Cendant Corporation Henry Silverman Major Case 4

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Cendant CorporationHenry SilvermanMajor Case 4

• Rashid Hijazi
• ACCT530
• Professor Michael Abner

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Contents

• Company Overview
• Ethical Issues
• Questions
• Optional Question
• Conclusion
• References

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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
  Silvermans 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.

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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.

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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 Silvermans
  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.

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Company Overview

• Silvermans 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.
  Silvermans 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.

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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.

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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.

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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.

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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.

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Questions

• Briefly summarize the accounting techniques used
  by Cendant to manipulate financial results.
  Categorize each technique into one of Schilits
  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.
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Questions

• Describe the failings of EY 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 EY
  to mislead the auditors into believing the
  Companys 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

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Questions

• EY 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.

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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 Companys 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.
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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.
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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.
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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.
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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.

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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/26
  4/f3d/201/in-re-cendant-corporation-litigation