Accounting & Tax

Duane Reade Subpoenaed over Lease Deals

Real estate transactions by Duane Reade were ''expressly designed to overstate the company's income,'' according to an internal investigation.
Stephen TaubMay 25, 2007

Duane Reade has disclosed that it received a grand jury subpoena from the U.S. Attorney’s Office for the Southern District of New York for documents related to certain real estate transactions. The drugstore chain also announced that it will restate its results for 2000 through 2004.

In a regulatory filing, the company added that the revision will take into account previously disclosed misstatements regarding dealings originated by Duane Reade’s former chairman and chief executive officer, who was replaced in November 2005.

Although not named in the current filing, Anthony J. Cuti was identified in a 2005 Duane Reade press release as the outgoing president and CEO. He was succeeded at that time by Richard W. Dreiling, who earlier this year also became chairman. was unable to reach Cuti for comment.

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Duane Reade, which was acquired by private-equity firm Oak Hill Capital Partners in 2004, still reports to the Securities and Exchange Commission because it has public bonds.

In its latest filing, Duane Reade identified about $14.4 million of pretax income from real estate transactions and related matters that occurred in fiscal years 2000 through 2004 for which the company’s accounting was improper. Accordingly, the company continued, it will restate its financials for the five months ended December 25, 2004, the seven months ended July 30, 2004, and the 2000 through 2003 fiscal years. The revisions will have no material impact on any financial statements in 2005, 2006, or 2007.

Duane Reade elaborated that the independent counsel who conducted the company’s investigation concluded that the real estate–related transactions were orchestrated by the former chairman and CEO and were “expressly designed to overstate the company’s income.”

To pull off the scheme, the independent counsel also found, the former chairman and CEO made certain false representations to the chief financial officer, other members of management, and Duane Reade’s independent accountants concerning the structure and economic substance of the transactions.

“The primary method used in the scheme was to make payments to certain entities that were ostensibly in respect of services provided by the entities and record the payments in connection with the company’s acquisition of various leases,” Duane Reade explained. “The payments were therefore capitalized as part of the company’s lease acquisition costs and amortized over the lives of the related leases.”

These amounts were paid back to the company by the entities, ostensibly for terminating operations in certain stores, for not exercising certain real estate options, and for taking other actions in respect to various leases. The payments made to Duane Reade were generally recorded as income at or about the time the agreements relating to the company actions were signed, according to the company.

“The independent counsel concluded that the agreements for the real estate–related transactions between the entities and the company had not been negotiated at arm’s length,” Duane Reade stated in its filing, and that the purported consideration in those transactions “was illusory and lacking in economic substance.”

The independent counsel therefore determined that the circular payments to the entities by the company and payments by the entities back to the company should not have been made and should not have been reflected in the financial statements as originally reported, Duane Reade concluded.

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