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The Cendant Mess Gets Messier

The Corporation: EXECUTIVE SUITE


With warring execs, a split board, and sagging stock, pressure on management is mounting

When franchising giant HFS Inc. and discount-shopping-club operator CUC International Inc. merged late last year, the new company, dubbed Cendant Corp., was supposed to become a marketing powerhouse selling millions of customers everything from travel services to mortgages. But that wasn't the only behemoth the deal spawned. When the company's board gathered in April--shortly after a bombshell disclosure that accounting irregularities had been discovered in CUC's books--the meeting had to be held at the law firm of Battle Fowler. The reason? Cendant's Manhattan offices didn't have a conference room that would hold 28 board members and their advisers.

That logistical headache speaks volumes about the struggle for control of Cendant. The company's unwieldy board is effectively paralyzed, split between directors who support Walter A. Forbes, the Cendant chairman who founded CUC, and those who back Henry R. Silverman, the Cendant chief executive and HFS founder. Some investors say Silverman wants Forbes out. In the wake of the April bombshell, the CUC and HFS directors hired separate lawyers--and things have since gone from bad to worse. On July 14, the company disclosed that the accounting woes went far deeper than expected. And on July 22, Ernst & Young LLP, CUC's former auditor, said in a statement that "from information provided by Cendant to the media, it appears that efforts may have been taken to deceive the auditors." With the stock now trading around 17--down from 41 in April--investors have become increasingly vocal about hastening Forbes's exit.

Resolution may come quickly. As BUSINESS WEEK went to press, sources familiar with discussions said talks had been held recently between representatives for Forbes and representatives of the company about terms of his possible departure. Reached by phone, Forbes issued a terse "no comment." A spokesman for Forbes says he has no plans to leave.

Certainly, the heat has been turned up on the CUC founder. Silverman has been telling big shareholders who want Forbes removed to write or call board members. Says Director John D. Snodgrass: "I do receive faxes from large shareholders that request the board to take action." Even if the talks fall through, pressure is building for the board to act before a report ordered by the Cendant audit committee is completed in August.

Looking at the makeup of the Cendant board, it's easy to see why the management issue hasn't been resolved quickly. It's twice as big as the boards of most large public companies, says Thomas J. Neff, U.S. chairman of headhunter SpencerStuart. That alone impedes decisive action. And more than half of the directors could be described as insiders, ex-insiders, or business associates of Cendant, of its two predecessors, or of Forbes.

Seven of the directors are Cendant executives; an eighth resigned his executive post just before the accounting disclosures but remains as a director. Six other directors--including two on the four-member audit committee that is overseeing the accounting probe--have current or recent business dealings with Cendant, directly or through other companies in which they're involved. And the head of that committee, Frederick D. Green, has partnered with Forbes in developing golf courses in such spots as Nantucket, Mass.JOB SWAP? None of that sits well with big investors, some of whom have already dumped blocks of shares. And governance experts say the board's makeup raises questions about its directors' independence. "Those are warning signs...that you have CEOs [meaning Silverman and Forbes] who have appointed people with conflicts," says Sarah A.B. Teslik, executive director of the Council of Institutional Investors. "That can make oversight difficult."

Both executives deny problems with the board. "I think that is off-base," says Forbes. "The former CUC directors now on the board are decent people trying to do a good job in a difficult period." Adds Silverman: "If the board listens to the facts in a dispassionate way, I would expect them to do the right thing."

For now though, board action does not appear imminent. One director from the CUC side says he doesn't think the board should meet until the auditors' report comes out. He's paying little attention to Cendant's statements about revenue restatement. "I've known Walter for... years and never caught him lying," he says. But Snodgrass, from the HFS side, says: "If all that has been written is true, I think he should go." Other directors didn't return calls or would not comment on the record.

Under terms of the merger, Forbes and Silverman were to swap jobs in January, 2000. Many investors say it is inevitable that Forbes will exit. But if he does not go voluntarily, an 80% vote of the board is required to remove him. To avoid paying Forbes a severance package worth at least $50 million, Cendant must terminate him "for cause," according to the company's proxy. Included in that definition: "serious, willful misconduct" such as fraud.

That doesn't mean shareholders are sitting on their hands. Hans Utsch, president of the Kaufmann Fund and a large Cendant investor, plans to write a letter urging the board to remove Forbes. And at last count, 68 shareholder lawsuits had been filed against the company. A spokesman for Cendant says the company does not comment on pending litigation.

