Cendant CorporationHenry Silverman

Major Case 4

Rashid Hijazi

ACCT530

Professor Michael Abner

Contents

Company Overview Ethical Issues Questions Optional Question Conclusion References

Company Overview

Henry Silverman, a business executive and private equity investor created Hospitality Franchise Systems (HFS) as a vehicle to acquire a number of hotel franchises in the early 1990s. Among Silverman’s purchases were such brands as Ramada and Howard Johnson's as well as Days Inn, which he was able to buy for $290 million (less than half what he had sold it for) after the company had filed for bankruptcy in 1991. Silverman quickly took Hospitality Franchise Systems public in a 1992 IPO.

Company Overview

Henry R. Silverman is an American entrepreneur and private equity investor. Silverman is best known for his role in building Cendant Corporation into a multibillion dollar business services company that provided car rentals, travel reservation services as well as real estate brokerage services and was also the largest franchisor of hotels globally.

Among the brands that Silverman controlled included hotels and motels such as AmeriHost INN, Days Inn, Howard Johnson's, Ramada, Super 8 and Travelodge.

Company Overview

Building on his experience with Days Inn, while at Blackstone Silverman created Hospitality Franchise Systems (HFS) which would acquire a number of hotel franchises. Among Silverman’s purchases were such brands as Ramada and Howard Johnson's as well as Days Inn, which he was able to buy for $290 million (almost half what he had sold it for) after the company had filed for bankruptcy in 1991. Hospitality Franchise Systems went public in a 1992 IPO.

Company Overview

Silverman’s compensation was the subject of scrutiny in 2004. In 2002, on the back of strong performance at Cendant, Silverman signed a 10-year contract that provided for medical benefits, office space as well as travel perks including a corporate airplane and a company car and driver. Of greater attention was the compensation Silverman received in 2003. Silverman’s 2003 compensation was estimated at $60 million, which included $14 million in cash salary and bonus, $37 million in stock options and $4.6 million paid as premiums on a company funded life insurance policy.

Company Overview

Cendant Corporation was a New York-based provider of business and consumer services, primarily within the real estate and travel industries. In 2005 and 2006, Cendant broke up and spun off or sold its constituent businesses. Although the company was based in New York City, the majority of Cendant's headquarters employees were located in Parsippany-Troy Hills, New Jersey.

The last CEO of Cendant was Henry Silverman. In early 2005, Cendant purchased ebookers for just

under £190 million. Later in the year, Cendant acquired London based Gullivers Travel Associates.

Ethical Issues

The SEC expects a public company to report truthful information in all of its filings with the Commission. The accounting profession is harmed when an audit does not obtain sufficient, competent evidence, judged with professional skepticism.

Objectivity requires that the company should approach its decision about the proper revenue recognition procedure with fair-mindedness and without partially to one set of stakeholders.

Ethical Issues

Using rights theory, it is not right to mislead the investors by making it look as though the company is doing better than it really is. Any attempt to intentionally misstate the financial statements violates the categorical imperative.

Using justice theory, stakeholder interests are not fairly represented because the perceived interests of the management are given priority over the interest of all other stakeholders.

Ethical Issues

Rule-utilitarianism requires that the correct rule should be followed. Act-utilitarianism requires that the act that creates the greatest good for the greatest number of stakeholders should be selected.

None of the stakeholders benefit from an action that misstates net income. Using virtue theory, honesty requires that the statements should be truthful and recognize revenue using generally accepted accounting principles.

Trustworthiness means that the accountants should not violate the investors’ faith that the statements are accurate and reliable.

Questions

Briefly summarize the accounting techniques used by Cendant to manipulate financial results. Categorize each technique into one of Schilit’s financial shenanigans.

Cendant used aggressive accounting to shift current marketing expenses to a later period by capitalizing the costs; this is shenanigan number 4. Cendant also shifted future expenses to the current period and later released reserves into income. When Cendant made acquisition, it took large restricting charges to create bogus income; this is shenanigan number 7. Then in subsequent period, Cendant released these reserves into income; this is shenanigan number 5.

