Cendant Corporation Research Paper

1. Introduction

In this paper I will investigate fraud issue, explain the definition of the notion, define its types, description and characteristics of fraud, and explain fraud risk factors or, in other words, what are the warning signs that the person or an organization are facing the fraud actions, as well as present how people commit frauds. In the main part of the paper I will research the case of Cendant Corporation fraud, including the events and the Chairman of the Corporation was sentenced for fraud.

In the conclusion I will summarize key points of the paper and make important conclusions regarding the paper’s main theme.

2. Fraud

Fraud is generally defined as the deception that is made by person or group of people for their personal benefit or to damage another person. There is no common definition of this notion, as each definition is dependant on legal jurisdiction. Fraud is said to be the crime, and also the violation of the civil law. The most common type of fraud is defrauding people of money.

In the criminal law, the fraud is defined as the offense or crime of designedly deceiving another to damage them, often to get services or property not in the just way. Forged objects are generally used for the accomplishment of the fraud. Frauds in the criminal law are called theft by deception, larceny by deception and fraud, etc.

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Nowadays we are living in the changing global environment, and present society is facing the increased level of frauds for a series of reasons. First of all it is the growing organizations’ complexity and growing speed level of modern types of commerce and computerization. Then, it is the history of inattention, understaffing of internal audit functions, aggressive accounting practices, and acceptance of the small frauds and considering them necessary to be successful in business, increasingly transient employees, and also ineffective and outdated internal controls.

There are about 9 common types of fraud, which include: asset misappropriation, false accounting, computer fraud, intellectual property fraud and insurance fraud, infringements or thefts by third parties, corruption, investment scheme fraud, and money laundering. Asset misappropriation is referred to the case when business assets of the company are stolen by third parties or even its employees, or both acting in collusion. For instance inside the organization common frauds include: making false claims regarding the expenses, payroll frauds, and direct cash theft, or stole of stock, realizable assets and intellectual property. When employees are acting in collusion with third parties, those cases include: related party transactions, when company’s employee has the financial interest in the bargain, getting commission from the supplier, thunder from third parties to process inappropriate transaction or disclose internal information.

False accounting is generally connection with representation of financial information of the organization in the better light then it is in reality. It can be performed by understating liabilities and overstating assets to reveal that the company is financially strong. Reasons for doing this vary from the attempt to obtain additional financing and supporting price of the stock to the desire to attract new investors and customers (Blanco and Evans 2000).

Computer fraud is just the name of the fraud, and computer in this word combination is just the tool of committing such a fraud. Computer frauds involve stole or diverting money from one banking account to the other through unauthorized access to the bank computer system by means of hacking. Then, one can also have business in Internet, an Internet shop, for example, and receive payments for goods or services that are not delivered or have defects and cannot be returned. Manipulating company’s stock price by publishing invalid news on the bulletin board, attacking web-sites in order to obtain internal information and records, and stealing intellectual property by means of unauthorized access to computer are also relate to computer frauds.

Insurance frauds include false claims about losses that never happened, overstated claims, multiple claims, under-insuring on purpose in order to decrease premium, assets destruction to claim on insurance and getting cover on favorable terms on the ground of false information(Blanco and Evans 2000).

Intellectual property frauds involve all illegal actions with subjects of intellectual property. Intellectual property contains such items as customer lists, design rights, patents, and is equal business assets of the organization as machinery, for example. And it can be stolen by company’s staff and by third parties, though such incidents are not always apparent at once, which is a real threat to the company’s future business activity.

Corruption and bribery are said to be off-book frauds which appear in the form of bid rigging, gifts and commissions. It is necessary that each organization had set guidelines where it should be defined what to be considered a gift, kickback or commission and which of them are significant enough to be considered inappropriate.

Money laundering is no exactly the fraud, but is very tightly linked with the notion, as it is the mechanism by which the crime outcomes or profits are distributed and legalized. This involves getting bank loans against assets, which are obtained from criminal activities and also issuing organization’s cheques to third parties so that they issue them to individuals.

Infringement by third parties include deliberate royalties under-reporting by the party that sells products under license, on purpose development of the competing products or services and stealing design rights that have already been created and registered (patented), and also selling fake products as if they were genuine articles, for example branded luxury perfumes, cosmetics, computer software, clothes, etc (Blanco and Evans 2000).

And finally investment scheme fraud is tightly connected with asset misappropriation, as it presumes taking money from customers with the promise of overwhelming returns, but using that cash values for own purposes.

There can be also marriage and academic frauds. Marriage Fraud can have few forms and is when an individual is entering a marriage for the personal benefit or profit and not have a real desire to start sincere marital relationships. Personal benefit can include desire to obtain immigration benefits. And academic frauds presume falsification of the research findings that lead to scientific misconduct.