Silverman, meanwhile, is facing pressures of his own from investors to boost the stock. According to sources familiar with the position of veteran Wall Street investor Leon G. Cooperman, he wants the Cendant CEO to sell off some noncore operations, including CUC's software businesses. That would raise money that could be used toward completing the planned $3.1 billion acquisition of credit insurer American Bankers Insurance Group Inc. using all cash instead of the cash-and-stock deal now planned, which some investors worry will be dilutive. And another big shareholder has been pressing Silverman to explore a complete spin-off of CUC, effectively undoing that merger. Silverman says it is "premature" to talk about restructuring the American Bankers deal and that a CUC spin-off would be impractical. "You can't unscramble the eggs," he says.

Certainly, no investor could have imagined the scope of the problem. When Cendant announced on Apr. 15 that it had uncovered accounting irregularities, most analysts and investors figured the company had, if anything, overstated the problem to protect management's credibility. But it was worse than expected. Auditors from Arthur Andersen & Co., which had been hired to comb through CUC's numbers, uncovered what was described as a "widespread and systemic" practice of overstating or fabricating results. Net income before charges for 1997 would have to be reduced by $200 million to $250 million, the company announced, twice the original estimate. Earnings for 1996 and 1995 would also have to be revised based in part on the discovery of fictitious CUC revenues.

It also turned out that a big chunk of a CUC charge taken at the time of the merger, about $200 million after taxes, would have to be reversed. That occurred on Henry Silverman's watch. "I was in shock when I read that," says David P. Brady, a senior portfolio manager at Stein Roe & Farnham Inc., a large Cendant shareholder. Silverman says that portion of the yearend charge was handled by CUC execs and auditors.

Barring a quick resolution of the management crisis, the ball will be in the hands of the Cendant board, which includes several directors who go back years with Forbes or Silverman. Three directors who were on the board at CUC--Bartlett Burnap, T. Barnes Donnelley, and Stanley M. Rumbough Jr.--were among its early investors, and have made substantial money in the past under Forbes's leadership.

Directors from the HFS side of the aisle also have connections. Several current Cendant directors bought limited partnership interests through a private placement in a new HFS hotel chain called Wingate. Included: Silverman, Snodgrass, who was the HFS president until last December, Cendant execs-and-board-members James E. Buckman and Stephen P. Holmes, and Cendant director and now president of America Online Robert W. Pittman. Cendant bought out those interests earlier this year. Silverman says the five directors did not vote on that decision, and that it was made by disinterested directors. In addition, Snodgrass served as a consultant this year for Cendant after it purchased Jackson Hewitt Inc., a tax-preparation company. Snodgrass says neither deal posed a conflict.MAGIC MOMENT. No one has suggested these deals were improperly handled. Still, says governance expert Charles M. Elson, "If you are making a profit aside from other shareholders, that certainly raises a question about independence from management."

Some directors are also taking heat for selling shares soon before the April disclosure. According to CDA Investnet, which tracks insider sales, Silverman sold 1.7 million shares in February at about $36, while Forbes sold 300,000 shares in March. Directors Rumbough, Burnap, and Martin L. Edelman sold in March, and Snodgrass sold over 1 million shares in March and April, ending the week before problems were announced. Says Robert M. Gabele, president of CDA Investnet: "These were among the most timely sales we've ever seen at the company."

Silverman says that his sale was part of a pattern of selling shares each quarter, while a spokesman for Forbes says he sells a small amount of shares every year. Snodgrass says he was diversifying his holdings. All three deny any knowledge of the accounting problems at the time of the sales. The other directors wouldn't comment on their sales.

Once the boardroom battle is resolved, investors may see a rebound in Cendant stock. But a number of analysts warn that failure to resolve that issue quickly could result in deterioration of Cendant's underlying businesses. Merrill Lynch & Co. analyst Mark R. Miller reduced his Cendant rating last week to neutral, citing concerns that the battle could distract management. Miller also noted the risk of management defections now that Cendant's stock options are less attractive. Indeed, if the Cendant board doesn't take control of the situation, the bad news may be just beginning.By Amy Barrett in Philadelphia and Jennifer Reingold in New YorkReturn to top

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