Questions

Describe the failings of E&Y with respect to conducting an audit in accordance with GAAS. Include in your discussion any violation of the AICPA Code of Professional Conduct.

Cendant made materially false statements to E&Y to mislead the auditors into believing the Company’s financial statements conformed to GAAP.

The statements concerned the creation and utilization of merger-related reserves

The auditors failed to recognize evidence that the company's establishment and use of the Cendant Reserve did not conform to GAAP.

While the component categories changed over the different drafts, the total amount of the reserve never changed materially

Despite this evidence, the auditors did not obtain adequate analyses, documentation, or support for changes they observed in the various revisions of the schedules submitted to support the establishment of the reserves

Questions

E&Y did not seem to meet the GAAS standards of integrity, objectivity, independence, and supervision of assistants of the general standards. It also did not obtain sufficient, competent evidence, nor express an opinion based on the evidence. The violations of the AICPA Code of Professional Conduct were Rule 101, Independence; 102, Integrity and Independence; 201, General Standards; 202, Accounting Principles; 203, Accounting Principles; and 501, Acts Discreditable.

Questions

Evaluate the actions of Cendant management with respect to its obligations to shareholders. Did it meet those obligations? Why or why not?

Cendant management did not meet the criteria of fiduciary duty

and did not protect the interests of all stakeholders. Additionally the

management profited from their own wrong-doing by selling the

Company’s securities at inflated prices while the fraud was

underway and undisclosed. These sales of securities brought

Cendant management millions of dollars in ill-gotten gains.

Questions

The corporate governance requirements for Cendant that were stipulated in the class action lawsuit seem to emphasize the need for independence of the board of directors and audit committee. Using the corporate governance provisions in the Sarbanes-Oxley Act and NYSE listing requirements, identify the additional governance requirements that could have been imposed on Cendant. What should they be designed to accomplish?

The NYSE-listed companies adopt and disclose their corporate governance guidelines thatcover director qualifications, responsibilities, access to management, compensation, management succession and annual evaluation of the board.

Questions

Additional governance criteria that could have been imposed include

adding a financial expert as one of the independent members of the audit

committee; strengthening the internal audit function by adding a director of

internal audit to management with direct reporting to the audit committee,

guidelines on executive compensation and tying to performance measures,

executive compensation reviewed by the compensation committee and

approved by the entire board. These measures are designed to protect all

stakeholders of a corporation; it directs, controls and holds management

accountable to achieve the long term strategic goals of the stakeholders.

Optional Question

The rules in accounting for merger and other restructuring reserves were changed after the frauds at companies like Cendant and Lucent. Research the new rules and explain how they differ from the rules in effect at the time of the Cendant fraud and why the rules were changed.

In the past, the pooling of interests method accounted for a business combination as the uniting of the ownership of interests of two or more companies by exchange of equity securities; no acquisition was recognized as the combination was completed without disbursing resources of the entities. The recorded assets and liabilities of the entities were carried forward to the combined corporation at the recorded amounts. Income of the combined corporation was the income of the entities for the entire fiscal period in the which the combination occured and the income for prior periods were combined and restated as income of the combined corporation.

Conclusion

After a pooling of interests had occurred, companies undertook restructuring and set up reserves to write-down overstated assets. Often the assets written off were not overstated.

The rules were changed to the acquisition method to stop the manipulation of reserves and goodwill under the pooling of interests method.

After a pooling of interests had occurred, companies undertook restructuring and set up reserves to write-down overstated assets. Often the assets written off were not overstated.

The rules were changed to the acquisition method to stop the manipulation of reserves and goodwill under the pooling of interests method.

References

Ethical Obligations and Decision Making in Accounting: Text and Cases, 2nd Edition

http://www.cendantbenefits.com/ www.sec.gov/litigation/complaints.htm Cendant Corporation Litigation, 264 F3d 201 264 F.3d 201 (3rd

Cir. 2001), http://openjurist.org/264/f3d/201/in-re-cendant-corporation-litigation