Cendant Corporation

Date: 1998   /   Region: AMER
Published November 29th, 2016
Ron Rimkus, CFA

Cendant Corporation was created by merging an ethical company with an unethical company. The unethical company was CUC International (CUC) and the ethical company was Hospitality Franchise Services (HFS). Although both companies were highly acquisitive before their 1997 merger, CUC used deceptive accounting practices to inflate its reported earnings. After the merger, CUC management (led by Walter Forbes) took over and continued these practices in the new Cendant Corporation. An investigation revealed that CUC had practiced unethical accounting since at least 1988, continuing until these deceptive practices came to light in 1998. Further investigation suggested that CUC management’s fraudulent practices went back even further, starting as early as 1983. CUC came to depend on an ongoing stream of falsified financial statements, hiding their fraud and projecting an image of growth and health.

Analysis and Commentary

Cendant Corporation was a consumer services conglomerate formed in December 1997 by a $14 billion merger between two companies — HFS Inc. and CUC International. The merger combined the travel and hotel holdings of HFS with CUC’s direct marketing business. Subsidiaries included name brands such as Avis Car Rental, Howard Johnson’s, Days Inn, and Ramada. Upon completion of the merger, CUC’s founder and CEO, Walter Forbes, was slated to be Chairman of the Board of the combined operation; the founder of HFS, Henry Silverman, was slated serve as President and CEO.

After the merger in late 1997, Cendant’s stock price initially surged. The company used the pooling-of-interests method to consolidate the combined company’s financial statements (which was then allowed by generally accepted accounting principles [GAAP]). Before the merger was officially transacted, CUC recorded merger-related charges of $556.4 million for 1997, which broke down as follows:

In the spring of 1998, however, company officials went public with the discovery of potential accounting discrepancies. According to Arthur Andersen’s forensic auditor report, the following were the problems:

  • A topside adjustment had been made to the quarterly financial statements.
  • Merger reserves were overstated.
  • Membership cancellation reserves were overstated.
  • Aggressive revenue recognition was used.

In topside journal entries, the corporate parent makes journal entries on the subsidiaries’ journals. Topside transactions are typically entered by an individual manually, rather than through accounting software that might automatically assign transaction data to specific accounting categories. Although such entries can be a legitimate business activity, they can also easily be used for fraud.

Upon the announcement of the accounting irregularities, Cendant’s stock price immediately dropped (from $36 to $19) — reducing the company’s market capitalization by $14 billion in a single day. The company’s internal investigations revealed that CUC managers, many of whom had taken leadership roles in the newly formed Cendant, had been booking false earnings for the three years leading up to the merger with HFS in order to meet analysts’ estimates.

Consequently, mergers create opportunities for bad actors to act on their selfish urges.

The overstatement of quarterly revenues increased with the passage of time, rising from $100 million in 1995 to $150 million in 1996 to $250 million in 1997. These amounts closely matched the difference between CUC’s actual results and Wall Street estimates for the corresponding periods. The growing amounts also suggest that CUC needed to continue ramping up growth through mergers to continue the fraud. CUC’s accounting staff at headquarters made entries to increase accounts receivable and revenues or reduce accounts payable or expenses. CUC also overstated the cash balance on its books.

The consistency of reported cash with actual cash levels is the simplest possible thing for an auditor to verify, yet it wasn’t until the merger between CUC and HFS that Cendant’s auditor first detected something awry (more on this later). In fact, the company’s earnings before interest, taxes, depreciation, and amortization did not reconcile with its reported cash balances, which suggests that the auditors failed to verify the cash balances at CUC’s banks (a rudimentary function of auditing).

In January 1998, CUC inappropriately released $115 million of Merger Reserve account into Income; that is, $108 million was released into revenues and only $7 million was a credit against expenses. This action has (at least) three problems from an accounting standpoint. First, releasing merger reserves into revenue is not consistent with the expressed purpose of the reserves. Second, the company did not have adequate documentation supporting such a decision. Third, releasing merger reserves into revenue is not consistent with GAAP.

Regarding the Membership Cancellation Reserve account, in the normal course of business, CUC recorded revenues from members who joined its system. At the time they recorded that revenue from memberships to the general ledger, they also had to estimate, based on past experience, the number of memberships that would be cancelled. These estimated cancellations were debited to the Membership Cancellation Reserve account (which decreased reported revenue). After a trial period, members’ credit cards would be charged. Any charge that was rejected was immediately charged against the Membership Cancellation Reserve. Meanwhile, new revenues and new reserves would be established for new memberships sold. Consequently, the Membership Cancellation Reserve account fluctuated on the basis of the number of new members and the number of memberships rejected and canceled. At some point prior to 1995, CUC adopted a policy of not recording the membership reserves for the fourth quarter of each fiscal year — thereby understating this reserve account. The understatement of the Membership Cancellation Reserve account affected income by $48 million in 1995, by $19 million in 1996, and by $12 million in 1997.

