In re Cendant Corp. Litigation

• Decision Date: 27 July 1999
• Docket Number: No. CIV.A. 98-1664.,CIV.A. 98-1664.
• Citation: 60 F.Supp.2d 354
• Parties: In re CENDANT CORPORATION LITIGATION.
• Court: U.S. District Court — District of New Jersey

60 F.Supp.2d 354

In re CENDANT CORPORATION LITIGATION.

No. CIV.A. 98-1664.

United States District Court, D. New Jersey.

July 27, 1999.

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Max Berger, Daniel L. Berger, Jeffrey N. Leibell, Gerald H. Silk, Bernstein Litowitz Berger & Grossmann LLP, New York City, Leonard Barrack, Jeffrey W. Golan, Leslie B. Molder, Barrack, Rodos & Bacine, Philadelphia, PA, Lead Counsel for Plaintiff Class.

Roger W. Kirby, Kirby McInerney & Squire, LLP, New York City, Lead Counsel for the Prides Class.

Herbert J. Stern, Stephen M. Greenberg, Joel M. Silverstein, Stern & Greenberg, Roseland, NJ, James G. Kreissman, Michael J. Chepiga, Jacob S. Putman, Lauren J. Rosenblum, Simpson Thacher & Bartlett, New York City, for HFS Defendants.

Steven S. Radin, Sills Cummis Zuckerman Radin Tichman Epstein & Gross, Newark, NJ, Greg A. Danilow, Timothy E. Hoeffner, Timothy A. Greensfelder, Well, Gotshal & Manges LLP, New York City, Dennis J. Block, Howard Hawkins, Cadwalader, Wickersham & Taft, New York City, for Christopher K. McLeod and the CUC Defendants.

Natalie M. Hiott-Levine, Dennis P. Orr, Scott T. Nonaka, Mayer, Brown & Platt, New York City, Caryn Jacobs, Alan N. Salpeter, Michele Odorizzi, Mayer, Brown & Platt, Chicago, IL, Kathryn A. Oberly, Robert G. Cohen, William P. Hammer, Jr., Ernst & Young LLP, New York City, for Defendant Ernst & Young LLP.

OPINION

WALLS, District Judge.

I. Introduction

This matter is before the Court on the motions of the HFS defendants, the CUC defendants, Christopher K. McLeod, and Ernst & Young to dismiss Lead Plaintiffs' complaint. With the exception of Ernst & Young's motion to dismiss the § 10(b) and Rule 10b-5 claims against it for stock purchases made after April 15, 1998, defendants' motions to dismiss the complaint are denied.

II. Background

Cendant Corporation ("Cendant") was formed by the merger of CUC International, Inc. ("CUC") and HFS Incorporated ("HFS") on December 17, 1997. CUC was the surviving corporation and it was renamed "Cendant" after the merger. Holders of HFS common stock were issued shares of CUC common stock pursuant to a Registration Statement dated August 28, 1997 ("Registration Statement") and a Joint Prospectus. (Am.Compl.¶ 33.) Because CUC was the surviving corporation, CUC shareholders did not exchange their stock as part of the merger.

On March 31, 1998, Cendant filed its Form 10-K Annual Report with the SEC including its 1997 financial statements. Two weeks later, after the close of the stock market on April 15, 1998, Cendant announced that it had discovered accounting irregularities in certain former CUC business units. As a result, it announced that it expected to restate its annual and quarterly financial statements for 1997 and possibly for earlier periods as well. The next day, Cendant's stock fell 47%, from $35 5/8 to $19 1/16 per share. Shareholder suits were then filed in this and other districts against Cendant, its officers and directors, and other parties including Ernst & Young LLP ("E & Y"). E & Y had acted as CUC's independent public accountant from 1983 through the formation of Cendant, and afterwards, audited the financial statements of Cendant Membership Services ("CMS"),¹ a wholly owned subsidiary of Cendant, for the year ended December 31, 1997. These financial statements of CMS were consolidated into Cendant's financial statements and included in Cendant's Form 10-K for the 1997 fiscal year, filed with the SEC. On July 14, 1998, Cendant announced that it would restate CUC's annual and quarterly financial statements for 1995 and 1996 as well as 1997. Following this announcement, Cendant's stock fell by another 9 % to $15 11/16 per share. Finally, on August 28, 1998, Cendant filed with the SEC a report prepared by Willkie Farr & Gallagher, the law firm it had engaged to perform an independent investigation, which disclosed, among other things, that Cendant would restate its 1995, 1996, and 1997 financial statements by approximately $500 million. Cendant's stock then fell by 11% to $11 5/8 on August 31, 1998, the first trading day after Cendant's disclosure of the financial report. Lead Plaintiffs allege that Cendant's market capitalization dropped from $30.4 billion before the April 15, 1998 disclosure to $9.9 billion on August 31, 1998, for a loss of $20.5 billion.

