Cendant and CUC Accounting Fraud Case: The Fraud Had Its Own Tracking Schedule

In the Cendant and CUC accounting fraud case, the Securities and Exchange Commission alleged that managers inflated annual income by more than $100 million in January 1998 alone, primarily by misusing reserves. The agency described a chain of instructions running from senior officers through financial reporting managers to the people posting journal entries. If you worked on a business unit’s close, that is a recognizable place to stand: you may know what the underlying activity supported and what someone instructed accounting to report instead.

This case follows the instructions, reserve adjustments and reporting records behind Cendant’s published results. The broader question of how reserves can change reported earnings reaches other companies too, but the distinguishing feature here was a schedule that, according to the Securities and Exchange Commission, management used to track the fraud itself.

CUC’s Accounting Instructions Continued Into Cendant

Cendant was created when CUC International and HFS merged on December 17, 1997. The Securities and Exchange Commission traced the financial fraud back to CUC in the 1980s and said it continued until Cendant discovered and disclosed it. The reserve adjustments described in the agency’s complaint reached across the merger into the new company’s annual income.

A federal court’s account of Cendant’s disclosures identifies the former CUC membership clubs operation as the unit where Cendant announced accounting irregularities. The next day, the stock price fell 46%.

Management Kept a Schedule of the Fraud

The Securities and Exchange Commission alleged that CUC’s chief financial officer created and maintained a schedule management used to track the fraud during its later years. He regularly directed financial reporting managers to make unsupported alterations to quarterly and annual results. The former controller, the agency alleged, was the officer most responsible for implementing his directives, including the January reserve adjustments. The fraud had its own progress report.

According to the agency’s complaint, the former vice president of accounting and financial reporting directed lower-level managers to make the alterations. The former director of financial reporting was regularly present when the chief financial officer calculated the unsupported changes and supervised the managers who entered them.

At the business-unit level, the agency alleged that the controller of CUC’s largest division made, or instructed others to make, journal entries carrying out much of the January income inflation. An accounting manager in the same division allegedly posted unsupported entries at the former corporate controller’s direction. A financial reporting supervisor allegedly made recurring unsupported quarterly alterations at the direction of the reporting executives. These are distinct roles an insider may be able to explain: calculating an adjustment, directing it, supervising it and entering it.

The Securities and Exchange Commission also alleged that the chief financial officer, former controller and former director of financial reporting profited by selling stock at prices inflated by the fraud. We see an ugly incentive in the agency’s allegation: people helping change the numbers also sold into the price those numbers supported.

How to Catch Accounting Fraud?

Catching accounting fraud means connecting the reported result with the transaction records, adjustments and instructions that produced it. In a case like Cendant’s, we would examine the records behind the earnings number with the person who understands the close. The SEC’s allegations make the questions concrete: who calculated the change, who directed it and where did it enter the accounts?

A public company’s accounting controls address authorization, recording and reconciliation. Those functions leave different evidence: an entry records the change, an approval identifies the decision, and the supporting calculation explains the claimed basis. For someone working below the corporate reporting level, a subsidiary ledger and the instructions accompanying an adjustment may show the difference between the business unit’s result and the number carried upward.

For a reserve adjustment, we would compare the reserve schedule and its assumptions with the entry and the activity it was supposed to reflect. In a membership business, the relevant comparison may include membership activity and contract terms. A recurring consolidation adjustment deserves the same connection to its stated basis, the close instructions and the reporting period it affected.

Audit correspondence supplies another part of that picture. The Securities and Exchange Commission’s CUC complaints included allegations of lying to auditors as well as false records and internal-control violations. We would compare what accounting knew with what the audit questions asked, which supporting records were provided and how management answered. An accountant who knows why an entry was made can explain a contradiction that the final statement leaves invisible.

The Reserve Pattern Appears Beyond Cendant

Dell provides a parallel for the use of reserves to cover weak operating results. In its civil complaint concerning Dell’s accounting, the Securities and Exchange Commission alleged that surplus reserves were released to cover shortfalls from fiscal 2002 through fiscal 2005 and distort the trend reported for a regional business segment.

For an insider seeing a similar pattern, the useful knowledge is what changed in the business when the reserve changed in the accounts. We connect the explanation for the release, the underlying assumptions and the reporting instructions. Cendant’s alleged management schedule adds a particularly direct question to that comparison: was someone separately tracking the alterations needed to produce the published number?

What the SEC Found About Cendant

The Securities and Exchange Commission’s June 14, 2000 announcement described a settled administrative order finding that Cendant’s books, records and accounts had been falsely altered and that materially false periodic reports had been filed. The agency found violations involving reporting, recordkeeping and internal controls. Cendant consented to an order requiring it to cease further violations, and the agency credited the company’s prompt remedial acts and cooperation.

The agency separately brought civil cases in the U.S. District Court for the District of New Jersey against former CUC officers and managers. Its account connected the corporate reporting failures to specific instructions and entries inside the accounting organization.

The same release reported criminal guilty pleas announced by the U.S. Attorney’s Office for the District of New Jersey. CUC’s former chief financial officer pleaded guilty to wire fraud and conspiracy involving mail fraud, wire fraud and false filings with the Securities and Exchange Commission. The former controller pleaded guilty to conspiracy to commit mail and wire fraud, and the former vice president of accounting and financial reporting pleaded guilty to aiding wire fraud.

What Is an Accounting Restatement?

Cendant’s accounting restatement changed a reported profit into a loss. Its corrections to earlier results reached the calendar years 1995 through 1997, all quarters in 1996 and 1997, and the first two quarters of 1998, according to the federal court’s account.

Cendant announced that it had lost $217.2 million in 1997 instead of earning the $55.5 million previously reported. The SEC’s description of unsupported entries, reserve use and management instructions explains the conduct behind the changed numbers.

An insider’s contribution can reach back to when the original result was being prepared. The reserve calculation, the instruction to alter it and the response to an audit question can connect a later correction with an earlier decision. We look for that connection with the person who knows how the entry reached the report.

The Value of Someone Who Knows the Close

Research on whistleblower incentives puts that insider knowledge in a broader setting. The March 2019 working paper Do Corporate Whistleblower Laws Deter Accounting Fraud?, hosted by MIT Sloan, studied companies held by state pension funds as states adopted False Claims Acts between 2001 and 2010. It found a 5% to 9% reduction in estimated accounting-fraud probability, measured with financial-statement indicators, after exposure to those whistleblower laws.

For someone seeing similar conduct today, a tip to the Securities and Exchange Commission can earn 10% to 30% of sanctions collected in a case with sanctions over $1 million. Separately, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. Our whistleblower experts shape your strongest whistleblower case with you.

If your knowledge comes from accounting, internal audit or compliance work, your role and how you learned the facts are part of that conversation. You bring the knowledge of what the records mean. Our whistleblower experts bring the case strategy and the securities fraud whistleblower lawyers needed to put that knowledge to work.

You Know Why the Entry Changed

If you saw reserve adjustments or close instructions that changed what investors were told, speak with our whistleblower experts about the records you know. We build the accounting story with you, bring in securities fraud whistleblower lawyers who understand financial-reporting cases, and stay beside you as the case develops.