In light of the merger between CUC and HFS, auditor Ernst and Young (E&Y) tested cash three months earlier than usual (Briloff 1999). This unexpected change presented a crisis to CUC’s controller, Steven Speaks. The company had been misreporting rejected memberships in the fourth quarter, and hence understating reserves, but the accounting entries necessary to hide these omissions had not yet been entered. As Briloff noted,

The Rejects/Cancellations for the months of July through September aggregating $112 million had already been booked because the end-of-year manipulations were not then anticipated; the booking of that $112 million produced a negative balance in the reserve of $70–$80 million. And now we return to the CIFA report (i.e., forensic audit): Before the E&Y testing took place, Speaks decided that Comp-U-Card would “un-book” the rejects that had been booked in the normal course in July, August and September of 1997. He directed a series of entries to be recorded that had the following effect:

The reversing of these reserve charges increased reported cash and the reported Membership Reserve as of 30 September 1997. Speaks then directed accounting staff to change the bank reconciliations for these months as “rejects will post.” Speaks later testified that he decided to adopt the new policy regarding the recording of rejections and cancellations at that time. From that point on, CUC would record rejects and cancellations with a three month lag. In effect, this new policy arbitrarily extended the old deceitful policy.

The SEC formally joined the previous internal investigation in May 1998 and revealed the full depth of CUC’s accounting fraud. According to later testimony by the company and the SEC, CUC managers would analyze the difference between actual financial results and the estimates put out by Wall Street analysts at the end of each quarter. They would then target specific aspects of the business to adjust in order to inflate earnings. After determining the best areas to change, the managers would then instruct others in the company hierarchy to adjust the various accounts — thus creating a false income statement and balance sheet. Their methods included underfunding reserves, accelerating recognition of revenues, deferring expenses, and drawing money from a merger account to boost income (DeVries and Kiger 2004). After lower-level managers made the accounting changes to the financials, the cycle would be completed by adjusting the top line of quarterly changes and, subsequently, making back-dated journal entries at the division level to get the general ledger to balance. CUC’s leadership was able to hide the irregularities through misrepresented accounting entries, often moving certain transactions off the books. For a company of this size to maintain two sets of books, however, requires a widespread internal effort to produce the second set of books so the company can present a blend of truth and fiction to the auditor without getting caught.

“It was a culture that had been developed over a period of years. It was ingrained . . . ingrained in us by our superiors” (CNN Money, 2000).

Further investigation by the SEC revealed that CUC had been committing various types of accounting fraud since at least 1988. Several senior leaders were forced to resign, and the SEC brought charges against Cendant leadership. After restating their financial statements in the fall of 1998, the company revealed it had overstated income from continuing operations before income taxes by around 24% and overstated earnings per share by 130% (around $500 billion). In June 2000, three senior financial executives in the company, Cosmo Corigliano (former chief financial officer of CUC), Casper Sabatino (former  accountant at CUC), and Anne Pember (former corporate controller of CUC), pleaded guilty to fraud in US District Court in Newark, NJ. According to testimony by Corigliano, “It was a culture that had been developed over a period of years. It was ingrained . . . ingrained in us by our superiors” (CNN Money, 2000).

According to a terrific piece of journalism in Fortune magazine (Elkind 1998), the merger had created a “feeding frenzy” for compensation among the new team of senior executives. E. Kirk Shelton, the number two man at CUC, negotiated a clause in the merger contract whereby he would personally receive $25 million if he was not made chief operating officer of the combined enterprise within two years. Across the board, the newly formed management team received material salary hikes, accelerated vesting of options, and generous severance provisions. (Silverman, for instance, received an option grant that would make him a billionaire.) In essence, these executives were extracting wealth from shareholders and giving it to themselves.

From a financial perspective, mergers create a lot of moving parts, with reallocations of business units, revaluations of assets and liabilities, and restructuring of numerous contracts. Consequently, mergers create opportunities for bad actors to act on their selfish urges. Analysts need to use mergers as an opportunity to examine changes in business structure, revaluation of assets and liabilities, and to uncover any sins in specific contracts.

As the merger was being completed, moreover, former CUC head Walter Forbes asked Silverman to maintain the former CUC’s financial reporting processes. So, rather than have the controller in each unit from the former CUC report to the new division heads from HFS, those controllers continued to report to CFO Corigliano and Corporate Controller Pember — two executives who later pleaded guilty to fraud charges in federal court.

In a word, the motive was greed — and maybe pride.

