Henry Silverman on Fraud and Recovery


With stories of corporate misbehavior continuing to dominate the news, CEOs are finding themselves and their businesses under intense -- and often uncomfortable -- scrutiny. For Cendant CEO and Chairman Henry F. Silverman, such scrutiny is all too familiar. Some four years after being the subject of the largest financial fraud case in U.S. history, the New York City-based company is still struggling with the aftereffects.

In 1998, four months after a merger between HFS Inc., a franchiser of real estate brokerage and car-rental properties, and CUC International, which owned discount-buying clubs, the newly formed company Cendant disclosed that CUC substantially overstated operating income. As a result, Cendant paid a record $2.85 billion to settle a consolidated shareholder lawsuit involving the common stock.

It also paid $351 million to settle a suit related to convertible securities. Cendant estimates that outstanding lawsuits will cost around $100 million to settle. Silverman concedes that this tainted history is definitely pressuring the stock. Analysts say although the outfit is sound, it still hasn't completely earned back investors' trust.

SQUEAKY CLEAN. The current crop of corporate scandals have dredged up memories of Cendant's past all over again. But while people may associate the company with corporate misbehavior, no one has turned up evidence of another scandal brewing there. That may be thanks largely to Silverman's efforts to keep Cendant squeaky clean.

In 1999, in response to the CUC debacle, Cendant moved to make its board more independent. Then in March of this year, it announced more changes in corporate governance that include barring its auditors from nonauditing functions, setting limitations on senior executives' ability to trade the company's stock, and capping future severance packages for top execs.

"The movie playing now is about Tyco, Enron, and Adelphia. A few years back, we were in that movie," Silverman says. He's quick to point out that he was not part of the fraud at CUC. "I like to think I wore the white hat back then," he says. Shares are down 26% this year, around $14, while earnings have been climbing.

With Cendant on track to post a 33% rise in earnings per share from 2001, Silverman expects the tide to turn for the stock. "Our stock price over time should follow our earnings and reflect a reasonable multiple." Right now, it trades at about 10 times 2002 EPS projections of $1.41, while it used to trade closer to the broader market historical p-e ratio of 15 times, he says.

On July 24, BusinessWeek Online's Amy Tsao spoke with Silverman in a phone interview about Cendant's efforts to keep a clean house and the pervasive nervousness about more revelations of corporate wrongdoing. Edited excerpts of their conversation follow:

Q: Are you surprised at all the attention -- and the investor reaction -- to corporate malfeasance?

A: No, I'm not surprised at all. There's a variety of reasons for it. First of all, as it occurs by itself, it's a very bad thing. Then, there's incredible media attention on it, which causes a heightened awareness and sensitivity. That leads to politicians who are now in a contest to see who can be tougher on this issue.... So, a lot of people are saying something should be done.

Q: Do you think that you and Cendant have been treated fairly?

A: Yeah, I think so. We discovered and disclosed we had fraud at CUC. There was fraud at the time. The first reaction is always going to be disbelief and denial. It's like the five stages of death. Eventually, there's acceptance. I don't have any issues over how we were treated.

We're a solid investment-grade company with [a] $15 billion market cap. I wish we weren't dealing with these issues again. Every time an Enron or WorldCom happens, people like you call us because we went through that unfortunate time.

Q: What specific moves has the company made to address issues of corporate governance?

A: We put out a press release this spring pointing out all the things we've done in the last three years. A whole series of changes were made to address [governance] issues. Auditors can only do auditing. We've gotten rid of staggered board elections. We have only independent directors on the compensation committee, nominating committee, and audit committee. We wanted to make sure investors knew what we were doing. Post-Enron, we wanted to show that we had taken steps to be proactive.

Q: When did Cendant start its moves to do this? If there was all this trouble a couple of years ago, didn't it behoove you to make changes before Enron?

A: Issues like the division of auditing really weren't issues in 1999. These issues came to the surface after our initial changes. All the independent board issues were addressed. The new changes address the distinction between auditing and consulting. For the record, we had used Arthur Andersen to do all our nonauditing work, while our auditor was Deloitte & Touche. We just had not codified it [back then].

Q: What changes have been made to your accounting methods?

A: After CUC, we needed to be on the leading edge on accounting disclosure and corporate governance. Since two years ago, every press release includes about a dozen tables, including earnings-driver information and [charts on] free cash flow. We publish an update every quarter as to any new developments regarding anything around any entity we're affiliated with.

In the future, we're also planning on breaking out organic growth from growth, so we can show how earnings before interest, tax, depreciation, and amortization [EBITDA] grow in a particular segment. We'll show what percentage is from acquisitions and what percentage is from pure organic growth.

We want to give investors as much information as possible. The more transparent and the less complex a company is, the less investors will have to take it on faith. It's easier to make an informed decision about investing in the stock.

Q: Why are you breaking out growth this way now?

A: The information is highly subjective, and we want to make sure it's as accurate as we can make it. It's hard to delineate growth in many of our businesses, where we integrate businesses we buy into an original company. What's organic, and what's not?

It's important to point out that more disclosure is not necessarily a silver bullet. More disclosure means more cynics and skeptics will point to things they disagree with. We want to make sure disclosure provides more transparency and as much accuracy as possible.

Q: What about accounting for options?

A: We account for options the way most every other company does. That's how we'll do it until the Financial Accounting Standard Board (FASB) or some other body tells us there's a better way of doing it. When that happens, we'll do it. The real issue is how to incentivize employees.

Q: You came under a lot of criticism for an options repricing package a couple of years ago. So what incentives do you do provide employees with now?

A: A combination of three things. Cash, restricted shares, and some limited use of options. If options are going to be expensed in the [income statement], then we'll move to a much different form of compensation with much more limited use of options.

Q: What will new regulations do to prevent more instances of corporate misbehavior?

A: [The new regulations] are kind of like chicken soup. They can't cure you -- but can't hurt you either. There will always be fraud in the world. I don't know how you regulate human behavior, which is what these rules are trying to do.

We were a very large company, so we got a lot of publicity. In our case, three executives pleaded guilty, and two others have been indicted. I have to assume those who were guilty must have known they were committing a crime. But it didn't deter them. I don't know that even arrests will be a deterrent. People rob banks every day knowing they could be arrested.

Q: If regulatory changes won't prevent bad behavior, then what will?

A: Individual mores and ethics of the leaders at companies, and their ability to instill what's right and what's wrong. We had a biannual meeting where all of the senior managers came to the New York office. I made a point to talk about integrity. I said: "If there's something you'd prefer not to read about on the front page of The Wall Street Journal, then just don't do it." Most companies, I'm afraid, haven't instilled that culture in their troops.

Q: When will headlines on corporate malfeasance subside?

A: There are two key dates investors should follow. First is Aug. 14, when we have to certify financials. You could see one or two do restatements prior to the deadline. Then in the first quarter of 2003 when the 2002 audit cycle is done.

Clearly investors will look at financial statements differently than they did before. I think we're looking at another nine months before this is flushed through the system. Until next March, we're not going to know how many more shoes are going to fall.

Q: Are you on track to meet the SEC's Aug. 14 deadline to certify your financial documents?

A: We're assuming that if all goes as planned, we'll certify ahead of time. I don't see how this changes anything. CEOs are paid to know about problems. We have been doing this internally since 1999, when there was fraud found in 1998. This is not a stretch at all for us.


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