It is possible to commit fraud by such means as phone, mail, internet and face to face (Albertson 2007). Risk situation on fraud commitment can be categorized as profits, processes and people. Some situations taken independently may not indicate on the motivation to commit a fraud, but taken along with other factors will appear to become a motivational factor.

As to the profits, such situations involve transactions that have substantial effect on profit, including the period when profit from transaction is recognized; unexpected high level of profits or losses compared to the other periods and to the industry competitors; unusual transactions with related parties; management increased interest in increasing price of company’s stock; management is under pressure for producing immediate results; deteriorating earnings quality; inappropriate or incomplete information regarding client to particular transaction; management compensation bonuses are directly dependent on company’s financial results; and finally transaction in which revenues are not consistent with the cash flow(Albertson 2007).

As to the people, signs of risk are the following: management is dominated by one person or a small group of people, and there is no supervisory board or committee to regulate and control their activity; frequent changes of auditors and advisors; remuneration is predominantly based on financial performance; lack of authority delegation in the organization, key personnel works excessive hours on constant basis; high level of accounting and financial staff turnover; no developed polices about company’s values and standards of behavior, no code of conduct; personnel from time to time is taking holidays without good reason or taking just one day-off at a time; rumors regarding lifestyles of personnel that is incompatible with their known level of income.

And as to the processes, risk situations are next: no checks are carried out in order to ensure that only appropriate personnel is employed by taking references and checking personal history; no control to ensure that goods and services are directed to appropriate customers; signs that it is impossible to rely on internal financial control; no IT systems control; internal or external audit is raising concerns regarding the quality of management or financial reporting(Albertson 2007).

3. Cendant Corporation

Cendant Corporation was formed on May 27, 1997 with the merger agreement between the Boards of Directors for HFS, Inc. and CUC International Inc. Cendant Corporation was created as a conglomerate that specialized in shopping-club memberships, Internet marketing and traveling. Its divisions contain the Howard Johnson, Days Inn, and Ramada hotel chains; the Coldwell Banker and Century 21 real-estate franchises; Sierra On-Line software and Avis rental cars. It was the merger of equals- 50/50. Henry Silverman, who was Chief Executive Officer of HFS Inc., was chosen as CEO and President of newly formed corporation, and Walter Forbes, who was CEO of CUC International Inc., was chosen as the company’s Chairman of the Board. The merger was finished in December, and stock of Cendant Corp. started trading on December 17, 1997, closing that day at the level of $32.62. Immediately after the merger, the company experienced success and on April 6, 1998 its price per share increased to the level of $41.69. The corporation was in the process of many acquisitions, including the negotiated acquisition of American Bankers Insurance Group. But company’s success was not long and company was not progressing and increasing its share price as the market analysts’ prognosis. On April 9, 1998 the corporation announced that three former CUC executives were leaving the corporation, including Cosmo Corigliano, CFO of CUC, and Amy Lipton, general counsel of CUC. This is what the Wall Street Journal reported on this regard: “Rumors of changes at the top of the company had sent the stock plunging earlier in the day. The stock closed at $37, down $2.0625, or 5.3%, in composite trading on the New York Stock Exchange... The company tried to reassure investors in a conference call, saying that first-quarter earnings met or exceeded analysts’ expectations of 25 cents a diluted share, according to First Call....In an interview, Mr. Silverman called the impending resignations ‘inevitable when large companies merge’.... He added that Ms. Lipton’s and Mr. Corigliano’s ‘jobs went away’ with the merger.”

In a week, on April 15, 1998 Cendant Corp. released a message that shocked everyone at the stock market after the markets had closed for the day. Management of the company had found out some accounting irregularities in its main membership-club operations that will demand it to decrease reported 1997 operating income by more then $100 million and that it will badly influence profit of this year (1998). The key issue at the moment was in the method utilized by the CUC unit in recognizing revenue in its club-membership sales. It was found out that too much of the revenue was booked up for future, while recording expenses that were associated with the memberships was deferred until future periods. The next day, Cendant Company’s stock price lowered from close on Wednesday of $36.00 to $19.06 as an astonishing 108 million shares traded hands. Before that, for Cendant Company the average trading volume had been about 4 million shares per day.