Changes in financial reporting structures can also create opportunities for analysts to discover bad actors. When the bad actors are in senior management (i.e., holding positions of power), they have the power to stifle dissent. When the bad actors report to managers, previously honest managers may become afraid to disclose the fraud out of concern for their jobs, for instance, or the performance of the company, as was revealed in the Daiwa Bank fraud). The Cendant fraud appears to be a case of an honest company blending with a dishonest company in a merger.

When asked in court about their roles in the fraud, Cendant’s accountants and controllers all essentially said  “We were just doing our jobs.” For instance, when the federal judge asked accountant Sabatino if he would call what he did “cooking the books,” he simply said, “Honestly, your honor, I thought I was just doing my job.” In essence, their bosses asked them to lie, cheat, and steal; so they did. Such actions appear to be explainable by the social psychology concept known as the “authority-misinfluence tendency.” In the famous Milgram experiments, subjects were asked to give electronic shocks to actors who answered certain questions incorrectly.[1] The experiments were overseen by “doctors” holding clipboards and wearing long white lab coats (in other words, the doctors looked “official”). In many cases, the test subjects were ordered to administer “shocks” to actors to the point of severe pain and even to the apparently loss of consciousness. The subjects weren’t really giving the actors shocks, of course, but thought they were. The subjects did so because they had assigned the responsibility for the outcome to the doctors running the experiment. In the business world, many people commit acts that they know are wrong because they are able to assign blame to their superiors. This refrain is so common in corporate fraud cases that it is simply astounding.

On 14 May 2004, Corigliano, the former CFO of CUC, reached a settlement with the SEC whereby he pleaded guilty to securities fraud and agreed to pay back to the company $14 million in exchange for a light sentence (three years of probation). This settlement cleared him to testify against Walter Forbes, among others. Corigliano testified that he helped manipulate the company’s reported earnings for years at Forbes’ direction. He also testified that he met Walter Forbes regularly to discuss how much money would be taken from inflated reserves and used to increase reported profits to meet targets.

In 2005, E. Kirk Shelton, the former vice chairman of Cendant, was convicted of conspiracy, securities fraud, mail fraud, wire fraud, and making false filings with the SEC. He was sentenced to 10 years in prison and ordered to pay criminal restitution of $3.275 billion.

In October 2006, Walter Forbes was found guilty of conspiracy and of two counts of submitting false reports to the SEC in overstating his company’s earnings by more than $250 million. He was acquitted on a fourth count of securities fraud.

Some have argued that Walter Forbes might have been unaware of the fraud (as he claimed) because he engaged in the merger and was, therefore, “bound to get caught.” The viability of the fraud itself, however, probably required ever more merger and acquisition deals so that the company could continue to “manufacture” higher and higher earnings to please Wall Street. Thus, thanks to the opaqueness of merger accounting and the fact that Forbes was to become the CEO of the combined company, it seems likely that he intended to retain control over the combined company and perpetuate the scheme. Whatever the case, this particular fraud was perpetrated by a company that was profitable (without the fraud) and had well-known brands and successful product lines. These senior managers were clearly committing the fraud to inflate earnings and extract ongoing rewards from the company. In a word, the motive was greed — and maybe pride.

[1] Stanley Milgram began conducting the authority experiments in 1961. For more, see “About Education.”

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  • 1989: The stock price of CUC International, one of the merger partners that later form Cendant Corporation, plummets amid questions about the company’s accounting methods, which appear to inflate earnings and cash flow. CUC executives acknowledge the error and adjust methods.
  • 1990s: HFS (Hospitality Franchise Services) acquires a great deal of debt by engaging in multiple hotel franchise purchases. The financing strategy is criticized for benefiting executives but hurting the long-term health of the company.
  • 1993 – 1998: CUC managers engage in various aggressive financial accounting techniques, including adjusting financial statements to inflate earnings and better match analyst predictions. These practices are hidden from auditors.
  • 1996: CUC and HFS begin merger talks “to support the rapid growth of both companies.”
  • 28 May 1997: The merger between CUC and HFS is formally announced.
  • September 1997: The CUC company auditor, Ernst & Young, attempts to verify the company’s cash balances three months early because of the pending merger.
  • December 1997: The $14 billion merger between HFS and CUC is completed. Cendant Corporation, the name of the merged organizations, is led by HFS founder Henry Silverman. The new company combines HFS travel and hotel holdings with CUC’s direct marketing business. Holdings include Avis Car Rental, Howard Johnson, Days Inn, and Ramada. Silverman is named CEO, and CUC founder and CEO, Walter Forbes, assumes leadership as Chairman of the Board of the combined company. The terms of the merger include retaining separate accounting operations for the two companies for a period of time.
  • January 1998: Cendant stock reaches $33 a share and then peaks in early April 1998 at $41 a share.

