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When it comes to surviving cooking-the-book corporate scandals, it’s good to be the CEO. That seems to be the message from the prosecution of the top executive of Cendant Corp., the first major company hauled to court for the type of massive accounting frauds that rocked the nation and led to reforms. After a six-month trial and two months of deliberations, a jury in Hartford, Conn., could not reach a verdict on Jan. 4 on the 16 counts against former Cendant chairman Walter Forbes. But the jury did convict his second-in-command, vice chairman E. Kirk Shelton. Forbes, prosecuted by the U.S. Attorney’s Office for New Jersey, was the CEO of CUC International Inc. in Stamford, Conn., from 1980 to December 1997, when it merged with HFC Inc. of Parsippany to form Cendant. The HFC side franchises hotel chains such as Ramada Inns and Days Inns, as well as Avis Rent-a-Car, Century 21 and Coldwell Banker. The CUC side sells shopping-club memberships. Four months after the deal, the merged company disclosed that CUC had been inflating its earnings since the 1980s. Cendant’s stock plummeted on April 15, 1998, from $41 to $7.50, wiping out $14 billion in shareholder value in a day. In what was the largest accounting scandal at the time, the company later restated $571 million in income. Three top CUC financial executives pleaded guilty to fraud and testified against Forbes, 62, and former CUC president and chief operating officer Shelton. Shelton, 41, who played more of a hands-on role in the creation of the financial statements, was found guilty on all 12 counts he faced, including conspiracy and wire fraud. U.S. Attorney Christopher Christie must now decide whether to retry Forbes, while Shelton must now decide whether to begin cooperating with Christie’s office and testify against his former boss in return for leniency. Christie’s spokesman, Michael Drewniak, says no decision has been made. Shelton’s attorney, Thomas Puccio of New York, did not return a call seeking comment. Forbes’ main defense during the 70 days of testimony between May 10 and Nov. 8 of last year was that he was focused on the big picture and unaware of day-to-day happenings. He testified that he worked on “the strategy vision part, talking to key clients … ” He told jurors he was “ much more valuable to shareholders doing that than being in day-to-day operations.” Forbes, like Shelton, retained top talent: Brendan Sullivan Jr. and Barry Simon, white-collar litigation partners at Washington, D.C.’s Williams & Connolly, who often work in tandem on high-profile cases. Puccio, Shelton’s attorney, is the former prosecutor from Brooklyn who led the Abscam political corruption prosecution in the early 1980s and has defended a string of high-profile clients. Sullivan and Barry did not deny there was massive fraud, but argued it was carried out by those below, in particular, Cosmo Corigliano, CUC’s chief financial officer from late 1994 until the merger. Corigliano pleaded guilty in 2000 and agreed to cooperate, as did Anne Pember, a former director of accounting at a CUC division, and Casper Sabatino, the CUC accountant in charge of external reporting. They have yet to be sentenced. “The defense of Walter Forbes is that he didn’t know about it,” Sullivan said in closing arguments, which collectively went on for nine days. Forbes also blamed the outside auditors, Ernst & Young, which in 2000 paid $340 million to settle a shareholders’ class action securities suit. Corigliano testified that he had briefed Forbes and had showed him “cheat sheets” that detailed how revenues and earnings were being pumped up to burnish quarterly and annual statements to meet Wall Street’s expectations. But Forbes denied seeing such material or learning of the cooked books, while Sullivan labeled Corigliano a “con man” and “serial liar.” Compared with fellow defendant Shelton, there was a dearth of memos or documents linking Forbes to the fraud, and Corigliano was the only witness to directly connect Forbes to it. Forbes also was cleared of insider trading. He had been accused of dumping $11 million of stock a month before Cendant disclosed the fraud. Cendant’s stock collapse was followed by the scandals at Enron, Worldcom, Tyco, HealthSouth and others. The cases led to reforms, especially the Sarbanes-Oxley statute that requires CEOs to take personal responsibility for financial statements they sign. But like Forbes, other top executives will be relying on what some call the dumb CEO defense. Former Enron CEO and Chairman Kenneth Lay is expected to blame his CFO, Andrew