding and abetting violations of Exchange Act Section 17(a). Each agreed to pay disgorgement of $4,000 representing their share of the ill-gotten gains, along with prejudgment interest and a civil penalty of $25,000.

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