This Court consolidated all the shareholder suits against Cendant, with the exception of a shareholder derivative action, through a Consolidation Order dated May 29, 1998.² On September 8, 1998, this Court appointed the California Public Employees' Retirement System, the New York State Common Retirement Fund and the New York City Pension Funds ("the CalPERS group") collectively as the Lead Plaintiffs for all Cendant shareholders other than holders of Feline Prides derivative products ("Prides"). Welch & Forbes was selected as Lead Plaintiff for the Prides holders. The Court then conducted an auction to determine the lowest qualified bidders to represent the Cendant shareholders and the Prides holders as counsel. After the auction, the Court approved the Lead Plaintiffs' choice of counsel and appointed Kaufman Malchman Kirby & Squire, LLP³ as Lead Counsel for the Prides holders and Bernstein Litowitz Berger & Grossman LLP and Barrack, Rodos & Bacine as Lead Counsel for the remaining Cendant shareholders. (October 9, 1998 and October 13, 1998 Orders.)

Following the selection of lead plaintiff and approval of lead counsel, on December 14, 1998, the CalPERS group filed an amended and consolidated class action complaint on behalf of all persons and entities who purchased or acquired Cendant or CUC publicly traded securities, excluding Prides, during the period of May 31, 1995 through August 28, 1998 (the "class period"), and were injured thereby. Concurrently, the CalPERS group filed a motion for class certification which was granted by this Court on January 27, 1999. The complaint named as defendants Cendant, E & Y, and individual officers and directors of Cendant, CUC, and HFS. The complaint alleges that defendants Walter Forbes, E. Kirk Shelton, Christopher K. McLeod, Cosmo Corigliano, and Anne M. Pember were officers of CUC before the merger, reviewed or were aware of the false and misleading statements alleged in the complaint, and "were in a position to control or influence their contents or otherwise cause corrective or accurate disclosures to have been made." (Am. Compl.¶¶ 16-17.) The complaint asserts that the following defendants, together with defendants Walter Forbes, Shelton, and McLeod, were members of CUC's Board of Directors before the merger, signed the Registration Statement, and were named therein as directors of Cendant upon the completion of the merger: Burton C. Perfit, T. Barnes Donnelley, Stephen A. Greyser, Kenneth A. Williams, Barlett Burnap, Robert P. Rittereiser, and Stanley M. Rumbough, Jr. (Id. at ¶ 18.) All of the named officers of CUC are known collectively as the "CUC individual defendants." The following defendants, except Scott Forbes, were directors of HFS before the merger and were named in the Registration Statement, as directors of Cendant upon the completion of the merger: Henry R. Silverman, John D. Snodgrass, Michael P. Monaco, James E. Buckman, Scott E. Forbes, Steven P. Holmes, Robert D. Kunisch, Leonard S. Coleman, Christel DeHaan, Martin L. Edelman, Brian Mulroney, Robert E. Nederlander, Robert W. Pittman, E. John Rosenwald, Jr., Leonard Schutzman, and Robert F. Smith (collectively, the "HFS individual defendants"). Scott Forbes served as the Senior Vice President-Finance of HFS and then Cendant from August 24, 1993 to April 15, 1998, and has been the Executive Vice President and Chief Accounting Officer of Cendant since April 15, 1998.

Plaintiffs claim that defendants made several materially false and misleading statements during the class period. Plaintiffs allege that a number of CUC and Cendant's filings with the SEC from June, 1995 through April, 1998 were materially false and misleading as were their press releases from May 31, 1995 through June 2, 1998 in which they announced their quarterly and annual earnings. (Am. Compl.¶¶ 66-67.) These press releases and SEC filings, according to plaintiffs, contained or incorporated by reference Cendant and CUC financial statements that were not prepared in conformity with Generally Accepted Accounting Principles ("GAAP") and contained other assertions that were materially false and misleading. (Am.Compl.¶¶ 68-82.) In particular, plaintiffs allege that Cendant and CUC overstated their revenues, net income, and operating income for the 1995, 1996, and 1997 fiscal years through various improper accounting practices. These included manipulation of merger reserves (reserves created which consist of the anticipated future costs of a business combination), irregular revenue recognition practices, CUC's improper accounting for membership cancellations, as well as a number of other improper accounting practices by CUC and its subsidiaries including Comp-U-Card. (Am.Compl.¶¶ 71-78.)

In addition, plaintiffs assert that the August 28, 1997 Registration Statement and the Joint Proxy Statement/Prospectus were materially false and misleading because of the financial statements incorporated by reference therein, misrepresentations contained in the Merger Agreement which was an appendix to the Joint Proxy Statement/Prospectus, and misrepresentations regarding the "due diligence" conducted by HFS in connection with the merger. (Am.Compl.¶¶ 86-102.) Plaintiffs maintain that E & Y failed to audit CUC's annual reports for 1995, 1996, and 1997 in accordance with Generally Accepted Auditing Standards ("GAAS") and review standards established by the American Institute of Certified Public Accountants (the "AICPA"). (Am.Compl.¶ 7.) Plaintiffs claim that E & Y's misrepresentations included: its assertions in its certification that...