Fastow, when he goes to trial. Fastow has pleaded guilty, along with a dozen Enron officials, and is cooperating. Bernard Ebbers, the former Worldcom chairman and CEO, is expected to point the finger at CFO Scott Sullivan, who has pleaded guilty and is cooperating. The Wall Street Journal reported last Wednesday that Ebbers’ lawyers will portray their client as the dealmaker, leader and motivator who delegated complex financial matters to Sullivan and had no understanding of the arcane world of accounting. Like Forbes, Ebbers eschewed e-mail and written memos. CFO Sullivan, the defense will argue, orchestrated the fraud and is lying to cut his jail time. Similarly, HealthSouth Chairman and CEO Richard Scrushy is expected to blame several CFOs who worked under him and have pleaded guilty. The Cendant criminal case, U.S. v. Forbes, 02-cr-264, was brought in Newark in 2001 by U.S. Attorney Robert Cleary. Cendant was then based in Parsippany. But in March 2002, U.S. District Judge William Walls shipped the case to Hartford for the convenience of Connecticut residents Forbes and Shelton. The case was tried by Assistant U.S. Attorneys John Carney, Richard Schechter and James McMahon. Carney is chief of the office’s securities and health care fraud unit, while Schechter is deputy chief of the criminal division, where McMahon also works. The three have handled many tough prosecutions, including corporations and their executives. But they were up against a defense team famous for unraveling government cases. Williams & Connolly’s Sullivan and Simon are well known for their scorched-earth litigation practices. One source on the government side, who wished not to be identified, called the tactics of Forbes’ lawyers aggressive — such as lengthy cross-examinations and frequent challenges. Sullivan, often with Simon, has represented an impressive lineup of clients. They include Omni International Corp.; Grumman Corp. CEO John O’Brien; former New York Stock Exchange Chairman Richard Grasso; Warnaco Group CEO Linda Wachner; former Housing and Urban Development Secretary Henry Cisneros; and 18 states that sued Microsoft Corp. for antitrust violations. Sullivan gained fame in 1987 by his successful defense of Col. Oliver North in the Iran-Contra scandal, in part by subpoenaing President Ronald Reagan, two congressmen and records from three House committees. Puccio gained the acquittal of Claus von Bulow in the 1980s in his second trial for allegedly poisoning his wife. Other famous clients include former Bronx Democratic leader Stanley Friedman; heavyweight boxing champ Mike Tyson’s manager, Bill Cayton; and police brutality victim Abner Louima. ERSATZ EARNINGS While CUC began overstating its net income in the 1980s, the fraud began in earnest in 1996, when accountants inflated net income by $60 million, or 28 percent above actual earnings, for the year ending in January 1996. The following fiscal year another $56 million was artificially brought to the bottom line. And just prior to merging into HFC in December 1997, the annualized earnings for that year were inflated by $170 million. One method used was to deliberately underfund a reserve CUC was required to maintain to allow for customers who canceled or failed to pay for CUC’s Comp-U-Card membership services. The amount not funded as reserve was then reported as revenue. The company also used the old-fashioned way: accelerating recognition of revenues and deferring recognition of expenses. But the company also used excess funds that had been deliberately included in merger and acquisition reserves to increase operating income. The goal was to keep the stock up by reporting 25 percent increases in income growth for years. It worked. From the time CUC went public in 1989 until its merger with HFC, the stock climbed almost 2,000 percent. Cendant, now based in New York, has bounced back. It grosses more than $18 billion and nets more than $1 billion. But it had to pay $2.83 billion to settle the shareholders’ class action in late 1999. Coupled with the payout by accounting giant Ernst & Young, the total settlement was $3.17 billion — the biggest class action securities settlement in U.S. history. Shelton is scheduled to be sentenced by U.S. District Judge Alvin Thompson on March 24. If he does not make a deal to cooperate against Forbes, he could face a long prison term. The maximum on all counts is 40 years. Christie’s spokesman, Drewniak, says the office will not comment. Barry declines to comment, while Sullivan and Puccio did not return telephone calls.

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