On July 14, 1998 the corporation released another shocking message to the market: in order to meet earnings expectations of Wall Street, CUC had recorded nonexistent revenue of $300 million for the period of three years. During evaluation of the situation, Mr. Silverman said that, «We merged with a company and 50% to 60% of the earnings were without substance. It should be called a terrible transaction...A layman would call it fraud.» Ernst & Young LLP was auditor of CUC Corporation and had issued unqualified audit opinions for that three year period. In its defend Ernst & Young claimed, «Revenue recognition is a complex issue...accounting is an art. Accounting’s principles are subject to interpretation.» After announcement of the great losses involved, stock price of Cendant Corp. decreased up to $15.69, and reached a 52-week low. Consequently, on July 29, 1998 raising pressure from irritated investors forced Walter Forbes to leave the position of Chairman of Cendant Corporation, along with ten other members of Board of Directors of Cendant that were previously associated with CUC International Inc. Mr. Forbes received compensation pay of $47.5 million, and Mr. Silverman was elected as his successor as the new Chairman of the Corporation. During next several months, many factors made the stock price to fall even lower. First of all, the SEC had launched its own investigation into the accounting policies of the corporation. The severe requirements mandated by the SEC from its investigation forced the corporation to lower its projected earnings for 1998. Second, as the stock price continue to fall, it became obvious that the planned acquisitions of the company would be difficult to finish. Finally, Cendant Corporation called off its planned acquisitions of American Bankers Insurance Group, Inc. and Providian Auto & Home Insurance Co. Third, the fraud allegations lead to emergence of many lawsuits against the corporation. Arthur Andersen LLP made its own investigation and based on its results focused the responsibility for the fraud on Walter Forbes and the other CUC employees that were dismissed. Eventually, the overall market faced a fall in the third quarter of 1998. The Dow Jones Industrial Average decreased from its 1998 high of 9338 on July 17th to its low for the year of 7539 on August 31st (a fall of 19 percent in less than two months). In September 1998, stock price of Cendant Corporation had absorbed the compound effect of these factors and was trading in the range of $10 to $14 per share. Like many publicly traded companies, Cendant Corporation had a committee responsible for compensation, which was composed of four directors of the corporation, to supervise compensation policies of the company. The compensation packages of executives and major employees included three main components: salary, bonus and stock options. Main emphasis was given to compensation based on equity or stock options. The compensation committee considered that it was essential to make interests of management equal to those of shareholders. Stock options were issued with an exercise price that was equal to the stock price of the corporation on the issuance date. They were created to provide a significant payoff to employees when stock price of Cendant Company rose above this exercise price. In addition to stock options, employees were greatly encouraged (but not obliged) to keep stock ownership in the company. Unfortunately, the stock price decrease that Cendant experienced in 1998 was so dramatic that the exercise price of many employee stock options was even higher than stock price of Cendant Company (for instance, options were «underwater»). Moreover, even the options that were still in-the-money (for instance, had exercise prices below stock price of Cendant Corp.) had lost a drastic value amount. Morale and spirit of the Corporation was extremely low. Employees understood that the stock options they hoped would provide a significant payoff now cost almost nothing comparing to their expectations. Therefore in September of the same year, the compensation committee called a meeting in order to discuss possible changes that could be made to the compensation plans of the Corporation aiming to re-energize and re-motivate outstanding employees of the company. Many of the options were issued by the companies HFS or CUC and subsequently exchanged for Cendant options after the merger was completed. When the merger was completed in December of 1997, a substantial option grant was made to align the future interests of the involved employees. Additionally, Cendant did not need a vesting period for option grants. After examination of the data on the outstanding options, the magnitude of the money loss to the employees became obvious.

In general terms, top executives of CUC, which were led by former Chairman and CEO Walter Forbes, promoted a laissez-faire environment at the corporation that encouraged underlings to prepare reports with impunity. Cendant’s legal counsel, Willkie Farr & Gallagher, commissioned the 260-page audit, to be prepared by the accounting firm Arthur Andersen & Co., with assistance from, Deloitte & Touche, Cendant’s own auditor company.

Hundreds of interviews were held and more then 80 witnesses interrogated and finally the report was completed that cited pervasive and numerous instances in which CUC officials inflated earnings from 1995 to 1997.

Those inflations did not include more than $200 million that were results of accounting errors in records of CUC which also became the part of restated Cendant results from fiscal years 1995 to 1997.

The report did not immediately accuse Walter Forbes of fraud. But in one of its main findings, the auditing committee considered that the inability of Forbes and of former president and COO of CUC, E. Kirk Shelton, to check the abuses amounted to grave negligence in best situation and deliberate ignorance at worst.

This is what audit committee wrote on this regard: «To the extent that they were unaware of the irregularities, the amount by which CUC’ s earnings were inflated as reported in the restatement suggests that they did not adequately inform themselves as to the sources and level of profitability of the company.»

The report found that operating earnings at CUC had been inflated during the period of restatement in 17 of 22 operating units. Report stated that CUC subsidiaries made many unsupported entries, but those directions for the improper entries came from corporate headquarters of CUC Company.

