Walter Forbes, then aged 30, set up Comp-U-Card (CUC) in 1973 with Kirk Shelton. The company sold membership cards that allowed customers to buy goods and services from selected firms at discounted rates. During the 1980s and early 1990s the firm grew, attracting 30 million customers. It also started buying other companies, culminating in a 1997 merger with HFS Incorporated, which owned various franchises and hotel chains. The newly merged firm was renamed Cendant in 1997.
What was the scam?
From the 1980s onwards Forbes and Shelton systematically manipulated earnings to give the impression that their company was more profitable than it actually was, keeping CUC’s share price high. This allowed the firm to use its shares to buy other companies more cheaply than they would otherwise have been able to. The fraud reached a peak in the run-up to the merger with HFS, with more than $500m of fictitious profits created between 1995 and 1997, mostly through the creation of false orders, and manipulation in the accounts of the company’s reserves.
What happened next?
Shortly after the merger, two CUC managers, Casper Sabatino and Steven Speaks, told Cendant’s new chief financial officer that they had been told to help manipulate earnings. Speaks immediately told CEO Henry Silverman about the allegations. Cendant immediately notified the financial community about the irregularities, causing its shares to plummet. Forbes was forced to resign as chairman shortly afterwards. In 2001 Shelton and Forbes were indicted for fraud and insider trading (due to a stock sale shortly before the fraud was uncovered), and were eventually sentenced to ten and 12 years in jail respectively.
Lessons for investors
The scandal would end up wiping $14bn from the value of Cendant shares and bonds, far outstripping the $2.9bn that the company paid to shareholders in a lawsuit. The biggest losers were HFS’s shareholders, who received Cendant stock in exchange, only to see the value of the newly merged company plunge. If a company that you invest in merges with another company, consider whether you want to invest in the new entity, rather than just automatically holding onto the shares.