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Cendant announced in April of 1998 that it had discovered "accounting irregularities", initially estimated at $115 million, but which later turned out to total $300 million. The following trading day, the company's stock lost $15 billion in market value. CEO Henry Silverman was personally affected by this drop as his options lost $370 million in value, a record among CEO's in 1998 (USA Today, 17 April 1999). |
Cendant describes itself as "the world's premier marketer and provider of consumer and business services". Its businesses include real estate brokerage (Century 21, Coldwell Banker), other real estate services (Cendant Mortgage; Rent Net, a web site for finding apartments; and a relocation service), hotel and rental-car agency franchises (Avis, Days Inn, Howard Johnson, Ramada, Super 8, Travelodge, etc.), a vacation timeshare exchange service, tax preparation and mutual fund companies, and consumer-service programs, including a travel agency, a shopping service and the provision of extended warranties and credit card protection.
During 1995, 1996, and 1997, the management of CUC (the company which merged with HFS in December 1997 to become Cendant) booked phoney revenues in order to meet Wall Street's expectations for quarterly earnings. The falsified revenues totalled about $30 million in 1995, $87 million in 1996, and $176 million during the first three quarters of 1997.
Each year, management recorded these fictitious revenues and increased accounts receivable, then reversed the entries in the fourth quarter to prevent auditors from finding them. To conceal this, they then booked revenue that should have been taken later and utilised financial reserves that were set up to cover cancellations for CUC's membership clubs in discount travel, shopping, and dining. At the end of 1996, the company also began dipping into reserves intended to cover acquisition charges in order to boost revenue. Credit card rejections were sometimes recorded late.
While Arthur Andersen discovered the above accounting practices, Cendant, working with its auditor Deloitte & Touche, discovered additional accounting irregularities, including inappropriate depreciation of certain assets, delayed recognition of insurance claims and accounting that didn't meet generally accepted accounting principles (GAAP). Cendant announced on April 15, 1998 that it had discovered "accounting irregularities" and expected to lower its 1997 earnings, which had originally been reported at $872 million, by $115 million.
The following day its stock lost nearly $15 billion in market value, and 8 lawsuits were filed by shareholders who claimed that the company made misleading financial statements (Best's Review, P&C Edition, July 98). Twenty-six shareholder lawsuits would eventually be filed in all. CEO Henry Silverman was also affected by this drop as his options lost $370 million in value during 1998, a record among CEO's for that year (USA Today, 17 April 1999). |
December 1997: Cendant is created from the $11 billion merger of HFS, an owner of hotel chains and real estate brokers, and CUC International, a direct marketing company.
15 April 1998: Cendant announces that it expects to lower its 1997 earnings by $115 million after discovering "accounting irregularities". It had previously reported its 1997 earnings as $872 million, or $1 per share, before special charges.
16 April 1998: Cendant stock loses nearly $15 billion in market value, with the share price falling 16.56 to a new value of 19.06. Regulators in Florida state that they will need to review amended financial statements before Cendant's acquisition of American Bankers Insurance Group can continue as planned. Planned Cendant acquisitions of National Parking and Providian Auto and Home Insurance are also placed in doubt. Eight lawsuits are filed by shareholders who claim the company made misleading financial statements.
May 1998: Cendant dismisses CUC's auditors, Ernst & Young, and retains Deloitte & Touche instead.
14 July 1998: Cendant announces that the accounting fraud was deeper than originally thought, amounting to nearly $300 million over a three-year period. However, it states that, as part of the accounting overhaul, it plans to revoke $200 million in merger-related charges that were logged for 1997 as well as other CUC reserves that it deems unnecessary, causing the net decrease in 1997 earnings to be between zero and six cents per share. Cendant stock falls 3.1875 to 15.6875.
31 July 1998: A securities class action lawsuit is filed against Cendant.
14 October 1998: Cendant calls off its merger with American Bankers. |
Lessons to be Learned:
The firm culture over-emphasised the importance of earnings goals
CUC apparently failed to provide sufficient motivation or incentives to counteract the desire to meet earnings expectations, even if this meant turning to fraud.
Realignment of incentives may reduce pressure on employees to produce certain levels of earnings, profitability and so on.
Lack of thoroughness in understanding the businessDue diligence at the time of the merger should have revealed any accounting irregularities that existed.
Careful auditing and management of cash flows is crucial in uncovering possible fraud.
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