Asleep at the Books: A Fraud That Went On and On and On. Were the books ever honest at CUC International?
The biggest accounting fraud ever -- one
that cost investors $19 billion and
involved more than $500 million in phony
profits over just three years, now turns
out to have gone on almost forever.
Cosmo Corigliano was a 23-year-old
accountant for Ernst & Whinney when he
joined CUC in 1983, the same year it
went public. "The activities had started
about then," Mr. Corigliano told Judge
William H. Walls this week, as he
pleaded guilty to fraud charges.
Faking the numbers, he said, "was my
job, and my superiors were encouraging
me."
Mr. Corigliano, who rose to become CUC's chief financial officer, is
likely to end up in prison. He and a number of his subordinates are
cooperating with prosecutors, who are clearly gunning for his bosses at
CUC.
But for investors, the most interesting question is not whether Walter A.
Forbes, CUC's founder, will go to jail. It is how this fraud managed to go
on so long. The Securities and Exchange Commission is sure it started by
the late 1980's and thinks it may have begun in 1985 or before. It ended
in 1998, after CUC merged with HFS to form the Cendant Corporation
and a CUC accountant spilled the beans.
For all those years, the books were audited by Ernst & Young or its
predecessor, Ernst & Whinney. In hindsight, they missed more than a
few red flags. A report by Arthur Andersen, another accounting firm
hired after the fraud was exposed, described meetings in which Ernst &
Young officials asked questions and got odd answers. In one case, there
was no explanation or documentation for $25 million in profits. The
auditors decided that was not a material amount, and let it go. The
Andersen report did not criticize Ernst & Young, but that was no
surprise. Ernst & Young had refused to supply information to Andersen
until it was promised that the report would not comment on the quality of
the Ernst & Young audits.
The S.E.C. says that the fraud was easier to pull off because CUC
officials knew which subsidiaries would be audited, and therefore hid the
most obvious frauds in subsidiaries that they knew the auditors would not
look at.
As the fraud grew, CUC's old tactics of inflating revenues and
suppressing expenses were no longer adequate. So it took to
manipulating merger reserves, which are supposed to cover one-time
costs related to takeovers and are often ignored by investors. The
reserves became a cookie jar in which operating losses could be
fraudulently concealed. Unfortunately for CUC, some of its acquisitions
were such dogs that the merger reserves were soon exhausted, making it
necessary to make more acquisitions.
Did the auditors know what was going on? They deny it, and there is no
proof they did.
But they didn't show much suspicion when confronted with some
odd-looking transfers of funds between various accounts. Abraham
Briloff, an emeritus professor of accounting at Baruch College, studied
the Andersen report and concluded that "the auditors were fooled
because, in some measure at least, they wanted to be fooled." Had they
blown the whistle, people would have asked why they had not done so
years earlier.
That is not, needless to say, the way they see it at Ernst & Young.
"That suggestion is offensive," said Kathryn Oberly, the firm's general
counsel. "The CUC people were so determined to fool the auditors that
they could fool any audit firm or any team of auditors."
Investors may not find that especially reassuring. |