The auditors found that Cosmo Corigliano, the former CIO of CUC, along with Anne Pember, CUC’s former comptroller, had managed accounting irregularities. Report also mentioned that neither Corigliano nor Pember agreed to cooperation with the committee investigators.

Silverman, new CEO of the Corporation said the following about the scandal: “«This report brings to a close a difficult period for Cendant employees and shareholders alike. The investigation has identified how a group of people at CUC deliberately deceived and misled investors and business partners -and reveals a corporate culture that encouraged this behavior.»

According to Stacey Stowe from International Herald Tribune (Nov. 2006) in general it took almost eight years and three trials, and only in 2006 U.S. federal prosecutors won their case against Walter Forbes, the former chairman of the Cendant Corporation. Forbes was convicted on charges that he managed an accounting fraud that was the largest on record in year 1998. Investors lost about $19 billion when stock of Cendant Corporation fell after the disclosure.

A jury of eight men and four women in U.S. District Court deliberated for about two days and a half before finding Walter Forbes, 63 years old, of New Canaan, Connecticut, guilty of conspiracy and of two counts of submitting false reports to the Securities and Exchange Commission of the United States in over-reporting earnings of his company by more than $250 million.

Forbes was set free on $1.2 million bail. He was to be sentenced on January, 17 and sentenced to 25 years in prison. Prosecutors claimed that Forbes overstated earnings at his original company, CUC International, which later merged with HFS in 1997 in order to form Cendant Corporation - with holdings that contained among their businesses the Avis and Budget car rental companies and Coldwell Banker real estate and the Century 21 brokerage firms.

During the trial Cosmo Corigliano testified that the books had been cooked for years with the supervision of Forbes and that Corigliano and Forbes met on regular basis in order to discuss how much money would be taken from reserves that were inflated and used to raise profits to meet set objectives.

The condemnation of Forbes, who resigned from Cendant Corporation with a $47 million severance payment, followed the settlement of a civil case in 2000, in which Cendant Company paid $2.9 billion and Ernst & Young paid $335 million. In 2005 Cendant stockholders made the decision to change the company’s name to the Avis Budget Group. Besides Avis Budget, Cendant Corp. has been divided into publicly traded hotel, real estate and mortgage financing businesses.

In other words Cendant Corporation announced its decision to divide into four companies, as it was necessary to introduce some diversification in order to appeal to stockholders and striving to raise the value of the post-split up corporation. These four sectors contain «Travel Distribution, Real Estate, Hospitality and Vehicle Rental Companies.”

4. Conclusion

Fraud is said to be the deception that is made by one person or group of people for personal benefit or to damage another person or to take his money in illegal way. Definition of fraud is predominantly dependant on legal jurisdiction. Fraud is said to be the crime, and also the violation of the civil law. The most common type of fraud is defrauding people of money.

There are about 9 common types of fraud, which include: asset misappropriation, false accounting, computer fraud, intellectual property fraud and insurance fraud, infringements or thefts by third parties, corruption, investment scheme fraud, and money laundering.

It is possible to commit fraud by such means as mail, internet and phone.

Risk situation on fraud commitment can be categorized as profits, processes and people. Some situations taken independently may not indicate on the motivation to commit a fraud, but taken along with other factors will appear to become a motivational factor.

In order to prevent fraud and enhance ethical behavior in the company, organizations should develop code of ethics according to their core values and establish services of internal audit and monitoring.

Companies should also obtain all possible information about their employees, business partners and suppliers, as well as monitor flow of information between them, in order to reduce possibilities of fraud.

Fraud at Cendant Corporation was the first significant case of fraud in such tremendous scales. Cendant Corporation was formed on May 27, 1997 with the merger agreement between the Boards of Directors for HFS, Inc. and CUC International Inc. Cendant Corporation was created as a conglomerate that specialized in shopping-club memberships, Internet marketing and traveling. After a shocking fall of Cendant’s stock price in 1998, it was found out that top executives of CUC, which were led by former Chairman and CEO Walter Forbes, promoted a laissez-faire environment at the corporation that encouraged underlings to prepare reports with impunity.

As a result of fraud, Kirk Shelton, Cendant’s former vice chairman was sentenced to 10 years in prison, Cosmo Corigliano was sentenced to three years on probation with six months of home confinement and 300 hours community service, Anne Pember, Former director of accounting at CUC division of Comp-U-Card and CUC controller, was given two years probation and 200 hours of community service, Casper Sabatino, Former CUC accountant in charge of the company’s external reporting, received two years probation and finally Walter Forbes received 12 years and seven months in prison (Corporate Fraud Data Base). __________________________________________________________

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