Central Events

  • March 1998: When CUC stalls on completing requested financial reports, the HFS accounting team is sent to help. Unexplained and suspect merger reserve and merger savings funds listed in the CUC books raise additional concerns.
  • April 1998: Accounting “discrepancies” at CUC are revealed. Cendant launches an internal investigation of the company’s accounting.
  • 16 April 1998: Cendant releases a report admitting that 1997 earnings were overstated by $100 million. The stock price falls from $36 to $19 that day, eventually falling to $11 by August 1998.
  • June 1998: The US SEC officially launches an investigation of Cendant’s accounting.


  • June 1998: The shareholders sue Cendant for accounting fraud related to accounting discrepancies at CUC.
  • 28 July 1998: Silverman and the Cendant board of directors force Walter Forbes to resign. Silverman becomes Chairman of the Board.
  • 27 August 1998: Arthur Andersen delivers the results of its forensic audit to the Cendant board of directors. The audit reveals that CUC has overstated revenues and pretax income by more than $500 million over three years.
  • 25 January 1999: Cendant sues the CUC accounting firm Ernst & Young, which blames CUC executives.
  • December 1999: Cendant settles a class action shareholder lawsuit for $2.83 billion. Ernst & Young settles a lawsuit with shareholders for $335 million.
  • 14 June 2000: The SEC brings fraud charges against seven former CUC officials/executives. Three CUC executives plead guilty to accounting fraud. Silverman claims HFS had no knowledge of CUC’s accounting practices prior to the merger.
  • 2001: Forbes and E. Kirk Shelton, former CUC vice chairman, are indicted for fraud.
  • 10 May 2004: Forbes and Shelton are finally brought to trial.
  • 14 May 2004: Cosmo Corigliano, the former chief financial officer of CUC, reaches a settlement with the SEC whereby he pleads guilty to securities fraud and agrees to pay back to the company $14 million in exchange for a light sentence (three years of probation). This move clears him to testify against Forbes, among others.
  • 2005: Shelton is convicted of conspiracy, securities fraud, mail fraud, wire fraud, and making false filings with the SEC.
  • October 2006: Forbes is found guilty of conspiracy and of two counts of submitting false reports to the SEC in overstating his company’s earnings by more than $250 million. He is acquitted on a fourth count, securities fraud.

Investment Principles

Principle #1

The market’s endorsement of a particular company or management team is not pertinent to a due diligence process.

Principle #2

A company’s auditors may be unaware of the fraud because the company is maintaining two sets of books.

Principle #3

Orchestrating plausibility in the false set of books requires widespread illicit cooperation among many people.

Principle #4

Mergers and acquisitions give bad actors opportunities to enrich themselves by overstating earnings to help hit earnings targets, by overstating reserves that are subsequently released into earnings (by reallocating business units and revaluing assets and liabilities), and by the structuring of compensation contracts.

Principle #5

Changes of financial reporting structures create opportunities to identify bad actors.

Principle #6

Many participants in corporate fraud willingly do things they know are wrong because they can assign blame to their superiors.

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2 Former Cendant Execs Avoid Prison in Scandal.” 2007. NBC News (31 January).

Barrett, Amy. 1998. “Cendant: Who’s to Blame?Business Week (16 August).

Briloff, Abraham J. “A Pathological Probe of a Pool of Pervasive Perversion.” Baruch College.

Cendant Closes Fraud Case.” 1998. CNN Money (27 August).

Cendant Corporation — Company Profile, Information, Business Description, History, Background Information on Cendant Corporation. Reference for Business. 2016.

Ex-executives Admit Guilt. CNN Money, 2000. 14 June, 2000.

DeVries, Delwyn, and Jack E Kiger. 2004. “Journal Entries and Adjustments — Your Biggest Fraud Danger.” Journal of Corporate Accounting and Finance, vol. 15, no. 4 (May/June): 57–62.

Elkind, Peter. 2000. “Cendant Case Scorecard: Government 3; Book-Cookers 0.Fortune, CNN Money archive article.

Elkind, Peter. 1998. “A Merger Made in Hell.Fortune (9 November).

Fink, Ronald. 1998. “Hear No Fraud, See No Fraud, Speak No Fraud.CFO Magazine (1 October).

Lipton, Joshua. 2007. “No Leniency for Walter Forbes.” Forbes.com.

Morgenson, Gretchen. 2004. “Sunday Money; Before Enron, There Was Cendant.New York Times (9 May).

SEC. 2000. “SEC Enforcement Actions against Former Top Financial Officers and Managers at CUC International” (14 June).

Additional Reading

Marshall, Jordan Ray. 2004. “Using Topside Journal Entries to Conceal Fraud.” University of Tennessee Honors Thesis Project.

Securities and Exchange Commission vs. Walter Forbes and E. Kirk Shelton. 2001. SEC Litigation Release (28 February).